Anyone involved in the real estate investing business will tell you that location location location are the three most important factors for success with rental properties. Location refers to a whole lot of aspects including the country, the state, the city or town, and the neighborhood where you buy a property. Naturally, investing in a large city offers a landlord a very different experience from investing in a small town. In this article, we will look at the most important differences which you should keep in mind when deciding whether to buy an investment property in a major city or a small town.
1. Property Prices
The first step to investing in a rental property is buying the actual property. Thus, the first crucial difference which you will encounter in these two locations is the price that you need to pay for your rental. Generally speaking, real estate tends to sell for significantly more in large busy cities with above-average population growth and a strong labor market. Both homebuyers and real estate investors compete in these tough markets, pushing property prices up. Data from Mashvisor, a real estate data analytics company, shows that the median property price in such locations can reach really high levels. For example, the median value of current listings in San Francisco amounts to $1,694,600; while it is $1,102,300 in New York City; $1,045,700 in Los Angeles; and $880,500 in Boston. Other large cities have more reasonable real estate prices, like Nashville ($448,300), Chicago ($445,700), Las Vegas ($443,100), and Dallas ($409,500). Nevertheless, such prices are usually unaffordable for first-time investors who should consider buying rental property in a smaller town, where you can frequently find a good deal for less than $200,000.
2. Rental Rates
The second most important determinant of return on investment in real estate – besides the property price – is the rental income. Overall, large cities offer considerably higher rents because of the higher cost of living and the stronger demand from renters. For instance, based on Mashvisor’s calculations, the average rental income for long-term rental properties amounts to $4,550 in San Francisco; $3,370 in Los Angeles; $2,670 in New York; and $2,530 in Boston. Such rental rates provide opportunities for strong positive cash flow month after month and good return on investment, whether you look at the cap rate or the cash on cash return. However, beginner investors should not forget that this rental income comes with a high property price as well.
3. Price to Rent Ratio
The price to rent ratio is one of the most important measures in real estate – from the perspective of both renters and rental property investors. The price to rent ratio is calculated by dividing the average property price in a market by the average annual rent. A high price to rent ratio (21 and above) means that renting is more affordable than buying a home, while a low price to rent ratio (15 and below) signifies the opposite – that buying a home makes more financial sense than renting one. In general, investing in major cities is accompanied by a high price to rent ratios. For investors, this means that they can expect strong rental demand as buying a home is usually unaffordable, and renting is a smarter move from a purely financial point of view. Nevertheless, a high price to rent ratio is not purely good news (through demand) for an investor as it implies a compromise between the price and the rental income.
4. Competition from Other Investors
Many real estate investors – especially experienced ones – are attracted to major cities by the rental demand, population growth, and the unlimited opportunities for investments there. Meanwhile, smaller markets do not face such an influx of investors, which translates into less competition. This is a great thing for new real estate investors who are still learning the basics of buying, owning, and managing a rental property and could really benefit from a less tight, more relaxed environment. This is an important benefit of investing in small towns where the limited number of tenants is compensated for by a smaller number of landlords as well. Due to the lack of tough competition, investors in small markets don’t need to worry too much about offering better furniture and more services and appliances than other landlords in the neighborhood, which is a major concern for investors in busy locations with thousands of rental properties.
5. Running Expenses
Another number which factors in an investor’s return from rental properties is the ongoing monthly costs of owning and running an investment property. Maintaining, managing, and repairing real estate property costs much more in a large city than in a small town. The reason for this is the higher prices of both goods and services. What this means from an investor’s point of view is that a major part of the high rental income will go towards covering the costs of running the rental. Thus, at the end of the day, it is hard to draw a general conclusion about whether investing in large cities or small towns offers better cash flow. It all depends on the specific market and the particular investment property.
6. Return on Investment
Finally, we come to the factor of the highest importance for deciding whether you should buy a rental property in a major city or in a small town: the return you can expect. The cash on cash return and the cap rate are both affected by all indicators which we’ve discussed above including the property price, the recurring expenses, the rental rate, and the occupancy rate (determined by the price to rent ratio and the rental supply and demand). Consequently, it is impossible to conclude whether large cities or small towns provide the best return on investment in long-term rental properties, and this fact is confirmed by Mashvisor’s nationwide real estate market analysis. The average cash on cash return for traditional rental properties varies significantly in both large and small markets, depending on a wide range of factors. In fact, investors can find profitable opportunities in both locations, provided that they are able to afford the property prices. The key to making money with a rental property regardless of the location is to conduct careful investment property analysis which takes into consideration both the cost and the rental income as well as the occupancy rates to assure positive cash flow and high return on investment.
As you have seen, investing in large cities and small towns comes with many important differences, and which strategy you choose should depend on your budget, aspirations, and personal preferences. Regardless of which location you go for, don’t forget to analyze a few available properties to choose the one which will optimize your cash flow and return.
Daniela Andreevska is Marketing Director at Mashvisor, a real estate analytics tool that helps real estate investors quickly find traditional and Airbnb investment properties. A research process that’s usually 3 months now can take 15 minutes. We provide all the real estate information in easy to understand visualizations.