Invest in Real Estate: smaller or bigger towns?

A lot of readers have been asking me why I prefer to invest in smaller markets. Whenever there is news on the best towns or markets to invest, it is common that only big towns pop up. I typically get the same questions over and over again, so I decided to write a comprehensive post on the pros and cons of investing in real estate in smaller towns and how that compares to bigger towns.

I lived in some big cities up until this day: Frankfurt, Germany and Milano, Italy, to mention two. But I actually grew up in a small city in Portugal, close to Spain, with less than 50.000 inhabitants.  When I first started to consider investing in Real Estate (after the first decision, to invest in Portugal), I remember discussing with a friend over investing in rural and mid-to-small markets in mid-east Portugal vs going to the bigger cities, such as Lisbon and Porto.

When I meet other Portuguese real estate investors, their assumption is that I invest in Lisbon or Porto. In fact, I think that there is a very strong misconception in Portugal that only big cities are suited for real estate investing. I could not disagree more… let me go over the pros and cons to investing in small and big towns.

Pros/benefits of investing in real estate in small towns/rural areas

• Properties are usually significantly cheaper than in bigger towns.
  • This allows you to start investing sooner than later (as you don’t need as much cash).
  • Your risk is lower, in absolute amounts. Investing less money makes it a less risky investment.
  • Cash flow is, typically, bigger (although appreciation is typically lower).
• More often than not, competition is way lower.
  • I don’t mean proportionally lower. I mean lower even if you consider percentual terms. This is often because there is the misconception that small towns cannot generate great returns, so you’ll likely be competing with fewer people.
• Yields are typically higher, as acquisition prices are proportionally much lower and rents typically don’t decrease by the same order.
• The investments are typically safer because small markets are usually not exposed to the same speculation as bigger cities.
  • Smaller towns are usually not as likely to have huge spikes in influxes of population.
  • Rarely become a trendy touristic spot (unlike bigger cities).

Although these are great points, there are also downsides to investing in smaller towns, which I list below:

Cons/downsides of investing in real estate in small towns/rural areas

• Appreciation is usually lower than in bigger cities.
  • This is not a rule, though! For instance, Tampa, Florida grew in population, from 280.000 people in 1990 to 377.000 today while Detroit has decreased in population, from over a 1 million people to less than 700.000 nowadays!
• Even if the offer/demand ratio is proportionally similar to bigger towns, properties can take longer to rent out/sell because the absolute number of prospective tenants/buyers is much smaller.
  • Finding the right tenants may also take much longer!
    • People have usually jobs that don’t pay as well as in bigger cities.
    • The market is sometimes not receptive to more complex financing ways, or terms (e.g. co-signers).
• Higher exposure to specific industries or even companies. In small towns, more often than not, there are a handful of big employers for the entire population.
  • If that industry declines, you may experience many defaults.
• You may have a much harder time to find people to work on your real estate business. From the plumber to a good contractor: there will be much fewer of each.
• If you don’t like nearby and your portfolio doesn’t have enough volume yet to employ people, you may drive around more often, for showings, than in bigger cities.
  • Of course that if you live there, it will be even easier!
• Forget about anonymity.
  • In small towns, the rumors and news seem to move lightning speed.
  • This can also play to your favor as it may help you to get tenants – and build a brand – faster!

In my opinion, small towns can be a great place to invest in real estate. In fact, most of my real estate portfolio is exposed to small towns. Below, I will go over the various pros and cons that I listed above, providing more details about them.

Cheaper properties

The average price of my properties is about €30,000. The first property I bought was purchased with savings from my childhood and the liquidation of a stock portfolio I had bought then. Although I bought the second property with a mortgage, I had saved enough money by living and working in Germany for about 3 years. This tells you how disproportional the price of my properties and my income was. I bet it is difficult to buy real estate in any part of the world with savings from 3 years of work.

Of course that all the properties I bought needed massive renovation, as I also think that this is the best way to create value, but if I were to invest in bigger markets in Portugal, such as Lisbon and Porto, I would pay 4-10x per square meter. Yet, the rent would only be about 2-4x higher, if that much. This also allowed me to start investing in Real Estate quite early in the game. This has also helped me tremendously with increasing my rental income, thus putting me in a better position to negotiate with the bank.

Competition

Given that most real estate investors I know believe that there is only money to be made in the bigger cities, I end up not having a lot of competition. This actually gives me a very nice edge: I actually wait a lot before I buy real estate. By letting the properties sit on the market for a big while, I can actually use that as an argument to present an offer way lower than the listing price, while the owners also increase their willingness to sell. This has proven to be a very effective MO for me.

In bigger markets, we actually end up making higher offers, as we have the pressure of other investors’ offers. This can be quite of a disadvantage. Another great advantage of lower competition are margins, which increase the yields. This applies both to buy and hold and fix and flip.

Yields

My real estate portfolio returns are quite nice. For instance, my third rental property yields about 20% on the total investment, and a much higher sum if we consider cash on cash, as I leveraged to buy it. This is much nicer than anything I would be able to reach through the stock market, I believe. However, the most important point is that these yields are certainly way higher than the yields I could get in bigger markets, such as Lisbon.

The yields are related to competition, as I say above, but a number of other things. If you buy the property at a higher discount, even with normalized rents we will obtain better yields. My strategy is to have above-average properties at below-average prices, and even in this case my yields are pretty juicy!

How safe are the investments?

Right now, Lisbon is one of the sexiest cities in Europe. Every year, it attracts a multitude of people, mostly because of the conflict in North Africa and the saturation of other European cities. Plus, in a matter of 4 years, the city has managed to multiply by 8 the number of hostels and hotels. This is truly remarkable.

However, I do believe that this trend will soon stop. Other cities will become more prominent and the conflicts in Africa will end. These cities (in Poland, Bulgaria, Croatia, etc) will be cheaper than Lisbon, and because they haven’t been accessible to everyone in the last 20 years or so, they will attract a lot of tourists, I assume. What generated a huge appreciation of real estate may be responsible for a huge correction.

Smaller towns tend to be much more controlled markets. They are not exposed to huge spikes in tourism or change of airline routes. They don’t have an airport to start with! As a result, the number of jobs therein doesn’t really grow that much, which means that not many new people come. Yet, many locals tend to stay around. Today, with the amount of business that is done over the internet, we can afford to live in smaller towns and work for the world. I truly believe this will be crucial to maintaining populations in smaller regions, as they create their own jobs.

Although investing in smaller towns can be safer, in terms of volatility, we should also expect lower appreciation. I am personally OK with that, but we all are different as investors and this has to be taken into account.

Knowing the market inside out

What is it easier to fully understand? A small market, or a big one? The small one, of course. In fact, big markets like those in bigger towns actually tend to be made out of small markets, where every market is different from the other one. This can be a pain in the neck! If a real estate agent calls me up and tells me “I’ve got a property for $30.000” I will only know whether that is a good deal if it is a rural area or a small town, like those I invest in. In Lisbon, that could be a bargain or a very expensive deal.

Bigger towns have bigger market complexities. This, whether you admit it or not, is a big disadvantage. Not only you need more time to assess deals as the change to make a mistake is also higher. In fact, finding rentals in small towns is way easier! I know most agents around (at least those in the market for more than 6 months). They know me, as there are also not that many investors. I get to know of deals quite fast and I can find better deals way faster than if I were in a bigger town. So, add that one to the list: finding good real estate deals in small or rural areas is way easier!

This is really the key to finding good deals in small towns and rural markets: get along with the agents and let me know you are buying. Because the market is small, you’ll be presented deals really fast.

Building a brand – the rumor can work to your advantage

If you read my post on tricks to set up a real estate business, you should instantly know where I am going with this. I actually come up with a really nice plan to promote a brand in the markets I invest. I will order some signs (just like hotel signs) and stick them to my buildings. Together with the facebook pages I created to promote my real estate, I hope this will help to move a brand. Doing this in a bigger town would be considerably more difficult unless you had a much bigger number of units.

I’ve had many calls from friends of my tenants, who wanted to know “whether I had homes to available”. At some point, my tenants were working for me, beyond paying me every month. This would also work in big towns, but it is highly unlikely it would work as well as in a small town. In fact, I think that if you are able to build a brand in some small town or rural area, you’d be much more successful in continuing that brand in a bigger town.

While building a brand is important – although merely a business accomplishment – your impact will also be bigger. I am particularly happy to help and contribute to the renovation of the look of the city. I find it particularly appealing to buy a property with a distressed facade and renovate it. Plus, 1 in a million won’t be noticed – 1 in 1000 will!

Fewer tenants to choose from…

I like to have really awesome tenants. First, I like tenants with large salaries. Second, I typically ask for co-signers (who are responsible for paying the rent if my tenants default). In smaller towns – let us be realistic – this is harder to get because there are fewer tenants to choose from!

Not only this can mean fewer tenants to choose from, it can also mean more time to get the property rented out. Fortunately, my properties have almost 0% vacancy rates, even if I invest in small towns.

Are you an appreciation guy?

I follow a free cash flow model when I invest. Put simply, this means that I focus on getting my money back as fast as possible (e.g. through monthly payments, such as with real estate) and I focus on high cash flow/yields, and I don’t look much at appreciation. In a rural setting, this is perfect because yields are high. However, if I were looking for high appreciation perhaps real estate in rural areas is not the kind of deals you should be looking for unless you expect a huge influx of people.

I also tend to think, based on my experience, that buy and hold works much better than wholesaling of fix-and-flip, when it comes to rural areas or small towns. My strategy is primarily buy-and-hold, although I have done flipping deals in a small town, but only because I knew there were many buyers for more money than what I paid for the property.

What about contractors, property managers and what not?

In smaller towns, from my experience, finding good contractors can be very hard. I actually know a few, but they are always overloaded with work. Unless you have yourself covered in this regard, it can be tough to maintain a large real estate business, due to the lack of people to work in this field.

As for property managers, I actually believe it is easier to find improvised property managers but harder to find professional ones. I personally get by just fine with improvised property managers, because they solve my needs and don’t cost me much money. However, if you need a professional property manager (I will assume you have enough volume to demand that) you’ll probably have to train one…

The same goes for other services you may need to keep your real estate business going.

Conclusion: should I invest in rural areas and small towns?

Rural areas and small towns are, in my opinion, very attractive to invest in real estate. I have personally invested in rural areas and small towns with tons of success, having many apartments for rent in small towns of Portugal.

However, there are challenges inherent to these areas and they are very specific characteristics to these markets. Therefore, if you are thinking about investing in a rural market or a small town (over a big one), it is very important that you take an educated decision. Plus, this can really be the difference between the type of business you will set up. As I said above, setting up a business in a big town or a small town / rural area can have fundamental changes at its core, which may or may not suit your investing profile.

The biggest disadvantages I can identify in these markets include being difficult to sell real estate in rural areas if you are a fix-and-flip investor. In my opinion, the best investment in rural areas is buy-and-hold.

Let me know down below if you invest in rural areas or small towns.