Why The California Market Is Special

California is a unique place to be investing in real estate. In fact, it comprises a whole slew of unique places, each of which has its own special features.

For instance, the rental market in the Inland Empire region is characterized by relatively new, spacious, and high-quality housing that’s positioned solidly mid-market, but it can sometimes be difficult to find new tenants.

In contrast, the Berkeley area’s rental market is downmarket, stocked with high-mileage units and in constantly high demand from students and similar types of tenants. And that’s not even considering super dynamic markets like the Bay Area, where older properties will still win sky-high rents and moneyed tenants are plentiful.

Though it’s impossible to fully characterize all of the different sub-markets that may be of interest to you when looking for rental property to buy in California, I find that it’s helpful to have a few very general rules of thumb about the state’s rental market dynamics.

Specifically, here are a few things you should be aware of:

• Coastal areas tend to support higher rents than elsewhere, with the exceptions being in the ritzy inland mountain towns.
• Desert areas tend to be difficult to compete in due to surplus housing and low levels of turnover of properties and tenants.
• Expect high housing quality and the ability to charge high rents in most suburban areas.
• The profitability of leasing out rentals in urban regions outside of the Bay Area and Los Angeles is often constrained by the relatively low rents that tenants can afford.
• Rural areas in the central valleys can often be as lucrative as the suburban areas or even urban valley areas.
• Rich rural areas tend to have very little housing stock dedicated to rentals as well as very few aspiring renters.

I would also caution investors that maintenance expenses will vary dramatically across the state. As in my example about my investments in Indio, harsh desert environments end up costing significantly more for HVAC maintenance due to high temperatures and the constant accumulation of gritty dust. The flip side is that properties in the temperate central valley or in areas like San Diego will have ideal weather conditions year-round, meaning your costs could be much lower.

If you’re a skilled real estate investor, you can probably make your business work effectively in most of the state’s regions—as long as you’re willing to adapt your strategy to the market. For new investors, it does make sense to devote some time to picking an especially favorable market where the conditions are ripe for growing your business rapidly.

Location

The location of your rental unit within its market is key.

Location determines the property’s distance to places of employment, not to mention the tenant’s access to education, entertainment, and everything else that’s necessary to survive and thrive. So, a unit’s location also factors heavily into how much you can charge for rent, what kind of tenants you should reasonably expect to be interested in renting, and how easy they will be to come by.

When you’re just getting your business off the runway, I think it’s a good idea to look for properties with slightly less than ideal locations within the context of the municipality you’re in. If you’re competing in a market like Bakesfield or Fresno, for example, check the city’s periphery rather than downtown or in up-and-coming neighborhoods. Doing so will prevent you from paying an excessive premium to purchase units in highly sought-after locations, and it will force you to find profitable opportunities where others aren’t likely to be looking.

In general, I also suggest that you avoid scanning for rentals to buy in industrial-adjacent areas. Their prices tend to be low, but few people are interested in living near active industrial work.

Structural Considerations And Renovation Opportunities

A property’s structure and its divisions between units are major considerations when buying rentals in California, or anywhere else.

Apartment buildings are the easiest way to understand why effective partitioning is good for your bottom line. Each unit is self-contained, easy to plan for, and relatively easy to maintain as a result of its similarity with other units in the building. Pricing individual units is a walk in the park, and buying them is largely a matter of valuing the property at the right multiple of its annual recurring rental income.

In contrast, single or multi-family homes are far more complex to value, purchase, set rent for, and maintain. But they’re also where you can add the most value by performing renovations that re-partition or heavily update the layout.

If you buy the right single-family house, you could easily turn it into one rental unit with enough space for four or five tenants co-living and managing the cycling of subletters for you. Or you could turn it into two or three separate units and manage the property more actively by updating your prices as tenants cycle in and out.

The choice is yours, depending on what your business is capable of doing and what the situation is in the local market.

Expected Tenants

You can pick the property you want to buy, and you should also pick your tenants very carefully.

Of course, you can’t know which kinds of tenants will be interested in renting from you while you’re still figuring out which places to buy. Still, you can get a good feel for the average type and quality of tenants in your market and then use that information to inform your decision.

In wealthier areas, you’ll obviously get wealthier tenants if your rental unit is located, amenitized, and priced accordingly. But don’t confuse the wealth of the average expected tenants in an area as a proxy for quality! Tenants typically have expectations for service that are in line with the price point they are paying for.

If you know that a particular rental unit will be perfect for upmarket tenants, you should expect to put more work into it to stay competitive with similar units. On the other hand, downmarket properties can sometimes be overpriced relative to their lower level of amenities and maintenance.

In the best conditions, a property will fulfill the requirements of its most likely tenants without any additional investment on your part. A good proxy for this sweet spot is a long history of occupancy by several different tenants.

Does It Fit Your Business?

The most important thing to think about when you’re looking to purchase rental property in California is if the property is a good fit for your business. It’s a huge question, and it’s one that you’ll be returning to again and again throughout your real estate investing career.

If you’re not sure how to answer it, consider answering these questions first:

• Will any existing tenants require significant attention on an ongoing basis?
• Can you purchase the property without incurring excessive financing costs?
• Can you easily find fresh tenants yourself, or will you need outside help?
• Which maintenance resources will be regularly needed to serve tenants’ needs?
• What renovations or repairs will be useful or necessary before finding a tenant
• What ongoing costs would the purchase introduce?
• Does the purchase introduce any new tax implications that will require special handling to address?
• What will additional rental income enable you to do that you can’t currently do?

If by chance you end up buying a rental property that doesn’t fit your business very well, you’ll likely have a much thinner profit margin than you’d prefer. And you’ll probably end up spending far more time and money attending to the new unit than you initially planned for, which could adversely affect your business elsewhere.

Beyond all that, the surest sign that a rental doesn’t fit your business is repeated frustration. Think carefully about what you’ll need to do to operate a property at a profit before you pull the trigger.