Investing In Washington DC Real Estate
Is investing in Washington DC real estate the right move for you?
Key points
- Housing demand is driven by the federal government, so investing in DC real estate can diversify your portfolio
- Look to invest at least $250-500K in equity
- DC real estate is exceptionally diverse, so local knowledge is essential.
Why DC Real Estate?
While stocks and bonds can be fine investments, real estate can also be an excellent addition to any portfolio. Real property is generally protected from inflation, able to produce rental income, and has significant diversification benefits
Investing in DC real estate, in particular, offers investors an unusual balance between desirability and affordability. Entry prices are still lower than NYC and San Francisco, yet desirability remains high thanks to steady demand from the US federal government.
Nowhere else in the world would loan a private investor a 30-year bond at less than 4% interest rate. Yet this happens all the time in the United States thanks to government backing.
What are the downsides?
Just as stocks can fall in value, real estate can also devalue in periods of economic stress. But DC is a special case. Demand from the federal government tends to be counter-cyclical. In other words, a market recession can cause more people to work in government, keeping housing demand high in times of economic stress.
DC saw a decline in home sales during the 2008 financial crisis, but by far less than the rest of the US.
The biggest problem with investing in DC real estate is actually the need for local knowledge. Different DC neighborhoods vary wildly due to the city’s history of segregation and inequality. According to the US Census Bureau, Washington DC has the highest wealth inequality of any state in the nation. Thankfully, the District has made great strides to equalize income. Yet, you still need to know the local market to make the right investment.
So where to start?
You need a local wealth manager
A wealth manager is a financial planner and asset manager rolled into one. It is their job to examine your portfolio as a whole and see how each investment fits in.
They have a distinct advantage over real estate agents: while a real estate agent can help you purchase a property, wealth managers can help you analyze the quality of a potential investment.
That’s why a wealth manager with good local DC knowledge can make a huge difference. Because when you’re making a large investment, even small changes can mean huge differences down the road.
Investing in DC real estate? A wealth manager you trust can make an enormous difference in picking the right investment.
You also need a good investment plan
Imagine building your portfolio without a master plan. It’s like building a house without a blueprint. You might want a fireplace, and so you start laying some brickwork. But then you decide that the walls should go a certain way, and you put in foundations elsewhere… but then what about the outdoor pool?
You’ll end up with a mess!
Yet many people forget to create a master plan before investing.
Like a well-planned construction project, make sure your investment portfolio has a well thought-out plan before you invest.
In this article, we explore how to invest in DC real estate. Firstly, we explore the three types of DC neighborhoods you should consider. Secondly, we will explore the four things to consider before buying real estate in Washington DC. Finally, we conclude by seeing how your DC real estate investment should fit in with the rest of your portfolio.
The three types of neighborhoods in DC
1. The well-established neighborhood
Washington DC has an unusually strict building code. By a special act of Congress, building heights are generally capped at 130ft and lower. In addition, much of downtown DC was zoned as historic districts in the 1950’s. These regulations place restrictions on how much a building’s exterior can be modified.
These two acts effectively limit the supply of new construction in much of downtown DC, keeping prices stable and high.
Pros of well-established neighborhoods
1. Stable prices
Investing in well-established neighborhoods is akin to investing in corporate bonds. Even though the value of well-established neighborhoods may go down, the value of these types of properties tends to hold up well even in times of recession. DC is a counter-cyclical market thanks to its high proportion of government workers.
2. High rental income
Unlike NYC or San Francisco, high-end DC real estate can actually generate good rental yields (also known as the property’s rate of return). You can aim for a rental yield of 5.0-7.0% for the right properties (versus 3.0-5.5% for NYC/SF). That means a $1 million property in DC should earn $50,000-70,000 per year in rent (or $4,167 – 5,833/month).
[Note: this is an unleveraged rate of return. Buying a property using a mortgage can raise your rate of return from 7.0% to 12.6% using a 3.8% 30-year mortgage with a 20% down payment]
3. High-quality tenants
Experienced real estate investors know the value of good tenants. Not only do good tenants pay on time, but they also keep the property in good repair. This becomes increasingly important for those who own multiple investment properties.
In addition, many high-end renters come to DC on work contracts that pay for housing. These can be a highly dependable source of cash flow.
Downsides of well-established neighborhoods
1. Lower price appreciation
Well-established neighborhoods have one major downside: price appreciation can be slower. Because prices are already quite high, affordability tends to be low for DC residents.
There is one exception: desirable neighborhoods with serious land constraints. Areas such as Capitol Hill have very little new housing supply, yet demand from government workers and diplomats remain high.
2. Longer investment duration
Prices in well-established neighborhoods tend to move slowly. Just like bond investing, investments here require long holding periods and a lot of patience.
3. Higher investment requirements
Properties in well-established neighborhoods also tend to be more expensive. Most investments will require jumbo mortgages, meaning you will need good credit to qualify.
Examples of well-established neighborhoods
- Southeast DC: Capitol Hill
- Northwest DC: Georgetown / Dupont Circle / Cleveland Park
- Central/Northern DC: Greater 14th St / Greater U St / Mt. Pleasant
Capitol Hill and others provide stable growth and income for conservative investors.
2. The up-and-coming neighborhood
For those looking for faster price appreciation, several neighborhoods in Washington DC have much better possibilities. These are the up-and-coming neighborhoods.
Up-and-coming neighborhoods have one thing in common: a newfound improvement in living desirability. The H-Street Corridor is an excellent example of an up-and-coming neighborhood that began its renaissance around 2004, reaching its peak around 2016-18.
Pros of up-and-coming neighborhoods
1. Higher price appreciation
Real estate in on the H-Street corridor quadrupled between 2004-2019. An investor who had bought a property with 20% down would have multiplied their investment more than ten times even before accounting for rental income.
Because DC is so land-constrained, the trend of neighborhood redevelopment should continue. Observant investors can profit by identifying up-and-coming neighborhoods before they get on others’ radar.
When looking at up-and-coming neighborhoods, you should look for areas that are not yet “discovered”. In particular, favor neighborhoods without a massive condo or rental projects in the works. Jumbo development projects are a sure sign the neighborhood is reaching a peak.
Frothy markets? Shaw and NoMa are two examples of up-and-coming neighborhoods that have up-and-left. Massive projects put hundreds of units on the market, driving down rents and cutting investment returns.
2. Lower investment costs
Properties in up-and-coming neighborhoods are priced in the $700K – $1 million range. There is a much lower cost of entry than in fully established DC neighborhoods such as Georgetown, where prices for single-family units run $800K – $1.3M.
Downsides of up-and-coming neighborhoods
1. Lower rental yields
Prices tend to outstrip rents in up-and-coming neighborhoods. That’s because current owners aren’t stupid: they know that if they don’t sell this year, they could get a higher price down the road.
This effectively drops the rental yield. Even though rental income is still the same, the denominator (the cost of investment) becomes larger. This means rental yields can be just 3.5-5.0% (compared to 5.0-7.0% in well-established neighborhoods). A $1 million investment may generate just $35,000 to $50,000/year ($2,916 – $4,167/month)
2. Higher price volatility
There’s no guarantee that prices will go up in these up-and-coming neighborhoods.
Brookland: for years, people believed that Brookland’s prime location on the Red Line would make it a highly desirable neighborhood. Yet retail development was hamstrung by the nearby Catholic University of America, effectively preventing a downtown nexus from forming
It’s not enough for up-and-coming neighborhoods in DC to have a good location. They need a catalyst too. Something that changes to make the neighborhood suddenly more desirable.
Examples of up-and-coming neighborhoods
- Northeast DC: Petworth / Park View / Michigan Park / Brookland / Takoma
- South and Southwest DC: Navy Yard / Waterfront District
- Alexandria: Del Ray / National Landing
- Silver Line Extension: Reston / Hattontown / Herndon
U-Street and other up-and-coming DC neighborhoods provide a greater potential for growth. But make sure you pick the right neighborhood that hasn’t already come and left.
3. The Yo-Yo Investment
So-called because of their yo-yo prices. These neighborhoods have significant potential, but also come with significant risks.
Many of these neighborhoods are either economically depressed or have fewer mass-transit options. That’s why these areas that fared the worst during the 2008-2009 financial crisis. Yet, thanks to DC housing demand growth, these regions also rebounded the strongest afterward.
Pros of yo-yo investments
1. High possibility for price appreciation
Taking on more risk also allows for greater rewards. Prices in Kingman Park, a neighborhood bordering the Anacostia River, saw median real estate prices more than double from $285K to $633K. The average DC property would have grown to just $463K.
2. Very high rental yields
For investors willing to stomach the risk, rental yields for yo-yo neighborhoods tend to be quite high. That’s because while rents may be cheaper, real estate prices are even lower. This decreases the denominator of the rental yield equation (rental income / price), driving rental yields higher. An investor should target a 7.0-9.0% rate of return, meaning a $1 million investment should yield $70,000 – $90,000 rental income per year (or $5,833 – $7,500/month)
3. More opportunities to generate super-normal returns
Many properties in yo-yo neighborhoods have opportunities for upgrades. Even though real estate prices range from $300-700K, be prepared to invest an additional $100,000 in repairs and enhancements.
- Convert from single-family to multi-family: the addition of multiple renters can increase rental income several times over.
- Improve an existing property: upgrading a lower-end property that has good subway access can help increase both rental income and the value of the house.
- New construction: replacing an older property with a newer project can help raise rents and land values
Don’t overlook Section 8 housing vouchers either. This is a program funded by the U.S. Department of Housing and Urban Development (HUD) to help low-income families find affordable housing. For those willing to deal with the paperwork, this is an excellent program to help attract more tenants.
Downsides of yo-yo investments
1. Greater price risk
Real estate prices in yo-yo neighborhoods tend to mirror stock prices. When times are good, prices go up. But when the economy falters, prices go down.
This means these investments offer less diversification from stock investments. These properties would have been unaffected by the 1999-2001 tech bubble, but prices suffered greatly during the 2008-2009 financial crisis. Demand from federal government workers tends to be lower in yo-yo neighborhoods.
2. Greater difficulty in finding good tenants
A sad but true economic fact in Washington DC: wealth and opportunity are poorly divided. Renters in yo-yo neighborhoods often have worse credit. If you want to invest in one of these neighborhoods, be prepared to do additional work in finding the right tenants.
Examples of yo-yo neighborhoods
- Southeast DC: Anacostia / Congress Heights / Douglass
- East DC: Benning / Capitol Heights
- Northeast DC and Maryland: Hyattsville / College Park / New Carrollton
Anacostia can provide excellent opportunities for multifamily home conversions, increasing your income stream from one renter to multiple.
4. [Bonus] The Suburban Neighborhood
As a side-note, the DC region also has a significant suburban neighborhood.
However, single-family homes in the $300-500K range tend to make poor investments. There’s little demand for renting out a 3-bedroom on the outskirts of town. Residents in Rockville, for example, tend to be long-term residents who bought a house for themselves and their families.
Examples of suburban neighborhoods
- Northern DC: Rockville / Wheaton-Glenmont / Forest Glen
- Western DC: Fairfax / Annandale
- Southern DC: Franconia / Mt Vernon
The four things you need to consider before buying DC real estate
Finally, we cover the special issues of investing in DC real estate.
1. Budget
You should invest more than $250,000.
To generate a reasonable return on investment, it’s usually better to buy in one of the three types of neighborhoods listed above.
- Well-established neighborhoods: 20% down on a $1.3 million townhouse + $70K renovations = $330K
- Up-and-coming neighborhoods: 20% down on a $900K townhouse + $120K conversion to make a separate basement unit = $300K
- Yo-yo neighborhoods: 25% down on a $600K detached house + $130K conversion to multifamily = $250K
2. Taxes
Be prepared for tax revaluations
In Washington DC, taxes are calculated by appraised value. But unlike most cities, DC appraised value will update after every sale. That means the moment you buy a house (regardless of its former tax-base), you must budget in a 0.85% tax rate the moment you transfer the deed.
But pay attention to tax deductions. Once you factor in DC tax credits and deductions, your overall tax rate should drop to roughly 0.5%.
3. HOA fees
Watch out for high HOA fees
If you’re buying in a condo, check the homeowner association fees first. Many condo developments in DC have a habit of charging very high HOA fees. And in the case of some luxury condos, these fees can eat up to 1/4 of income.
4. Local knowledge
Know the local quirks of the neighborhood
Washington DC is an extremely diverse city. This means each neighborhood operates very differently from one another.
Washington DC has the highest inequality in the US, as measured by the Gini coefficient.
There are no shortcuts in real estate investing, especially in Washington DC. Each property is unique, just as each neighborhood is unique. Make sure you do your homework and seek good advice.
Conclusion
Investing in DC real estate can be an excellent way to protect your wealth. Yet a $400K equity investment into a single property is no small amount.
That’s why it’s so important to make the right investment.
So if you’re not sure how to invest, it’s important to have the right advisor. Because real estate investments can take up a very large part of your net worth, you need to make sure that you’ve made the right choice.
At Jurnex Financial Advisors, we have the backing of Charles Schwab as our primary brokerage. Yet we retain our operational independence from any third party. This means you can have the confidence your money is safe with one of America’s best brokerages and still receive knowledge and advice from a local, independent firm.
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