Successful real estate investing relies on several factors, but “location, location, location” is top of the list. But “location” is a broad term, and evaluating the right place to invest your dollars means identifying the right markets both geographically and economically.
Some cities simply provide better opportunities than others based on factors like the relative cost of housing to average incomes, availability of good jobs, and demographic trends. At the local level, factors like the quality of schools, neighborhood safety, access to amenities like parks, shopping and entertainment and a host of other variables come into play.
Here are some guidelines to help you ask the right questions as you determine where to invest.
Start with your Goals
Are you investing for the long term or trying to achieve a shorter-term boost in value? Various markets throughout the country will produce more consistent cash flow per dollar invested, but the properties may not appreciate much. Other regions will exhibit strong trends for appreciation in value, but may not cash flow well due to the high costs of properties relative to rental rates.
This is why it is very important to know your investment goals and understand what it’s going to take to get there.
Investing Locally vs. Remote Markets
Many investors want to be able to see their investments or rely on their own expertise and local network to manage properties. If you live in a high cost city like San Francisco or Washington, DC, the real estate market can produce some positive opportunities, but only if you have significant capital to work with. In many cases, it may be better to evaluate other markets that fit your goals more cleanly.
When looking at a metro region, there are a wealth of statistics available to help you determine the overall viability of that market. Here are several categories of data to look into:
How many people live there?
Is the population expanding or contracting?
Is the economy diverse? A one company or one industry market can take a big hit if that one employer base goes through difficult times. A city with multiple economic drivers will be more stable and more likely to grow.
Are wages rising, falling or stagnant?
What is the unemployment rate?
Real Estate Factors
Once you find a market or couple of markets that look positive at the economic level, it makes sense to start looking at the general housing market in that area. Some of the questions to ask here include:
What is the ratio of owner occupied to rental properties? Areas with a higher percentage of renters will obviously create a bigger pool for you to choose from and more demand for quality rental units.
Rent-to-Value Ratios. A general rule is that monthly rents should be at least 1% of the property value. If you buy a property for $250K and can only rent it for $1,800/month, the likelihood that you will see positive cash flow if slim and you will be banking on appreciation.
Vacancy Rates and Time on Market. A property purchased at a bargain rate does you no good if you cannot find a renter. Evaluating trends in the number of vacant properties and average time to fill a vacant rental can be critical.
Housing Sales Statistics. Even if you are looking at a long term buy and hold, the ability to sell a property and receive a reasonable price is critical to your exit strategy. This can also be a solid indicator of the overall health of the real estate market. Look at trends in month’ supply of inventory, time on market, and asking vs sales prices.
Some markets are friendlier to real estate investors than others. If you take two individual properties with similar dynamics such as cost, condition and rental potential, you can see very different results based on things like taxes and whether landlord/tenancy laws are more or less favorable.
It really pays to understand the following factors:
Property tax rates
Property insurance rates
Municipal landlord taxes (an IRA or 401k may not be exempt from certain local taxes)
Local landlord/tenant laws – how easy is it to evict a tenant, for example.
Local Market Factors
In addition, you will want to look at things like neighborhood safety, quality of schools, access to transportation, proximity to shopping and recreation, and other factors that drive desirability.
Investing in real estate is not really that different than any other type of investment. You want to identify opportunities that present the maximum potential with the least risk possible.
Step 1 Population Growth
Use city-data.com to research the city’s population
Goal: Since the year 2000, has the city’s population gone up at least 20%
(Ex: Phoenix, Orlando, Las Vegas, Columbus Ohio)
Step 2 Income Growth
Use city-data.com or bestplaces.net to research the city’s income growth
Goal: 30% income growth since the year 2000. This implies that the city is keeping up with inflation. If it’s not keeping up with inflation, than you end up with high levels of delinquency especially in Class C properties.
Step 3 Median House Value
Use city-data.com to research the city’s median house or condo value
Goal: 40% increase in median house or condo value since the year 2000.
Step 4: Amount of Crime
Goal: Under 500 crimes in the previous year. You want to see that the number of crimes has come down over time.
If you apply these four principals, you will stay away from cities that will not flourish during an economic down turn. Next, you want to look into the neighborhood within that city.
Step 5: Neighborhood Household Income
Goal: Income needs to be between $40K-$70K
This is ideal in order to generate the cap rate necessary for a successful syndication and stay above the increase in delinquency marker. Under $40K household income is tied to increase in delinquency. Above $70K, the neighborhood demands a lower cap rate, therefore best for a REIT acquisition vs. a syndication.
Step 6: Neighborhood Poverty Level
Goal: Poverty Level below 20%
Never invest in a neighborhood where the poverty level is above 20%. Above the 20% mark, your unit churn expense will kill any and all profit.
Step 6: Neighborhood Unemployment Rate
Google unemployment rate for the city
Goal: Make sure that the neighborhood unemployment rate is not more than 2% higher than the city’s unemployment rate. If it is higher, than the moment a recession hits, the unemployment for that neighborhood is going to skyrocket.
Step 7: Neighborhood Demographic Diversity
Goal: You want there to be at least two demographic races of people that make up the neighborhood.
Note: You don’t buy for good times, you buy for bad times and always stress test every deal!