Investing in real estate is tremendously exciting, and can be very lucrative. Out of 2,153 world billionaires in 2018, 10% hail from the real estate industry.
However, needless to say, real estate investing is not without risk. And even though the analysis of the property being purchased is important, deep understanding of the particular real estate market is not less crucial. (It may even be more so.)
One of my favorite quotes attributed to Warren Buffet is, “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” To adopt this quote to real estate language, I would replace “business” with “real estate market.” You can have the most beautiful real estate property on the planet, but if there’s no demand for it, or the quality of the tenant base is poor, you are in trouble.
On this note, let’s look at some things one should look at when choosing a market to invest:
1. Population And Population Growth
You want the market big enough that you always have a rather large pool of interested buyers and tenants. Corporations are also looking for more sizable cities to open their headquarters in so there is a large enough pool of potential employees. What’s large enough? A population of 200,000 people seems to be the magic minimum number most experts agree on. You also want to see population growth. Net population creates demand, so avoid areas where this is declining.
2. Job Growth And Unemployment Rate
Job growth is of tremendous importance. Ultimately, people move wherever the jobs are. To understand how strong job growth is in a particular area, you can compare it to the national one-year job growth rate (1.5% as of June 2019). For example, Orlando, Florida, has a job growth of 3.1% and Dallas-Fort Worth-Arlington’ job growth is 2.9% (as of May 2019). Job growth translates into demand for apartments and is a leading indicator of the condition of the rental market in the area.
3. Job Diversity
It is better to avoid cities with a large concentration of jobs in the same industry, especially if those jobs are in manufacturing or in cyclical industries (such as steel, coal, oil, etc.). Detroit and Pittsburgh (automotive and steel industry concentrations, respectively) are good examples of what can happen when the city has a substantial concentration in one industry. Pittsburgh and Detroit are still experiencing negative population growth resulting from the competitive pressures leading to the decline of the once-dominant industry. Manufacturing jobs are more vulnerable by nature and are prone to being outsourced. Instead, look for cities with more jobs in various service sectors: healthcare, finance, education, business services. Those tend to be more stable.
4. Median Household Income
Another important metric is median household income (MHH). Housing is the No. 1 expense for the majority of people, and MHH is the main driver that determines whether the existing demographic will have the ability to pay rent in the long run. For one perspective, we focus on Class B and C properties and generally look for a MHH of at least $40,000. It’s important to focus on a one-mile radius to understand the true demographics. Sometimes we see brokers’ marketing materials showing median household income “within a 10-minute drive.” This is not a relevant number. A 10-minute drive away, one could easily find a completely different tenant profile and area household income. When doing analysis, it is important to focus on the immediate surroundings — one to two miles is ideal. Try to understand where the median household income trend is heading as well: Has it been on the rise or declining in the last several years?
5. Crime
Understanding neighborhood crime rates can paint a picture of the demographics in the area. Usually, there tends to be a high correlation between crime rates and delinquency rates of the tenants living in the apartment complexes/rental housing. A simple web search of the property itself can reveal whether there were any serious crimes at the property or in the area recently. Many websites today also provide easily accessible recent crime statistics.
All of the criteria mentioned could be researched online; however, going to the market and seeing the area for yourself is very helpful. When looking at properties, we always start with the market analysis, and when touring potential acquisition targets, we drive around two or three miles in each direction to get a better feel for the market. You can draw conclusions about the market by looking at what kind of retail stores are located in the vicinity. Large retail companies and restaurants do a lot of research before committing themselves to opening new stores in the area, and as such, you can use this information to guesstimate the nearby demographics. As an example, if you see a Starbucks in the area, you can assume that there is enough affluent population in that neighborhood to allow the sufficient volume of customers for that Starbucks who are willing to pay $3-4 for a cup of coffee. On the other side, if you see a Dollar Store, you can expect a less affluent population living nearby.
When touring properties, be observant. See if the windows have bars on them indicating potential crime issues, what kind of cars you see in the parking lots and what conditions those cars are in, and how many of them are at the property (a full parking lot may indicate that the tenants do not work steadily).
Understanding the market you are investing in will make or break your investment success, and doing proper due diligence will mitigate a chance of costly mistakes.