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I am often asked what my real estate acquisition team looks for when we obtain investment properties for our funds. It’s a complicated formula that takes into account a dizzying number of variables, including alignment of the specific fund’s strategy and objectives, the real estate cycle and the realities of current market demands. But the common thread that binds all our acquisitions is what I like to call the “Big Three.” These three location metrics inform every single acquisition I make, and are in my view the foundation of a successful real estate investment. So what are they, and why do they matter?
Demand Generators
Demand generators are factors that determine the local need for your investment property. It is essentially the presence of businesses, employers, transit, schools and attractions in the area that generate the consumers your property is intended to serve. Identifying demand generators is important — the absence of a thriving commercial center, for example, could indicate job scarcity. Without employment, there’s little to support the local economy. And if the local economy is weak, the population relocates in search of opportunity, and the demand for local real estate falls. Therefore, understanding access and proximity to your demand generators is vital to choosing a location for a successful real estate investment.
To peel back the onion even more, as with any product, it’s critical know your customers. Being familiar with local demand generators can be useful in pinpointing factors that influence prospective tenants and future buyers. Smart investors should not only consider current demand generators in assessing cash flow potential but also what that pool looks like years down the road to estimate appreciation at resale. This data then informs decisions on whether to purchase properties in a specific location and at what price point, as well as how much capital to put into renovations and when those improvements are made.
Supply Indicators
As part of every due diligence effort on new markets, identify the direct competition based on the three Ps: price, product and proximity. When considering a specific property type for investment, gauge the existing demand for that property type and then take into account future developments that could over-saturate supply. These attributes impact a market’s current and future vacancy rates, which are key components in forecasting investment performance. For commercial real estate investments, I consider healthy vacancy rates typically less than 5% for multifamily, 8-12% for office and 5-10% for retail. When evaluating a specific location for investment opportunities, make benchmarking comparisons for a specific property type, but look at all three commercial metrics as indicators of a local real estate market’s overall economic health.
Most cities or chambers of commerce will publish useful data points, and various real estate databases will have transaction details that will inform supply and demand metrics. Keep an eye out for articles from local news outlets highlighting economic trends and future developments. Don’t overlook these resources when performing a market study — they are invaluable in analyzing financial feasibility for an investment and can be instrumental in determining whether to pursue the acquisition.
Market Comparables
The final metric that makes up the “Big Three” is comps, or the comparable lease rates and sales prices from the past three to six months. Comps are important because they indicate how much revenue you will be able to generate from the investment and whether a certain location is crowded with too much supply. When evaluating real estate comps, it’s essential to recognize that different regions, even sections of a city on a street-by-street level, can have very different lease rates and sales prices. These metrics should be carefully researched to filter for property type and to benchmark the specific location.
While comparing price per square feet can be helpful, the best comparisons for benchmarking and determining investment revenue will also take into account the age of the property, the use and unit mix, and structural and cosmetic upgrades.
The “Big Three” should be a critical part of the initial evaluation in determining where you make your real estate investments. Always make sure that the results are appropriate for your individual investment goals. It is crucial to establish a solid framework to organize what otherwise could be a chaotic, overwhelming process.