“Location, location, location.” It’s a pretty familiar phrase when it comes to real estate and is just as applicable to a home buyer looking to purchase their primary residence as it is to a real estate investor looking to find good returns on a stable rental property. But although almost everyone has heard this phrase, what does this really mean when it comes to honing in on the criteria for a market that will be good for your investment property. Before getting to those individual criteria, I want to stress that before you get to the point of searching for a good market to invest in, it’s important that you spend some time educating yourself on the principles of real estate investing. Once you understand some of the basics of rental property investing it will make it much easier to evaluate and compare properties in different markets.
To start with, it’s always worth evaluating your own local market to see if properties there meet some of the criteria we are going to look at. Investing locally is logistically more straightforward; however, if the numbers don’t add up in your favor, it’s time to look beyond your backyard to find a market that will make the numbers work. It might require a little more effort to put systems in place to acquire and manage an out of town or out of state investment, but it can definitely be done. If you do need to look beyond your local market you might want to start by investigating cities that you have some previous or ongoing connection. For example, you could look into cities where you went to college or graduate school for a few years as you will have some basic familiarity with the neighborhoods and microeconomics of that city. Or perhaps there is a city that you periodically visit family or friends that might be worth looking at. If you can find a market in an area like this that you might be visiting regularly anyway, you have a few advantages there: a friend or family member could be your boots on the ground for items that you might need help with while owning a rental property in there and you might also be able to write off a portion of any visit there as a business expense when done properly. Whether you are able to find a city you have some connection to or not, you still will need to use the same criteria to analyze the underlying fundamentals of that city to make sure it is a good one for investment purposes. Let’s take a look at some of those criteria.
The U.S. is divided into approximately 388 metropolitan service areas (MSA) by the U.S. Office of Management and Budget (OMB) and used by the government for various statistical purposes. Each MSA is a contiguous area of high population density with usually 1 or sometimes 2 major cities with this urban core having substantial impact on the area as a whole. Things to evaluate in a MSA:
- Population – The current U.S. Census Bureau population counter shows the U.S. population to be 325 million and increasing at a net rate of 1 person every 12 seconds. Granted, this net increase includes both live births as well as net migration but it is undeniable that the population is growing with no end in sight and all of those people need a place to call home. What you want to do is position yourself to be in the markets that are attracting the population for various reasons such as preferable climate or more and better jobs. For a look at cities with high population growth take a look at these articles from USA Today and Forbes: https://www.usatoday.com/story/money/nation-now/2017/05/25/census-bureau-shows-fastest-growing-cities-u-s/344945001/ or https://www.forbes.com/sites/samanthasharf/2017/02/10/full-list-americas-fastest-growing-cities-2017/#994d1b33a36e
- Economy – You want to look for markets that have a diverse range of jobs in multiple sectors such as healthcare, government, education, technology, and manufacturing. If you end up in a market in which the stability of the economy relies too heavily on just one type of job or one employer, say manufacturing, if that type of job suffers job losses or that company goes out of business or moves their business to another city there can be significant effects on your tenant’s ability to pay rent if they no longer have a steady job and few job prospects in other industries. Other factors to evaluate in the strength of an economy and provided for any given MSA are GDP growth, household income, home prices and employee wages. All of these are factors that contribute to the health and stability of an economy.
- Employment rates – This is obviously important for making sure you are in a market that has a rental pool with a high percentage of employed workers. The average national unemployment rate is currently around 4.4%. Evaluating your target market in comparison to this number can help you determine if your market is doing better or worse than the country on average. You also want to look at whether this number is trending up or down.
- Rent growth – Rent growth trends are often correlated to job growth, but not only growth of the number of jobs but the quality of those jobs. Having high quality jobs means more stable employment and the ability to find tenants with good jobs. For more information on city specific rent rate growth check out https://www.apartmentlist.com/rentonomics/national-rent-data/.
- Business environment – Having a business favorable environment in terms of taxes and regulation can make it more likely for companies to bring and keep their business in a city which will subsequently attract a strong pool of employees which will be part of your potential tenant pool.
- Landlord tenant laws – When it comes to owning rental property, there are definitely some states that have significant tenant protection laws in place. Those states can create an environment where it is either more difficult or takes longer to evict tenants, even if they are in violation of their lease or property rules. This can impact your bottom line as an investor when it can take several months to go through the due process of evicting a tenant. Check out this link for more specifics on landlord friend states: http://www.rentersinsurance.com/2012/03/8-states-where-rental-laws-favor-landlords/ .
- Property taxes – The amount of property tax you pay on your investment property will also impact your bottom line as a direct expense, so all things being equal you might use this as a way to compare properties in different areas for investment performance. You can check with the county tax assessor’s office for tax rates or for more information on state specific tax rates take a look at this article: https://wallethub.com/edu/states-with-the-highest-and-lowest-property-taxes/11585/.
Once you have found a few markets to dig into from a macro level, you next want to evaluate some of the submarkets within that MSA. Renters prefer to live in areas with the same features as the primary residence homebuyer: safety, proximity to jobs, convenient amenities, and good schools. A few resources you can consult back to for a multitude of data on any given city are:
- City-Data (www.city-data.com) – This is practically a one stop shop for analysis of almost any possible piece of market/submarket analysis from population trends, employment information, historical weather information, crime, education, city financial status, and many more. There isn’t much that is not included on this site, so definitely one to keep handy.
- Sperlings Best Places (http://www.bestplaces.net/) – This site also covers the main areas of analysis. One additional feature it has is a “Compare Cities” analysis feature where you can do a side by side comparison of 2 cities at once which could be handy in trying to decide between a couple of different cities.
- National Association of Realtors (http://www.nar.realtor/) – This organization presents a lot of research on housing indicators and statistics in various reports that it periodically puts out.
- Realtor.com (www.realtor.com) – This site provides real estate market trends and current listings for both housing for purchase as well as for rent which can be helpful in getting local numbers for your projections.
- Area Vibes (http://www.areavibes.com/) – This is another site that gives a good overview of the major categories you should be evaluating in your market search. Each city is given a “livability score” factoring in all of the data they tabulate on each city.
- Great Schools (http://www.greatschools.org/) – You can search any school or area to find ratings and reviews for particular schools and also compare those to all other schools in a given area.
- U.S. Census Bureau (www.census.gov) – This site has a lot of demographic data including a live population counter giving you a visual of the increasing U.S. population on a moment by moment basis. Interesting data here for those that want to dig into demographics a bit more.
- Loopnet (http://www.loopnet.com/) – This site is primarily centered around commercial real estate, but it does have some interesting statistics and graphs in the resources section that review market trends in many major cities in each state.
In addition to these research tools, another good way to get feedback on a particular city or area is to jump on BiggerPockets (www.biggerpockets.com) and search the forums for discussions on a city or neighborhood that you are interested in. Almost always you will find an ongoing discussion about the rental potential of various areas. If you can’t find what you are looking for then start a thread of your own to inquire about an area. There is no shortage of other investors out there looking to contribute with feedback and advice so take advantage of the great resource that it is.
You’ll notice none of the criteria we looked at refer to choosing a market for the purpose of appreciation. If you utilize the discussed criteria to guide you in your market selection you will likely end up in a market that has a good or reasonable chance of appreciation, but that should be looked at as a side benefit, icing on the cake, to the main goal of finding a solid property in a stable market that produces reliable and consistent cash flow for you. To do otherwise is primarily speculating and not really investing. Good luck in your market search!