How to Analyze a Market for Real Estate Investing
If I had a nickel for every time I heard that the reason somebody hadn’t begun investing in real estate is that they couldn’t figure out how to analyze a market. …I would probably have a few more nickels to my name. I decided to write this article to explain how I would analyze a market if I was starting over. This is also how I will analyze potential markets as I choose to expand my operations going forward.
Whether you like it or not, as a military real estate investor you will most likely end up investing from a distance eventually. You could look at this as a disadvantage or like I do, an advantage. If you know you’ll have to invest in real estate long distance, then you can choose any market in the nation to invest in.
For many real estate investors, analyzing a market for real estate investing is not an easy feat. Many of these investors are over-thinking things though. This article will l help you get past these doubts and choose a market today so that you can finally move on to building your team!
There are two types of lenses that you should look through when analyzing a market. The first is macro, which means looking at the market as a whole compared to other markets. An example of this would be lining up the Honolulu market and comparing it (as a whole) to the San Diego market.
The second lens is micro factors, which we will get to later on.
The simplest place to begin this search is with a market you’re already familiar with. This could be any number of markets, and as a service member, you have likely seen multiple markets. I grew up in Little Rock, Arkansas, but have lived in San Diego, California; Kaneohe, Hawaii; Springfield, Missouri, among others. This has given me a huge advantage in choosing a real estate market and ultimately has allowed me to try different strategies in various markets.
Currently, all of my rental properties are in Missouri simply because that is where I was living when I first got into real estate. I figured it would be easier to learn how to invest locally and then continue long-distance REI once I got stationed elsewhere.
Now that I understand how to invest in real estate, I would gladly invest in any market that fits my style of investing…provided I am able to build the right team!
Think of locations where you have connections, enjoyed living, or would like to live/retire one day. If none of these markets work for you, then analyze other markets. It is always nice to invest somewhere familiar though because familiarity often equates to comfort, and you must be comfortable investing in whatever market you choose.
You should also look at where other people are investing. Whether you know them personally or not, if a market has a lot of active investors, it could be an indication of a good market. This is a double-edged sword though because too much competition will drive prices higher.
One of the most important market criteria for me is the price-to-rent ratio. This simple ratio can make or break a rental market for me. Simply put, this is the average rental income that properties will bring in (on average) per dollar it costs to purchase a home.
You have probably heard of the 1% rule for rental property investing before. That is exactly what the price-to-rent ratio is!
If you plan to invest in buy-and-hold real estate, it is important that you understand this simple metric. If you invest in a market where it is fairly easy to find 1% price-to-rent properties, it will be simple to build your portfolio.
On the other hand, if you invest in a market where it is extremely difficult to find a property that will break even from rental income, you need to have a lot of cash reserves for each property. I’m very hesitant to buy and hold any rental property that doesn’t cash flow. I want to know that I can hold onto this property through the next bubble, recession, virus, etc.
Growth vs. Stability
Do you want to invest in a growth market or a stable one?
I am going to use two markets I’m familiar with to explain this concept. San Diego, California, is a growth market. At the height of the market in June 2005, the median home price was $500K. By January 2009, the median home price had dropped to $280K. Recently, in Dec 2019, the median home price in San Diego reached $594K (source)! San Diego is a growth market, meaning there is a large swing between highs and lows, and appreciation can help you build wealth quickly.
Springfield, on the other hand, saw a small blip in the market during the last crash, and home values have stayed fairly linear in their rise/fall over the years. This is an example of a more stable market, meaning you will see much less appreciation, but the market value will not plummet as wildly during a recession.
The best way to determine which of these market types suits you best is to fall back on your REI niche. If you plan to flip homes and wholesale real estate, a growth market could be a great choice for you. If you plan to buy simple rental properties for the long haul in order to live off the cash flow, perhaps a stable market is better for you.
Another factor is your risk acceptance or aversion. If you are extremely risk-averse, I recommend looking for stable real estate markets so you don’t pull your hair out anytime a potential recession appears on the horizon.
If you are extremely risk-acceptant, perhaps you will enjoy the more volatile, higher appreciation markets. I must caution you though, always view appreciation as a bonus and not as a given. If you bank on appreciation, eventually you could get burned pretty badly.
Population growth is one of the most telling signs of a market. I like to see at least 1% of population growth annually for the last five or ten years. Obviously, the more the population grows, the more of a housing demand there will be.
I am wary of any market that has a declining population unless there is an easily recognizable and resolvable reason for it.
You can find this data by looking at Census data, local county data, or citydata.com. City-Data is the easiest place to gather all sorts of data on any market you’re analyzing. I highly recommend you check it out when comparing potential investment markets!
Is the economy growing? This always seemed like a no brainer to me, but especially after the economic downfall we saw in March 2020, it should be obvious how much of an effect the economy has on a market.
I like to see an increase in median income, an influx of new businesses, new types of businesses, and an overall growing economy.
If the economy dies in a city, you can be certain that it is only a matter of time before the population declines and market values dissolve.
The second piece of the economy you need to watch is diversity. Look at what happened to Detroit, where the economy relied heavily on the auto industry and not much else. Their market has been declining for a long time.
You want to know that your market is not too heavily reliant on one section of the economy. I like markets that have large health and education sectors. There will always be a need for hospitals and education. I love to see a growing tech industry, as well as a stable industrial sector. There are so many industries out there, and they all add/subtract from your economy differently.
Take some time to really dig into which industries are in your market and understand whether or not they are growing industries or dying ones.
The more diverse your economy is, the better!
Landlord Friendly > Tenant Friendly
This isn’t necessarily a deal-breaker for me, but you need to understand the landlord laws in your state. California is notoriously tenant-friendly, while my state of residence (Arkansas) favors their landlords a lot.
Understanding tenant and landlord laws will help you budget for eviction expenses and other issues that could arise. I definitely prefer landlord friendly states, but it isn’t necessary for me. There is always a way to buffer for bad tenants, and if I have to hold larger cash reserves for eviction issues to get into a great market, that is fine.
Without getting too political (that isn’t the intent of this statement), a simple way to determine a state’s landlord policy is to ask yourself if it is more liberal or conservative. More liberal states are (almost) always tenant-friendly, whereas conservative states are (almost) always more landlord-friendly.
These things seem to go fairly hand in hand, so understanding the political climate of your potential market is valuable as well. Even if a state is landlord friendly now, if they are becoming more liberal there is a chance these policies could change later on and vice versa.
The political piece of this is just food for thought. It is definitely wise to research landlord laws when choosing a market to invest in real estate.
You need to look at the crime rate from both a macro and micro perspective. On the macro level, I would be hesitant to invest anywhere that has an EXTREMELY high crime rate throughout the market.
The major thing I look for here is what kind of crime is highest, and then I like to try and understand if there is a reason for it. If a market has a very high rate of looting/robbery, this might be worrisome unless the market just had a hurricane pass through and it all occurred during this time.
My market appeared to have a very high murder rate a few years back. When I dug into it further, I realized there were 2-3 instances when multiple people were murdered. These 2-3 instances spiked the murder rate per capita, but realistically the number of instances was still very low.
This isn’t the biggest factor for me on a macro level. I do, however, generally refrain from investing anywhere I wouldn’t be okay living.
More on micro crime factors later!
The most important thing about choosing a market for real estate investing is that you must be comfortable with the market. It could be the best market in the world, but if you aren’t comfortable with it, you will not be able to pull the trigger on properties.
As you’re researching all of these macro factors, you need to ensure that you are comfortable. I don’t consider this negotiable.
Do not choose a market because other people are…choose it because you believe it is a good market.
Micro factors are those items that affect your real estate market locally. These are the factors that will help you hone in on which zip codes, neighborhoods, suburbs, etc., you want to focus on inside of your market. This is going to depend a lot on your specific investment strategy and where we are in the market cycle.
If you are wanting to BRRRR homes in parts of town that are becoming more gentrified, you will be purchasing in different areas than if you were purchasing A-class apartment complexes for student housing.
I believe crime rates are much more important on the micro-level than from the macro perspective we discussed previously. Every market has both great neighborhoods and less than ideal ones. It is your job to figure out which neighborhoods and zip codes have crime rates acceptable to you. There are several ways you can generally find this information in the form of crime heat maps. Worst case scenario, you can talk to the local police department or sheriff’s office.
Another great way to figure this out is to simply ask a few local property managers. Figure out which areas of town they would avoid, and then avoid them.
The reason you need to be familiar with your market is to take advantage of local amenities! Investing near a hospital, college, major employer, or social hotspot can be a great strategy. These areas bring consistent tenants and generally thrive in better areas of town.
I also love investing near downtown because you are near a lot of amenities, and gentrification is often going to occur. If you have an active downtown, it could be a great area to invest in!
Take time to learn where the social hangouts, large employers, colleges, and otherwise “nice” areas are. People will want to live in these places and are often willing to pay a premium to do so.
Ease of Commute
Another micro factor to consider when choosing a market for investing in real estate is the ease of commute. This could be anything from the walk score around employers or downtown to the amount of traffic people will face daily. A lot of people enjoy living outside of the city. This could be due to the lower cost of living, the ability to own more land, or just to be away from the hustle and bustle of the city.
Understanding commute times throughout your city is useful. Look into which neighborhoods afford these luxuries while still avoiding massive commute times.
This is not a major concern, but little micro factors like this matter to people.
If you are investing in single-family homes, there is a good chance you will be renting to families. One of the biggest factors people consider when renting or buying a home for their family is the school district. If you can find a neighborhood that meets all of the above factors AND is in a great school district, that is a huge win!
A less desirable school district isn’t necessarily a show stopper, but it can hinder your tenant pool for families. Just some food for thought.
How to Analyze a Market – TL;DR
Look at population trends, economic trends, economic diversity, landlord laws, crime rates, and other such data to evaluate which market you want to choose for real estate investing.
Then become very familiar with that market and learn which parts of town have the best employers, schools, social hotspots, and for lack of a better word “vibes.”
Throw a Dart!
If you take nothing else away from this article, please…listen to this!
Many, MANY investors take all of this information and narrow it down to a list of 5-10 real estate markets. They go cross-eyed trying to figure out which of these 5-10 markets is PERFECT.
You have managed to narrow down every potential market for real estate investing in the nation to less than ten…
JUST. PICK. ONE!!!
You’re telling me that out of every market in the nation, these five are the best. That means they are all awesome. You need to stop worrying about the minute details and pick one to get started.
Don’t get “deer in the headlights” syndrome now and freeze trying to determine the perfect market. Choose one and never look back. As your business grows, you can easily expand into one or two of these other markets. But for now, pick a market and begin building your team so that you can take action!
Learning how to analyze a market for real estate investing takes time, diligence, and planning. You need to understand what your investment strategy is in order to correctly choose a market that works for you.