We believe an investor can purchase a property in any submarket of any metropolitan area in the USA and win.
It’s possible to purchase a D-Class (think: crack den) apartment building in Detroit and make a boatload of money. However, few investors have the expertise in the D-Class space to deal with the challenges that come along with it. Also, they may have the headwinds of negative job growth and a decreasing population to contend with in that market. But it could be a home run if they bought the property at the right price and had a manager with expertise in dealing with difficult tenants.
It’s also possible to choose an A-Class (premium) apartment building in a high-growth market like Atlanta, Georgia, and lose. If the investor has overpaid for the building and/or the management doesn’t run it properly, then best of luck.
Our philosophy involves compounding as many “tailwinds” as possible by betting on a market most likely to experience appreciation and then buying properties with solid value-add potential. We don’t count on the appreciation to reach our goals. Still, if our market does experience appreciation, we will likely exceed our initial financial projections and the expectations of our investors.
So, how do we position ourselves strategically for the best likelihood of appreciation? We carefully study various industry research reports; then, we do our demographic studies on the markets that look the most promising to us. Finally, we choose target markets based on these studies.
Here are the top 5 criteria that we use in our market analysis.
1. Job Growth
Nearly all experienced commercial real estate investors will agree that the number one metric for stability and appreciation is projected job growth.
When the city administration has a pro-business outlook, they will be interested in attracting large businesses to the area and creating an entrepreneurial atmosphere for startups and family businesses to thrive. The city and state governments can create this atmosphere by keeping taxes low and creating a favorable regulatory environment.
With business growth comes job creation. Companies with a lot of high-paying, white-collar jobs create even more employment. Statistically, for every new high-paying tech or medical position, several lower-paying jobs will also be created as a byproduct.
Job growth, of course, most often leads to population growth for a metropolitan area, and implicitly leads to lower unemployment, which in turn leads to lower rates of poverty and crime. So, we focus heavily on job growth.
2. Crime
We can all recall stories from friends and acquaintances that relate to the horrible experience they have had as a landlord owning a rental house or two. It could be a tale about a meth addict who decided to set up a small production facility in the rental house, causing the landlord to pay for expensive remediation once the tenant had left.
Or it could be a story about a protracted, expensive eviction that cost several months’ rent, thousands in legal fees, and further thousands in repairs when the tenant applied an axe to the drywall and doors on the way out.
Stories such as these inspire us to seek neighborhoods with lower crime rates. A property in an area with high crime rates will have difficulty with rent growth and vacancy, and it will be challenging to attract and retain good tenants.
3. Industry Diversity
Another essential criterion for a target market is the diversity of the local industries. For instance, there may be a disproportionate number of high-paying jobs in a city that leans heavily upon the oil industry. But what happens if oil prices drop and the local economy tanks because oil is the main economic driver? People move away, vacancy rises, and rents can even decrease.
The same goes for a military town. Occasionally, a base will be closed, and if that base is the leading employer in the area, then times could get tricky for the property owners in town.
Ideally, we seek out a market where several industries are represented. It could be a mix of universities, healthcare, and technology, for instance. The point is, that it’s important to have more than one big employer in one’s target market.
4. Market Size
It’s better to own a commercial real estate asset in a larger market than in a smaller one. If you own a building in a small, isolated town like Casper, Wyoming, it will probably be more difficult to liquidate than a similar property in Denver, Colorado. A larger market will have a bigger pool of buyers so that disposition risk is lower. A more extensive metro will generally also have a better diversity of industries.
We like to target markets where the metropolitan population is above 250,000 people as a rule of thumb. It’s okay if the submarket is a suburb within striking distance of the city. A metro area with a population of 250,000 to 1 million is often called a Tier 3 market. Those cities with populations ranging from 1-5 million are called Tier 2 markets. We prefer those two market tiers as the growth tends to be more dynamic than that of the megacities, and they don’t have the industry volatility of the small Tier 4 or 5 markets.
5. Median Household Income
Generally speaking, areas with a higher median household income also correlate with lower crime and poverty rates. We would like to see a figure of at least $40,000 per year for our target market and submarket.
Not only that, but we also look at the change in household income for the past few years. If the trend is upward, that’s a good thing.
Conclusion
Careful market selection is one of the best ways to help ensure that an investment property will be a winner. Doing a thorough due diligence analysis on the market before purchasing properties in that area, we set ourselves up for higher potential asset appreciation through market rent increases.
We want to see a healthy, business-friendly environment that will promote employment growth in the region. Second, we need to choose a submarket with low levels of crime. Third, we closely examine the industry diversity in a market, especially regarding large employers. Fourth, we only consider metropolitan areas large enough to support high employment diversity and minimize disposition risk. Lastly, we prefer markets where the median household income meets our minimum criteria and is trending upward.
Are you interested in learning more about passive real estate investment? If so, please read some of our other articles. If you have any suggestions or questions, please don’t hesitate to contact us.
If you would like to explore the possibility of passive investment with us, please don’t hesitate to schedule a call with us today. It’s important to us to learn about potential investors’ goals and to form a relationship before offering any opportunities. Scheduling a 25-minute, no-pressure call is the best way to get started. If we are not a good fit, we will do our best to point you in the right direction.
Disclaimer: The opinions conveyed in this article are provided for educational purposes only and should not be interpreted as an offer to buy or sell any securities or to make or contemplate any investment.