How To Select A Market
I was speaking to an investor the other day who wanted to narrow down her list of potential markets to buy investment properties in. She had a list of markets a mile long and was having a hard time narrowing the list down. Each city had its own list of reasons for why it would be a great market.
In some markets she had friends, or had lived there before and knew some of the neighborhoods. In some markets she had heard news stories about companies moving in or seen them listed on some of the many lists of “Best Cities” that one can find floating around on the internet. We talked for awhile and although she made some great points, there was no data to back up why these cities should be chosen over other cities. I shared with her my criteria for evaluating potential markets and I’ll share the same with you now. My approach to market analysis is five fold:
1. Population Growth - Population Growth is an important metric in analyzing a market. A city with a growing population is an indication of a healthy job market and a bright future (at least for a few years). An area with a declining population, especially an area that has seen a decline over several decades could have underlying issues that could affect the profitability of your investment. Every city or town has a certain number of homes and as people move away, supply and demand will affect the future resale of your property. I always look at population trends over several decades and look for markets that have seen a minimum of 20% population growth over the last 20 years.
2. Job Growth - Job Growth is a metric that cannot be overlooked. If residents don’t have jobs, they won’t be able to pay rent or buy homes. Areas with poor job growth tend to decline over time and this could affect your investment dramatically, especially if you are a buy and hold investor. Looking at job growth as a metric is two-fold. I always look at the job growth rate for the past 12 months and target markets with a job growth rate at or higher than the national average. In addition, I also look at the future job growth predictions to confirm that job growth is expected to continue.
3. Income Growth - Individual Income is the third metric I look to. This is often referred to as Median Household Income. This metric, like Job Growth, is two fold. The first piece of this metric is Median Household Income at the current moment. MHI needs to be high enough to support current rent or mortgage prices. A tenant or buyer may have a job, but if they don’t put enough in their pocket at the end of the month, they won’t be able to pay rent or their mortgage. This is a more difficult metric to lock down as it will vary based on geography and there is no one size fits all rule. $40,000 per year salary will go a lot farther in Des Moines, Iowa than in San Francisco, California. I always look at a ratio of average MHI to average housing prices. The average rent or mortgage in the area should be roughly 30-40% of MHI. Secondly, I looks at Income growth over time and target markets that have seen 30% Income Growth over the last 20 years.
4. House Value Growth - Housing Value Growth is an important metric for real estate investors because it will give you an indication of how housing has performed over time. You’ve likely heard the popular adage “Real Estate always increases in value”. This may be true on an extreme macro level, but there are plenty of markets in the United States where homes have actually decreased in value, or appreciated so slowly that their value has not matched inflation. I always look for markets where housing has increased in value by 40% or more in the last twenty years.
5. Crime Trend - Every city has it’s good and not-so-good neighborhoods, but the overall trend in crime is still an important metric to look at. In this metric, I don’t look at where the crime rate is today, this will vary city by city and direct comparisons are difficult. Rather I look at the overall trend in crime over many years. I always target markets where the trend line is down. Decreasing crime means a safer city where more people are likely to move, where businesses can thrive, and where your investments can be a blessing for you, not a curse.
6. Job Diversity - Job Diversity is an important factor to consider as it will affect the long term prospects of any market. Like many of my other metrics, this one is two fold. In looking at job diversity it’s important to check for two things
A) The market is not too heavily reliant on any single company or industry. Industries come and go as new technologies emerge. A market that relies heavily on a specific industry will not only be vulnerable in the long term should an industry lose its place in the market, but also in the short term as prices for goods or materials can go up and down dramatically. Companies can be the same way. If a factory or plant employs most of the workers in a city, town, or metro then the area is vulnerable if that factory or plant is shut down. Government installations like military bases tend to be more stable, but are not immune to this either.
B) The major industries employing an area are not ones that have an immediate threat to their long term viability. Examples of this could be manufacturing. A market that has a high number of its jobs in manufacturing, whether directly or indirectly could see trouble ahead.
There you have it! My six metrics for evaluating potential markets.
It’s important to remember that these are not hard and fast rules. There are exceptions to everything and these are just basic guidelines that I personally use to evaluate potential markets. The data gathered from answering these questions is just one part of a thorough market analysis. If you have any questions, feel free to leave a comment or contact me directly. Happy Investing!