In the previous article we discussed the demographics and macro-economic considerations you should review when qualifying a market for real estate investment. In this article we will dive deeper into the Regulatory Environment, The Local Real Estate Market and Sub-market.
See part one of this article here.
Landlord and tenant laws
As with all business, the regulatory environment is important to understand as this may help or hinder your business. In the case of owning rental property, it is preferable to be in a market where regulations are not overly favorable to tenants. For example, if you need to evict a non-paying tenant but because of the law you can not remove them for a year that will significantly impact your revenue.
Changes in leadership always brings in new policies that sometimes can be unpredictable. The local government may plan to pass regulation that impacts zoning, tenant landlord laws or other areas of your investment. You should investigate if there are any near-term plans for legislation that may impact your investment plans.
Real Estate Market
Apartment Supply and Demand
As an investor you will want opportunities to invest. If you are in a market that does not have enough of a good supply of apartments you will not have opportunities to purchase. You should also consider the demand from renters.
Are there more apartments than renters to fill the units? Are developers planning to continue building and create even more oversupply? While you want to have enough apartments that you have opportunities to purchase, there is a point where too many apartments may cause a decrease in rental rates as there is no demand for the units.
The Market Cycle
Similar to reviewing the supply and demand of units for renters you should also look at the overall supply and demand of investors. This can be identified by figuring out what part of the market cycle this market is in. If the market is in an expansion phase you will likely see great appreciation and it will be a good time acquire property.
If the market is in a recession then it would be a bad time to sell real estate; for those skilled in investing, this may be the best time to buy investment property. If the market is at its peak, then it may be a better time to be selling real estate. Understanding the market cycle will directly impact how you enter a market and your investing strategy.
Housing Value Changes
If houses are cheap in the area you are investing, then it may make more sense for a qualified tenant to purchase their own home rather than rent. The housing values provide a snapshot of how affluent an area may be and the potential market ceiling for rent increases.
These housing values also give you an indicator of what pricing expectations you should have for the acquisitions you plan to make (i.e. you would want your price per unit of acquisition to be less than the single family home sales as buying in bulk should give you a discount).
For the specific sub-market you are investing in, you want to keep in consideration all the previously mentioned items when investigating the sub-market level. A sub-market refers to the specific neighborhood within a city; for example, if your market was New York City then the neighborhood “Flatiron District” would be a potential sub-market.
While an overall market may check all the boxes it is possible that there are bad sub-markets within the market; you don’t want to accidentally choose to invest in the wrong sub-market. In addition to the previously mentioned factors you can also look at the following items:
Path of Progress
The path of progress refers to physical location and direction where change is being seen in a market, primarily positive change. This means new developments, amenities, increased incomes, job opportunities and more. Typically, these changes move in a linear geographic fashion. If you are able to identify markets on the outskirts of the path of progress this will allow you to buy properties at a discounted price compared to those in developed areas while enjoying much of benefits of the amenities and resident pool that can’t afford the more developed areas.
Understanding the tenant pool provides insight into what rents you can charge and if there will be demand and capacity to pay those rents. This will also inform you of the type of properties, amenities, unit mixes etc. that will be in demand. You can adjust your investment strategy to appropriately match that of the tenant pool to ensure you will have the largest number of potential applicants for your units.
Current Average Rents and Trends
The average amount of rent should be compared to the cost of a typical mortgage for a single-family house in the area. This will give you a quick indicator of the attractiveness of renting vs owning in the area. Further, you would also be able to use this metric as an indicator if your sub-market is in the path of progress.
Consistent upward rent growth that outpaces other areas is a good indicator that the location is in the path of progress. Another way this data point can help is assessing the price per unit of an acquisition. Similar to how single family investors would look at the ratio of rent compared to the cost of a single family home multifamily investors can do the same by breaking down the average rent compared to the price per unit of the acquisition.
Bringing It All Together
As you can see a lot goes into selecting a good real estate market to invest in. While there is much work to do in preparing to invest in a market you will be able to reap the benefits of this research once you start investing. If you pick a good market you will be able to grow and build your portfolio as that market grows.
The criteria that you should use to evaluate a real estate market to invest in are: