Real Estate Investing Basics

3 Important Factors When Considering A Market for Real Estate Investment

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factors when choosing a real estate market for investment

Between the rise of the internet and the availability of inexpensive airline travel, real estate investors are increasingly investing in markets outside of their own.  This is especially true when it comes to markets like Southern California where the price to rent ratios simply don’t make sense for real estate investors interested in cash flow.  As a result, many of these investors end up researching markets in other states to determine where to buy and hold real estate.

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Having worked with a number of out-of-state investors over the years, I have begun to formulate a list of the most import criteria to consider when investing in another market.  Understanding that most of the investors I work with are interested in cash flow as well as long-term growth, I would rank these 3 factors as the most important when considering a particular market:

Factors to Consider when Choosing a Market for Real Estate Investment

1.)    Employment and Job Growth. In my opinion, monthly cash flow is great, but I would only invest in a market if there is an opportunity for long term growth as well. Historically, the markets with steady appreciation and population growth do so as a result of strong job growth. I look for markets that have a friendly corporate environment, strong employment centers and data that indicates continued job creation in the years to come. This is typically a great indicator that the population will continue to increase, the demand for real estate will be strong and that prices will steadily rise as a result.

2.)    Price to Rent Ratio.  Some people call this statistic the “Gross Rent Multiplier” which is essentially just the price of a property divided be the gross income.  This is by no means a detailed analysis of a particular property, but a high-level approach to begin to understand a market by analyzing average price to rent ratios.

For example, if you were to look at a market in Southern California where a typical investment property would cost approximately $300,000 with rents around $1,500/mo, you would calculate the GRM to be around 200. Contrast this with a market like Atlanta, GA where an investment property could be purchased for $80,000 with rent of about $1,000/mo. The average GRM in Atlanta would look much stronger at 80 compared to 200 in Southern California.

 3.)    Legal Climate. Thirdly, I would want to invest in a market that was not unfriendly to landlords and investors. Every state and local municipality is going to have differences that relate to interpretation of contracts, time-frame for evictions, lawsuits against landlords, etc.  I think it is critically important to invest in jurisdictions that allow investors to evict tenants in a reasonable amount of time.  Putting yourself in a situation where a tenant could live rent free for a long period of time while you deal with a cumbersome legal process  is a quick way to an unprofitable investment.

Choosing a market and understanding the factors that should contribute to this decision is critically important for any investor. Whether you are considering an out-of-state investment or simply looking at different sub-markets in your city, it is imperative that you put in the time and do the research. The more knowledge you have before investing, the more likely your investment will be a profitable one.

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience...
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    Jim Pratt
    Replied over 8 years ago
    Spot on, I have learned this the hard way. Bought good property at great prices in a one horse town. Stagnation is not a good thing even with great cash flow, easy to buy hard to sell.
    Kevin Hughes
    Replied over 8 years ago
    I wholeheartedly agree with your criteria… after the past few years of markets in transition, how does one measure the above noted characteristics. At any given time, an individual market is shifting dramatically in one direction or the other. Facts gathered yesterday are often meaningless today even when trying to measure long term trends.
    Replied over 8 years ago
    Employment and job growth I think is the most important of the three. I think this one factor alone informs the other two. Thoughts?
    Ken Corsini
    Replied over 8 years ago
    I agree that this is a very important factor, but all 3 of these factors can be mutually exclusive. There have been those markets with incredible job growth where the price to rent ratios were too high for a buy/rent strategy.
    phil gainey
    Replied over 8 years ago
    I’d bet my bottom dollar that people who have made the most money “buying and holding” in the past, have done so through price appreciation. Price appreciation gleaned from natural supply and demand factors relevant to a particular area. Usually areas with low GRMs, like SoCal, Hawaii, NYC…etc. If you wait for down markets and pick up properties in these areas and can break even, you will be rewarded hansomely over the long term. And if you are lucking enough to live in areas like that, you don’t have to worry about problems that go along with investing out of area. Like property managers that neglect and mismange your property when you are 2000 miles away. You can drive your properties weekly to see how things are going. The general consensus is that, for most investors anyway, investing long distance is not a good idea. Most people who think it is, are those who are located in a given area, and make their living SELLING to people who live on the other side of the country!
    Replied over 8 years ago
    Phil, I would agree with you – Bubble markets that have experienced rapid appreciation at certain points in time have made a lot of people wealthy in the process. However, the flip side of that coin is the painful amount of equity that can be lost when those markets tank … or fail to recover. It really comes down to risk tolerance – if you are comfortable investing in a market with zero cash flow and the possibility of appreciation at some point in the future, more power to you.
    Ken Schaafsma
    Replied over 8 years ago
    Ken, Good article. A couple more considerations is if it is in a resort area and carrying costs. Where I live in Costa Rica, that means the popular tourist destinations like Jaco, Manuel Antonio, Tamarindo and occupancy levels are greatly affected by tourism which is affected by a number of variables. Tourists, retirees and second home owners make up a big part of our real estate market here (both sales and rentals). Further, carrying costs like insurance and taxes can play a big part of a buying decision. I suppose if you are comparing properties for rental in the same local area this wouldn’t be as much of a factor, but I know that taxes can vary by school district, neighborhood, etc. and if you are buying in areas with hurricanes or sink holes like in Florida or along the East Coast, insurance can be a big deal.
    harry hallows
    Replied over 8 years ago
    Ken, Great article. The only thing I would add is that your primary source of wealth building is going to be buying underperforming assets, allowing you to increase the value of the asset exponentially when you improve the property and reposition it in the market. All of your criteria will be essential to the success of that strategy.
    Replied almost 8 years ago
    Excellent article. I like the ratio of price:gross rent income. I have always wanted to invest but felt SoCal was just too expensive. I guess there are lots of short sales that could make it a better option but I don’t know. I am going to attend the OCInvestorsClub this month to see what others think. Originally, I am from Arkansas. There are lots of affordable homes there and maybe I should consider that before starting a portfolio in SoCal. My wife wants us to get our first home first though.
    Rudy Herrera
    Replied 10 months ago
    Great article! What are some of your favorite sources to gain data from Ken?