Real Estate News & Commentary

Vital Market Characteristics for Successful Long Term Investing (and What to Do in Their Absence)

Expertise: Personal Finance, Landlording & Rental Properties, Personal Development, Real Estate Investing Basics
38 Articles Written
Market

The best real estate investing strategy for regular investors I outlined a few weeks back can produce some outstanding results. When it’s executed with discipline without sacrificing its high asset quality standards, an investor can acquire and methodically pay off a portfolio of real estate assets over 10-15 years. In so doing, they could quadruple their capital base and draw a six figure income before taxes at retirement.

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

But as impressive as those numbers are, there is a catch: this strategy is not “one size fits all” and it is not applicable in all markets.

In fact, a common response I get from readers is that as enticing as it sounds, it just isn’t possible in the market where they reside. The reasons are many. In many of these markets, prices are from Mars, rents are from Venus. In others, prices are low but the wounds of the recession are still bleeding the local economy dry in high unemployment and poverty. And finally, in others – Landlords are viewed and treated as evil tyrants sucking the blood of their tenants (I’m paraphrasing).

So then, two main questions arise:

  1. What market characteristics are vital for the successful implementation of a long term investing strategy?
  2. What to do if your market doesn’t offer those characteristics?

Market Characteristics – Macro

First, we have to take a careful look at market characteristics at the macro level. How does your state fare in terms of job creation, population growth, unemployment rate and economic diversification? These make up the economic foundation on which to build a healthy long term portfolio. (One note of caution here: The potential for appreciation is never a substitute for good fundamentals.)

The local economy’s ability to create jobs impacts your prospective tenants’ ability to find and keep a good paying job which in turn allows them to make rent payments on time.

Population patterns and unemployment rates are further macro indicators of the local economy’s strength. You want to look at this data against the backdrop of national numbers to see if your state is performing better or worse and why.

Last but not least, Houston in the 1980s and Detroit in 2008 are proof positive that one trick pony economies don’t fare very well in downturns. Houston learnt a painful lesson from that period and diversified its economy well to have a more balanced approach that’s serving us well these days. Detroit has made upward strides from the depths of the abyss but most of their recovery has come as a result of the improved situation of the Big 3. Things are definitely better than what they were but they’re far from being properly diversified.

Market Characteristics – Real Estate

The second aspect we want to take into consideration are real estate market characteristics. We have to take a close look at price/rent ratios, operating expenses as a percentage of incoming rent, vacancy rates and the availability of recently built properties in high quality locations.

In 2012, the second and third states that created the most jobs were California and New York. The same two states that sport some of the highest price to rent ratios in the country. So it’s not sufficient that the macro picture works – the numbers must work as well. As a general rule of thumb, any market with a price to rent ratio over 10 will make it impossible for positive cashflow to materialize with few exceptions.

Another concern is the percentage of incoming rent “eaten” by operating expenses (property taxes, insurance, association dues etc). Some states have much higher property taxes and home insurance rates than others. In general, any scenario where operating costs exceed 40% of incoming rents will be devoid of cashflow unless a huge down payment is made.

What about vacancy rates? It’s important to have the correct expectation of how much money will be consumed by vacancy in any particular year. You want to invest in markets where average vacancy rates are low because that indicates healthy tenant demand.

Last, we must assess the availability of reasonably priced, recently built properties that cashflow in our local market. In this respect, some investors are done in by high prices, others by primarily old properties.

But as important as any of these macroeconomic and real estate market characteristics are on their own, it’s how they work in combination that really makes the difference. It’s not enough that your market offers favorable conditions in one or few of these factors. Everything must work well together for the market to be suitable for a successful long term real estate investing strategy.

What if Your Market Doesn’t Meet the Standard?

Invest out of state. Or don’t invest at all. But for the love of God, don’t try and make it work in a market where it won’t work. It’s been tried and it has failed every time. Don’t buy a “cashflowing property” in a market where properties don’t cashflow unless you plan on buying an AK-47 for the purposes of collecting rent. I know it’s scary to invest in properties that you can’t drive by whenever you want. But a truly successful real estate investment is one where you have no reason to drive by it at all (think about it – and click here to tweet this quote!). Times have changed and today there are systems you can implement to make your out of state investing easier. Take the time to speak to investors who have taken the leap and they will tell you about how they’ve never looked back after the  first one. They will tell you that once they saw what they could buy for the money, it was an absolute no brainer.

It comes down to a choice between guaranteed failure and scary success. You pick.

Thoughts?
Photo: Ms. Phoenix

Erion Shehaj helps successful professionals achieve financial independence using the Blueprint Real Estate Investing™ strategy. By combining the principles of robust financial planning with quality real estate investments, Erion shows ordinary people how to replace their salary with passive income and retire early to live life on their terms. Over his real estate career of 13+ years, Erion has helped his investor clients purchase $90M+ in real estate assets to build robust real estate portfolios and streams of passive income. In addition, Erion has been involved in successfully rolling out small multifamily new construction projects across Texas. Erion has written extensively about long term real estate investing and business in several publications like BiggerPockets (since 2013), Investing Architect, American Genius, Geek Estate and more.

    Jim Pratt
    Replied over 6 years ago
    Good post, stick to the basics, a growing area is just that, growing!
    James Hiddle
    Replied over 6 years ago
    Great blog Erion. I think this is where investors fail a lot when they don’t study their markets very well. They see a property they think will land them some filthy green stuff. They analyze the numbers and determine that they’ll land a $30K profit when they’re done flipping or they’re going to cash flow $200 out the door but than they wonder why their property isn’t selling or wonder why they can’t find a tenant for their rental. Just because a deal looks good on paper doesn’t mean it is. I have a 2 part process when it comes to analyzing a property. I do the numbers and than I check to see if the market supports anything. If the average DOM is 400 days than that should tell you that it isn’t a good market to flip. If the vacancy rate is high that should tell you that the rental market is dry. If there is a decrease in population growth due to either deaths or people leaving a given area than maybe it’s not a good market to invest in period. If there is strong foreclosure rates than that might indicate that it’s probably a good rental market. If there is strong job growth than that could be also a good indicator that a market might be feasible for a flip. All of these market indicators are a good way to evaluate the strengths and weakness of a particular market. You can have a fancy spreadsheet telling you that you’re going to have good cash flow or a nice tiddy profit but if the market doesn’t support those numbers than all of those numbers don’t mean a thing if you can’t move inventory or place someone for rent.
    Erion Shehaj
    Replied over 6 years ago
    Hi James Investors are optimistic by nature but some old fashioned due diligence never hurts. On the contrary…
    Larry Weingarten
    Replied over 6 years ago
    Hello: You say “Times have changed and today there are systems you can implement to make your out of state investing easier.” I’d love to see an article or detailed information on those systems as I’m learning the deals are not where I live. Thanks for your article! Yours, Larry
    Erion Shehaj
    Replied over 6 years ago
    Hi Larry I have written specifically on this topic here: http://signaturehouston.com/investing/7-powerful-tips-on-investment-property-management/ If you have further questions beyond the scope of the article my email is info at signaturehouston.com. Thanks for reading.
    Erion Shehaj
    Replied over 6 years ago
    Hi Larry I have written specifically on this topic here: http://signaturehouston.com/investing/7-powerful-tips-on-investment-property-management/ If you have further questions beyond the scope of the article my email is info at signaturehouston.com. Thanks for reading. Reply Report comment
    Ziv Magen
    Replied over 6 years ago
    Great post, thank you. 🙂 These are exactly the parameters we research before entering any new market, be it prefecture/state/city or even country-based. Spot-on.