If you live in an area like I do, an average 3-bed/2-bath house goes for $600K, and if you think that’s pricey, you can forget about getting into multifamily.
For the budding investor, seeing these prices can be extremely discouraging.
If you read my article where I discuss my goals, you’ll know I’m not one to be easily discouraged. So, I began considering alternative investment paths. I decided to give “investing at a distance” a try, and earlier this year, I purchased a three-unit located about 400 miles away from me.
One of the most important things I learned while buying property from a distance is that I have to take the due diligence process very seriously. Investors should always take the due diligence process seriously, but investing at a distance inherently increases risks exponentially. In my opinion, one of the best ways to mitigate risks associated with any investment property (but especially an out-of-state property) is to ensure the city you are buying in is economically thriving.
If you pick failing city, you are doomed from the start.
Picking a City and Determining the Economic Outlook
Picking a city can be influenced by your investment strategy, personal preference, or merely placing your finger on the map. Once you find a city that you may be interested in investing in, the analysis will always be the same. As investors, we want to know about the city’s job growth, unemployment, crime, industries, main source of income, other demographic information, and plans for the future.
We want to verify that the city is economically stable and will support our investment goals and strategies for the duration of time we invest in said city. Remember, the whole point of this is to mitigate the risk of making a bad investment decision.
While such an analysis may sound daunting, it only takes 30 minutes or so if you know what to look for.
The Comprehensive Annual Financial Report (CAFR)
A CAFR is a set of U.S. government financial statements comprising the financial report of a city (also other government entities) that adhere to the Governmental Accounting Standards Board (GASB). GASB provides standards for the content of a CAFR in its annually updated publications. A CAFR is “compiled” by the city and audited by an external accounting firm.
Let’s assume that you are a beach bum like I am (well, I want to be) and you decide Wilmington, N.C., would be a cool place to own investment property. Before you start wasting time looking at properties and finding a good neighborhood, you will want to determine whether or not the city as a whole is economically thriving. If the city is depressed, you won’t want to invest your hard-earned capital anywhere near it—regardless of how great the deal is.
You will need to find and download the city’s CAFR. You can Google “Wilmington, N.C. CAFR” or you can use this one, which I will be referencing throughout the rest of the article.
A CAFR is composed of three sections: Introductory, Financial, and Statistical. Each section will give you an immense amount of detail regarding the city’s operations, management, plans for improvement, demographics, and more.
If you want to take the analysis to the next level by tracing account balances year over year and learning how to comprehend fund accounting, then go for it. However, I’m going to show you how you can quickly get a feel for the city as a whole.
Step 1: Read through the Introductory Section
The introductory section will provide you with high-level details (which is what we are looking for), so it’s important to give it attention.
The first thing to note is the population growth year over year which is summed up nicely in a graph on page xii. By calculating the growth, year over year, you’ll find the city grew 1.8 percent in 2014. This is better than the national average and also better than North Carolina’s year-over-year growth.
On the same page, I want to point out a sentence that sticks out to me:
“Wilmington area should expect economic growth of 3.0 percent during 2014 and 3.3 percent in 2015. This will be the 2nd year in a row that the local economy will likely grow at the same rate as the nation, which is expected to rise by 3.0 percent.”
Even though they are estimating, the point is that the city’s economy is growing, which is important for our analysis.
On the very next page, xiii, we see that the unemployment rate has dropped rather drastically over the years. Additionally, we see that Wilmington is home to a diverse number of industries which is important as “one-industry towns” expose investors to unneeded risks. Just look at how the oil towns are doing today.
We also see that Wilmington is home to two schools—UNC Wilmington and Cape Fear Community College. This means that student rentals may be a viable strategy to pursue. It also means that there will likely be a fun nightlife in the area and a good restaurant and bar scene. This is critical for the growth of the city.
The remainder of the introductory section will go into details about the top employers and various industries, talk about the city’s R&D and commercial projects, and tourism and attractions. We can also see long term financial planning and the city’s major initiatives which you will certainly want to read through.
Step 2: Analyze the Financial Section
Believe it or not, I don’t really spend a ton of time reading through the financial section. However, I do focus on specific parts to identify trends about where the city is headed.
I always read (or skim) through the first couple of pages of the Management Discussion and Analysis (MD&A). The MD&A is set up nicely by providing “Financial Highlights” allowing us to gain a high-level understanding of the city’s financials. A few pages down, the MD&A defines funds, shows us the availability of capital, and the “Net Position” of the city. Don’t worry about this information unless you want to do a deep dive and understand governmental fund accounting.
I’m more interested in seeing what the main revenue drivers of the city are, and where money is being spent. After all, I may be a future taxpayer of Wilmington, so their spending needs to align with my objectives.
Scroll to page 118 “Schedule of Revenues, Expenditures and Changes in Fund Balance; Budget to Actual for the General Fund.” The general fund is a government’s basic operating fund and accounts for everything not accounted for in another fund. For our purposes, analyzing the general fund will give us the information we need. If you want to take it a step further, you can look at special revenue funds, capital project funds, debt service funds, and proprietary funds to see how the city is spending dollars on specific projects.
Page 118 will give you a good sense of how the city earns money, how the actual numbers compare to the budget, and also last year’s numbers. Page 119 will give you information on expenditures, and it seems like the city focuses on public safety. I’d want to search the local crime and see just how effective the city’s spending has been on keeping people safe.
Step 3: Analyze the Statistical Section
This is my favorite section to analyze because it is easy to understand, contains tons of great information, and allows one to identify trends.
I first look at page 190—changes in property tax. It seems, overall, the city did not raise property tax rates from what they were in 2013, which I find surprising.
On the next page, 191, we see the city’s top ten taxpayers. We saw this from the introductory section, but here they compare it to nine years ago. I look at this and always ask, if the number one taxpayer left, will it cause undue hardship on the city? Here the answer is likely no, seeing that Corning, Inc. amounts to less than 2 percent of the total assessed value.
Pages 200 and 201 are my favorite pages of the entire CAFR. Page 200 shows us the demographic and economic statistics over the last 10 years. We see that population has been growing steadily as well as per capita income. It’s unfortunate that we don’t have 2013 and 2014 income numbers, but sometimes that’s just the way it is.
We also see the median age has stayed relatively stable, meaning there is a good amount of young who are continually drawn to the city which is important for continued growth. We see the unemployment rate has experienced fluctuations but is currently at low levels.
Page 201 shows us the top 10 employers. Similar to the top 10 taxpayers, I always ask the question—if the number one employer left, would this cause undue hardship on the city? Since almost 6 percent of the city’s workers are employed by one employer, I might be inclined to say yes. However that employer is the county’s health network, so it’s unlikely that employer would ever “leave,” which mitigates my concerns.
Additionally, the top 10 employer list is made up of a diverse set of industries. So, if one industry left the city, I wouldn’t be concerned in the short-run.
After analyzing Wilmington’s CAFR, I would deem it a city worthy of my investment. It has many industries, a growing population, decreasing unemployment, money being spent on public safety, education systems, health systems, and a diverse amount of tourism opportunities. This city could be ripe for different real estate strategies, such as rentals to blue collar, white collar, students, tourists, etc., which makes it a top-tier location for my investment.
Now, just because I think this is a good city to invest in, doesn’t necessarily mean there are deals to be had. But the analysis we just performed validates that the city is thriving and a real estate investment in the city limits can potentially be rewarding.
Do you use a method similar to this to analyze remote markets? If not, how do you perform your analysis?
Let me know with a comment!