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Why Your Home Market May Not Be the Best Place to Invest

Logan Freeman
3 min read
Why Your Home Market May Not Be the Best Place to Invest

“Location, location, location” is a common battle cry in real estate investing—commercial real estate (CRE), in particular. Yes, real estate is about location—but that prime spot may not be in your local city or market.

As CRE investors, we typically default to our backyards for finding and acquiring deals. Local markets are familiar to us. For some of us, it’s where we grew up, it’s where we live and work, and it’s where we have personal and professional connections.

I don’t want to downplay the value of investing locally. There are certainly advantages to having boots on the ground, especially for finding value properties with above-market cap rates and returns on investment.

Related: How to Calculate Cap Rate (& Where Many People Get It Wrong)

Having ears to the ground can open the door to undervalued properties with substantial potential upside. You may be following the path of progress and growth in your area and eyeing the West Side for your next CRE project, but maybe the best deal isn’t on the West Side. Maybe it’s not even in your state.

How Does Your Market Compare?

Maybe your market is mature. Maybe it’s experiencing extreme volatility. Maybe now is a time to consider other markets.

When we say a real estate market is mature, we’re saying it has reached a state of equilibrium. These mature markets are static, marked by an absence of significant growth or a lack of innovation. Many investors are satisfied with static, with stable.

Do you live in or near a gateway market like New York, Los Angeles, Chicago, San Francisco, Boston, or Los Angeles—centers of long-established commerce and population?

Investors are drawn to these cities that never sleep, drawing intense competition in the CRE space from some of the largest private equity funds, REITs, and foreign investors in the world. Flush with Class A core and core-plus properties, these big-time investors are willing to sacrifice cap rates and profits for security and liquidity.

Related: Out-of-State Investing: The Good and the Bad

While many investors are satisfied with the status quo in bigger markets, some are tired of so-so returns and are looking to emerging markets for better cap rates, ROI, and growth potential.

As investors look elsewhere, what they’re discovering is that even as they move their investment focus inland, the stability and liquidity they seek in the bigger markets can also be found in secondary markets like cities in the Midwest and Texas—but with better cap rates and better returns.

This would explain the recent exodus of California investors for greener pastures in the Midwest, where they can find properties in similar market segments but at cap rates 100 to 150 basis points higher.

If a market is experiencing a period of volatility, the temptation for investors is to park their capital and wait for the market to recover. Timing the upswing can be risky, as waiting too long could mean paying too much for an asset, and jumping back in too soon could mean taking an immediate hit because the market hasn’t hit bottom yet.

Why sideline your capital when there are emerging, stable markets you can invest in immediately without holding onto cash that’s being eroded by inflation?

Chicago downtown skyline at twilight with highway and traffic.

Impact of COVID-19

Not all markets have been affected equally by the COVID-19 pandemic. Phoenix, for example, is getting hit hard by the COVID-19-induced economic crisis, with foreclosure and eviction rates twice that of the U.S. average.

Attom Data Solutions recently released a study ranking 500 U.S. real estate markets according to their vulnerability to COVID-19, based on metrics such as foreclosures, homeowner equity, wages, and other factors.

Of the 500 counties studied, the research found that 25 of the 50 least-vulnerable counties were in Colorado, Indiana, Missouri, Texas, and Wisconsin — clearly skewing Midwestern. These markets demonstrated lower levels of unaffordable housing, underwater mortgages, and foreclosure activity.

Related: Looking to Invest Out of State? Here’s How to Pick and Analyze a City

Major homeownership costs (mortgage, property taxes, and insurance) consumed less than 30% of average local wages in 28 of the 50 counties that were least at-risk from market problems connected to the pandemic in the third quarter of 2020.

The most vulnerable markets were scattered throughout New York, California, Connecticut, Maryland, Baltimore, Washington D.C., and Hawaii. In these vulnerable states, major homeownership costs consumed more than 30% of the average local wages.

The Attom Data Solutions study reinforces the COVID-19 phenomenon of young professionals and families fleeing vulnerable gateway markets for emerging, affordable, and economically stable markets in the Midwest and Texas in search of more space and greater affordability. And investors are following the migration; the Midwest has seen a huge uptick in investors from California.

midwest

Looking Forward

Location is still important, but many investors no longer restrict their search to their backyard.

It’s not always about the largest traffic count in your hometown or favorable demographics. If your hometown is in a funk, don’t make the mistake of sidelining your capital when you can keep your money working for you by looking elsewhere.

So before you settle for the best location in your current market, consider other markets across the U.S. or even outside the U.S. for above-market cap rates and ROI. It might even be somewhere you least expected.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.