It’s a huge advantage for an investor to buy across different markets. Multiple markets open up additional purchasing opportunities, rather than introducing limitations. It gives you the ability to pick and choose the best of the best.
But the bigger win, in my opinion, is lowering risk within your investments.
Ray Dalio, one of the most successful hedge fund investors and founder of Bridgewater Associates, had the following to say about diversification:
“I think the important thing here if I’m an investor is that the most important thing you can have is a good strategic asset allocation mix,” Dalio said in an interview with CNBC.
“In other words, you’re not going to win by trying to get what the next tip is—what’s going to be good and what’s going to be bad. You’re definitely going to lose. So, what the investor needs to do is have a balanced, structured portfolio—a portfolio that does well in different environments.”
There are lots of ways to balance your portfolio in real estate. Diversifying can take many forms, such as unit count per property, economic class, type of rental, or geography.
But let’s focus on geography. What do investors need to know before investing in a new market?
My company and I have invested in and managed properties across three states, 20 counties, and over 50 cities. We have learned a lot by trial and error, but you don’t have to.
What Investors Need to Know About a New Market
Local Deal Flow
We have found that most wholesalers and commercial brokers operate in specific regions. When looking to acquire properties in an area, establish relationships with the local folks. Once you buy a property there, brokers and wholesalers will be much quicker to work with you in the future.
Rent is something that will obviously change from location to location. We find local property managers to be an ideal source of accurate rent estimates. This is especially true if they will be managing the property you’re looking to purchase.
The property manager has a vested interest in giving you a real number since they have to place tenants. Wholesalers and agents can be very shady with estimates since they simply want to see a deal close.
Specifically in major cities, crime rates can change block to block. Baltimore, Md., and Trenton, N.J., are great examples of cities where within blocks a neighborhood can change from low crime to high crime. We have found that crime not only impacts rent and tenant quality but also less obvious things, such as willingness of contractors to work at a site.
Unfortunately, crime maps often don’t do a great job of showing how crime is changing over time. People who live in the area are usually a better source of information about the safety of an area. Local residents can comment on both immediate crime rates and how crime is evolving.
Certain regions are impacted greatly by seasonal fluctuations. Potential tenants may be sparse during certain times of year and plentiful during others.
For example, we manage and own college housing in a town dominated by the local university. Most students search for housing from February to May and sign a year-long lease. If you miss that time slot, it’s very hard to find tenants.
We have found that certain municipalities and cities have very strong historic preservation initiatives. On the positive side, these can provide tax credits. But preservation councils may prevent certain construction projects.
For example, a new construction team is working on a development project in Lancaster, Pa., where they want to level a historic building. The historic board is making it very difficult for the development team to get the project approved.
Each state (and even some cities) has their own specific eviction process and rules. It’s really important for owners to get to know the local eviction legal process.
Many will argue that filing evictions is the property manager’s job. But investors should also understand the local process prior to acquiring an asset. Even if they employ a property manager, it could dramatically impact your first three to six months of ownership if evictions drag out from hold-over tenants.
Inspection policies also vary. We see city inspections range from every year to every four years, while many towns don’t have an inspection at all. Inspections are important as you forecast deferred maintenance that an inspector may require to be changed.
For example, in York, Pa., the city has hired an outside firm to handle all inspections. The new codes team is much easier to work with than those in neighboring cities, which impacts maintenance costs over time.
Cities can even change their policies. Baltimore, for example, just passed a new inspection rule requiring an inspection every two years.
Health complications stemming from lead paint have received a growing amount of attention within the media and courts—and rightfully so. There are three levels of lead paint rules: federal, state, and city.
As an example, two cities in Pennsylvania (Philadelphia and Lancaster) require a lead paint safe certificate prior to moving in a family with a child under six. The rest of Pennsylvania isn’t nearly as strict—just requiring adherence to the national lead paint rules of providing notice in the lease.
Maryland requires a property to be “lead safe” at all tenant turns. Become familiar with lead rules, so you’ll understand costs and rulings prior to purchasing a property.
Just as important is knowing local codes. Local codes are even more critical in the multifamily space. Fire alarms, sprinkler systems, elevators, and electric codes can be very costly to change.
We had an instance where a codes officer told us a property needed a sprinkler system. The property was actually grandfathered into not needing a sprinkler system unless new construction started. That would have been a very expensive project had we not known the local codes!
Weather can be an issue when it comes to managing properties. Snow, extreme cold, wind, and hurricanes are all classic examples of weather-related issues that need to be planned for in both the pro forma analysis and the management operations plan.
Parking lots are an interesting example where weather plays a unique role. Keeping the pavement in decent condition and clearing snow are more complex tasks in the Northeast and Midwest compared to the South.
It’s crucial to understand where a city and even individual blocks are moving in terms of economic development. It’s key to learn about both long-term changes in a local economy and also more recent trends.
Bethlehem, Pa., is a good example of an interesting economic storyline. For much of the last 30 years, Bethlehem has had a difficult economic climate due to a massive loss of jobs in the coal industry. But the last few years have actually experienced positive growth, and the city is revitalizing.
What other considerations do you take into account when exploring new markets?