I believe in a top-down process for investing. That’s where you start with the big picture—macro trends going on in the economy—and start to drill down from there into specific areas, markets, asset classes, and so on. At that point, you look at specific assets that fall into the criteria you’ve selected.
There are a lot of ways real estate investors can make money. Many are probably restricting themselves to whichever market they live in (for obvious reasons). Other investors surely are doing a great job in markets far from home. And that’s awesome.
(Side note: Before diving in, by no means am I saying this is the only way—or even the best way—to choose a market. It’s simply one method I’ve experienced success with.)
If you’re willing and able to look at other areas of the country, it’s critical to have a data-driven process to make sure you’re choosing places where you can reasonably expect good long-term fundamentals to remain in place.
So, how do we go about this?
First, what is happening in the economy? Putting the COVID business aside for a moment, which we can all agree will have profound impacts on the economy for years, where are the jobs being created? Where are the people moving?
What we want is solid, high-paying job creation that should be resilient in recessions and have long-term tailwinds. We want markets that are attracting these types of jobs now and have structural elements in place that increase the likelihood of continued growth.
There are many ways to slice and dice the data, but in the interest of not turning this into a 50-page white paper, here is a basic process that can get you started.
How to Do a Real Estate Market Analysis
Starting with MSA-level population data, we can pull all metro areas with at least 1 million people and eliminate any with negative population growth from 2010 to 2019. After sorting by growth and cutting to the top 10, here’s what we’re left with:
I’ve evaluated deals in all of these markets and helped my firm make billions of dollars in acquisitions in these cities. There’s nothing wrong with any of these places. In fact, I’d encourage you to apply the process described here to any of these MSAs, and I think you’ll like what you find (though many of the Texas markets are lower on my list).
Below we’ll focus on Phoenix.
After Googling the various cities to determine where employers are moving, how the metro areas are changing, and why people are moving there, several themes emerge. These are all cities where the cost of living is low relative to major markets like New York, L.A., and Chicago. These areas also all have access to a highly educated workforce and are relatively business-friendly.
On the margin, as America’s strongest companies look to expand, these are all great targets for that expansion given the ability to find good office space, attract talented employees, and reduce tax burdens and overall cost structures. Major employers like Google, Oracle, Amazon, Microsoft, and Apple have all grown their presence in many of these cities.
Why Invest in Phoenix Real Estate?
I got particularly interested in Phoenix for a few important reasons. One major reason is that it has been and will continue to be a major destination for the exodus from California. Hey, Cali is a great state for a lot of reasons, but the tax burden and the cost of living there are a crushing weight on anyone who isn’t making millions.
If you’ve owned a house in California for 8-10 years, you may have enough equity in it to own free and clear in Phoenix—or at the very least get a place with a very modest mortgage.
The 5-hour trek from southern California isn’t too bad, and as employers have grown their presence in Phoenix, it has become an attractive option for many people. Imagine slashing your mortgage or rent cost in half and saving several thousand dollars on property and income taxes. It’s simply too big of a draw for many people!
Digging in further, we see that major private employers are weighted toward strong financial services companies and healthcare systems. State Farm Insurance has also made a big splash, expanding to 8,000-10,000 employees at their regional HQ in Tempe.
Technology and software are also growing quickly in Phoenix, where ASU and other universities graduate a ton of software engineers. In fact, software employment has grown 28% over the last 5 years. Even Zoom announced in May that they’d be opening an R&D center in Phoenix, citing engineering talent from ASU as one of many factors for choosing the city.
TSMC is opening a $12 billion semiconductor factory, too. And Microsoft, Google, Apple, Mayo Clinic, and DoorDash are among some of the other well-known names expanding in the area.
Despite a reputation as a retirement community, the median age in Phoenix is about 36, which is 2 years younger than the national median.
We’ve seen that the demand side of the equation is solid for Phoenix. The MSA has grown by about 755,000 people since 2010, or about 84,000 people every year. That’s about 229 individuals per day moving into Phoenix.
Let’s make some back-of-the-napkin calculations to contextualize this. If we assume the average household is four people and that half of the households will rent, there’d be about 28 units per day of rental demand (or about 10,220 units per year). I understand that this is simply shorthand and not perfectly accurate. The point is that there is a boatload of demand.
To be sure, the market is doing its best to increase supply to meet that demand. My research shows that approximately 7,000 units per year have been constructed on average since 2014. And 15,000 more units are currently under construction, set to be delivered over the next four quarters.
In contrast to rental units (shown below), single-family construction has been growing from the 2009 nadir but is still very low by historical standards, hovering around levels from the mid-1990s.
Up to this point, the increase in supply of rental units, despite being extremely aggressive, has not kept up with demand. Single-family homes continue to be added to the market but at a relatively modest pace. This has driven 20 straight quarters of rent growth over 4% for Phoenix, while vacancy has trended from the mid 7%s to the low 6%s since 2014 (before the COVID-19 disruption).
From here, we could start to go into a bunch more detail, analyzing employment and income data to further evaluate our target markets.
For Phoenix, a great next step would be to visit the city and drill down into the specific areas where people are moving. What exact buildings are employers moving into? How are entertainment options developing? Do people drive or use public transportation, and where are the main demand centers accessed by road or rail?
From there, you’ll be able to drill into specific parts of the MSA to research further. I’m a particular fan of some of the suburban areas where units are large, rents are affordable, schools are good, and it’s still incredibly easy to get to major employers and entertainment.
Over the short-term, I fully expect Phoenix to have problems absorbing the new supply set to hit the market while unemployment takes its toll and businesses and renters begin to adjust to a new set of circumstances due to the pandemic. Rent growth will be weak, and there will be some vacancy issues.
However, Phoenix is not the same town as it was in 2008. It got crushed during the recession due to its dependence on housing construction and related industries like lending, brokerage, manufacturing construction materials, etc. Today, Phoenix has a diversified economy with a strong presence in growing, high-pay fields that will be in demand for the foreseeable future.
If you’re looking for an area to focus on that has the long-term fundamentals in place—low cost of living, affordable housing, educated workforce, good climate, business-friendly environment—Phoenix makes a great candidate.
What factors do you consider when evaluating a market?
Share in a comment below.