How to choose the a market?

35 Replies

I have been wondering what market to invest in? I live in California and with its Laws from my understanding, it is geared more towards the tenants than the landlord and it can be crazy expensive to purchase and then taxes on top of that. I am sure there are places in and outside of California that are lower in taxes and as well as higher. However, as a newbie I wanted to get a few opinions on where a great place might be able to start.

Would turn key be a great start for a newbie or not?

Looking for both equity and cash flow and they do not need to be necessarily group together.

Thoughts anyone?

@William Orrock I'm sure by now you've seen on the forums that you are definitely not alone in your situation - all the reasons you listed about the CA market are why many investors go out of state (OOS).

And, as @Lane Kawaoka mentioned, the better bets are typically secondary and tertiary markets when growth is slower but steadier (think investing in growth stocks vs a hot new tech IPO). Prices are lower, rent to value ratios are higher, and many of them have much better tax rates than CA. Not to toot our own horn too much, but Birmingham, for example, has some of the lowest property tax rates in the country: https://smartasset.com/taxes/alabama-property-tax-...

Choosing a market depends a lot on what kind of investment you want. Sounds like you're focusing on buy and hold, which means you can either go turnkey or a more DIY route. DIY can mean that you buy distressed properties and rehab them yourself to force equity without spending a lot (would be tough to do OOS unless you have a lot of airline miles banked and plenty of free time) and manage them from a distance (not recommend for a new investor), or build a team in the market of your choosing (agent, contractor, property manager, many new OOS investors do this).

Turnkey means one company does it all from buying props to rehab to long-term management. A lot of companies call themselves turnkey that are actually just marketing properties owned and sold by other companies in exchange for a referral fee (I think we've discussed this on another thread); other pass you off to a third-party property manager after you close. If you go turnkey, look for a real full-service operator - one team to vet, one relationship to build.

Like everything, this choice comes down to a trade-off - time for money. With turnkey, you put in the legwork to find and vet the company (and I recommend flying out to visit before pulling the trigger) but once you close there should be almost no day to day interaction with your investment - that's why you buy turnkey, to have pros take care of the whole thing start to finish. However, you will pay market price for a fully rehabbed property (but you should NOT be paying more, that's a big red flag, get your own appraisals!). 

If you go DIY you have the opportunity to find distressed properties and rehab them to an ARV that's higher than the amount you put in (forced equity). It's never guaranteed, but it's an opportunity you won't have with turnkey because that's how the turnkey company makes money - we buy and rehab and sell at market, the spread is our income. One is a lot more work, but potentially higher returns (in the form of forced equity). The other is much more passive, but your equity growth will be limited to appreciation and the benefits of a tenant paying for 80% of your property over time (if you finance), which should not be understated. With DIY you put in the down payment on the distress prop (or the full price if you want to pay cash) and the rehab costs - all the risk of rehab and extended vacancy is on you. With turnkey you pay a higher downpayment for a market price rehabbed prop (no forced equity), but you close after inspections are passed etc so rehab risks are on the company, not you.

If you go turnkey, the people you choose are going to be more important than market. A solid turnkey company won't exist in a market that can't support it, so as long as you go with a company that's been around a while, has a good reputation, and solid references, you should be good. Still, you need to research the market yourself to ensure it aligns with your criteria, but the existence of profitable and reputable turnkey companies in a market is an indicator of viability.

If you go DIY, the people are still crucial, but you also need to choose a market where you can get the deals you want. Markets that have a big professional turnkey or large-scale investor presence make it harder to find and secure deals without being 'on the ground'. Birmingham is a great rental market, but for new folks who DIY it here, they will be up against us for most deals worth having (sorry!) and we have superior networks and capital behind us. Same will be true in Memphis, for example, where there are several good-sized turnkey operations. These are companies built to find the best deals possible, so it's tough to compete on their turf as an OOS investor until you really build your own network/team.

It's definitely still possible to successfully DIY it in these markets, but it will be an uphill battle. If you want to go this route from OOS, you may need to be a little more creative with your market selection. There are great rental markets hidden all over the country, and many folks make good money in smaller tertiary markets other people might not even consider. So, if you want to be more hands-on, you may need to do more market research (and on a wider range of market sizes) than if you went the turnkey route. Start with places you know well (places you've lived, where you have family, places you visit) and move out from there if the numbers don't work in those places.

Turnkey is primarily a cash flow focused investment. Personally, since appreciation can never be guaranteed, I prefer to focus on numbers I can predict and/or manipulate to my advantage. But there's no reason you can't focus on both. If you are looking to tackle both cash flow and equity investments, you might consider starting with turnkey to get the ball rolling while you learn the ropes and establish connections in a DIY market that will work for you. Many investors go this route because it gives them a  portfolio of income-producing properties that tenants are essentially paying for, and then when they expand into the DIY realm they know they have something solid to fall back on if it's not the right market/deal/investment. 

There is risk inherent in all investments, you can mitigate it in different ways, but it can never be eliminated. You mitigate the risk of a turnkey investment by doing your due diligence on the provider, doing your own prop analysis, getting your own appraisal and inspection (esp on the first deal). There will still be vacancy and maintenance costs, but a professional operator has processes in place to minimize those costs however and wherever possible. The DIY route has additional risks (choosing a bad deal in the wrong area, rehab issues, unforeseen structural or systemic problems etc) but you also have the potential for higher returns via forced equity. Just like building a stock portfolio, diversifying your holdings to spread out your risks is always a good idea ;)

Good luck!

@William Orrock

I wrote a response to this a few months ago, but it is still relevant.

https://www.biggerpockets.com/forums/88/topics/638...

I listed how we go about evaluating markets and some of the most important data points and KPIs for our company.  I also talk about the website we  use to aggregate the data and then fill out an easy spreadsheet to evaluate each market side by side.  We've evaluated about 20 markets across mostly the southeast U.S. to determine the 7-10 we like the best.  All of us, myself included, tend to talk about all the best points of each city.  Rarely does anyone tell you about the warts!  Net Job Growth and how that growth is forecast for the foreseeable timetable is key for any long-term market.  Not new jobs or splashy headlines, but NET JOB GROWTH.  That means how many new jobs minus the jobs being lost.  Take a look at the post and feel free to ask any questions if it brings up more.

Best to you ~

Thanks a lot guys for your opinions until now. I am thrilled to hear about where you guys are coming from.  Turn key companies can be really awesome, but I’ve heard horror stories and those are the ones that ruin it for guys like you.  Maybe we can chat more about Alabama and Tennessee sometime here soon.  Thanks for your time Clayton and Chris.  

@William Orrock I live in CA as well and I purchased 11 investment properties my first year... None of which were in CA - for a myriad of reasons. You're right, CA is not a landlord friendly state but besides that, I see more long term upside in small to mid-size markets. That said, it depends on what you're looking for - more cash flow, more long term appreciation, etc. I've found a nice mix of both good cash flow and positive equity in the markets I've been investing in. I'm happy to lend any insight/advice I can, but the best advice I can give is don't overthink it - if the numbers make sense and it fits your investment goals, go get it!

@William Orrock - This depends a lot on your goals.  I started with turnkey in TN and some passive crowd funding opportunities while I worked on my education.  I have since switched to buying value-add multifamily  and some flipping (also in TN) because I would just not reach my financial goals with turnkey/passive ownership.  

A limitation to turnkey is that you are basically buying at close to or retail prices. Although they may cash flow, the additional upside is slow because it is based on appreciation (if it appreciates), principal pay down, depreciation, inflation hedging, and tax benefits. Turnkey is a great conservative long term wealth strategy, however there may be way to accelerate your returns with other strategies. Again, depends on your goals.

I did start my active stuff from out of state and have since started splitting time between Alaska and TN.

I recommend you listen to this episode of Rod Khleif's podcast with Neal Bawa http://traffic.libsyn.com/lifetimecashflowpodcast/neal_bawa_AUDIO_edit.mp3?dest-id=350694.

Neal goes into a lot of detail on market selection.

@William Orrock

This is what I look for when deciding which markets to invest in:

  • Population growth – A solid market is one that has population growth. Markets that have flat or negative population growth can indicate a problem, while markets that continuously have people moving into them is a sign that there will be more demand for apartments. One of the markets with the highest population growth is Dallas, TX, while the Providence, RI market has shown no significant population growth at all. Where to find information? Simply google it! For example, search “Jacksonville population” and you’ll see the trend. Focus on the last 5-10 years.
  • Job Growth – Population usually follows jobs, and a great market is one that adds many new jobs each year. I usually look for markets with an unemployment rate that is lower than the national average (4.1%). In addition to evaluating the city job growth, you need to pay attention to any major industry or employer that may be responsible for more than 25% of the market, because if the dominant industry or employer is in trouble so is your property (due to layoffs). A solid market is one that has steady job growth and a diverse economy. Where to find information? www.city-data.com and www.census.gov.
  • Rent Growth – A strong multifamily market is a market that has increasing rents. If rents are in a downward trend, then your property might suffer from declining rents as well. This is also a rule of thumb, and each investment is unique, but general speaking I try to stay away from markets that have a declining rent trend. Where to find information? www.census.gov has information on the average rent in the past several years in major cities.
  • Appreciation Potential – The lion share of the profits is made when you sell the property. This is why appreciation is key. I look at markets that have strong appreciation potential, and if property values are increasing, it is more likely that I'd be able to sell my investment at a significantly higher price than when I bought it. This is why I believe that you make money when you sell a property, not when you buy it. A word of caution, though: real estate is a cyclical business, and even markets with strong appreciation can suffer when the economy turns. A market with increasing prices is not a guarantee that you'll make profit when you exit, but it's a safer market to be in when you buy. Where to find information? Many large brokerage firms offer free reports that show rents and real estate prices. You can find the reports from reputable companies such as CBRE, Marcus and Millichap, Yardi Metrix, etc.
  • Landlord Friendly State – Landlord-friendly markets have a direct impact on real estate and the return of the investments. Some states, such as California, are very tenant-friendly, which means that it can take up to 9 and even 11 months to evict an unpaying tenant while, in the meantime, you pay for the mortgage and the expenses. Other states, such as Texas and Florida, are landlord-friendly and provide owners with a quick eviction process. Where to find information? Simply Google: “How long does it take to evict an unpaying tenant in …” 
Originally posted by @Ellie Perlman :

@William Orrock

This is what I look for when deciding which markets to invest in:

  • Population growth – A solid market is one that has population growth. Markets that have flat or negative population growth can indicate a problem, while markets that continuously have people moving into them is a sign that there will be more demand for apartments. One of the markets with the highest population growth is Dallas, TX, while the Providence, RI market has shown no significant population growth at all. Where to find information? Simply google it! For example, search “Jacksonville population” and you’ll see the trend. Focus on the last 5-10 years.
  • Job Growth – Population usually follows jobs, and a great market is one that adds many new jobs each year. I usually look for markets with an unemployment rate that is lower than the national average (4.1%). In addition to evaluating the city job growth, you need to pay attention to any major industry or employer that may be responsible for more than 25% of the market, because if the dominant industry or employer is in trouble so is your property (due to layoffs). A solid market is one that has steady job growth and a diverse economy. Where to find information? www.city-data.com and www.census.gov.
  • Rent Growth – A strong multifamily market is a market that has increasing rents. If rents are in a downward trend, then your property might suffer from declining rents as well. This is also a rule of thumb, and each investment is unique, but general speaking I try to stay away from markets that have a declining rent trend. Where to find information? www.census.gov has information on the average rent in the past several years in major cities.
  • Appreciation Potential – The lion share of the profits is made when you sell the property. This is why appreciation is key. I look at markets that have strong appreciation potential, and if property values are increasing, it is more likely that I'd be able to sell my investment at a significantly higher price than when I bought it. This is why I believe that you make money when you sell a property, not when you buy it. A word of caution, though: real estate is a cyclical business, and even markets with strong appreciation can suffer when the economy turns. A market with increasing prices is not a guarantee that you'll make profit when you exit, but it's a safer market to be in when you buy. Where to find information? Many large brokerage firms offer free reports that show rents and real estate prices. You can find the reports from reputable companies such as CBRE, Marcus and Millichap, Yardi Metrix, etc.
  • Landlord Friendly State – Landlord-friendly markets have a direct impact on real estate and the return of the investments. Some states, such as California, are very tenant-friendly, which means that it can take up to 9 and even 11 months to evict an unpaying tenant while, in the meantime, you pay for the mortgage and the expenses. Other states, such as Texas and Florida, are landlord-friendly and provide owners with a quick eviction process. Where to find information? Simply Google: “How long does it take to evict an unpaying tenant in …” 

 Is there a way to "save" posts on BP? @Mindy Jensen @Brandon Turner

@William Orrock great post. You got some great feedback, and a good list of items from @Ellie Perlman .

To build, I’d suggest determining if you want to self-manage from afar, find a turnkey property or partner with others. From there identify your market criteria and pull together a short list. It helps to visit the markets and talk to brokers and have them show you around.

If you self-manage, focus on an area that is ideal for you. Maybe a city you travel to frequently or have family/friends to serve as boots on the ground. If turnkey, focus on finding the right PM and then select the property. If going the partnership route, lean on their expertise, but double check the data and ensure there is growth in the area.