Choosing The Right Market For Multifamily Investing
When choosing a real estate market, the phrase that often comes to mind is ‘location, location, location’. What is not mentioned are the different factors that make that location the best for your money. When it comes to multifamily investing, having a thorough market analysis criteria is extremely important for the success of your investments. Thorough knowledge of a market also allows us to clarify and inform our investors of our decisions. Many people believe or use the blanket term ‘the real estate market’ when discussing real estate. This is a common error as real estate is a hyper-local investment. The US is divided into 7 major regions that consist of just under 400 MSAs. These MSAs are then narrowed down to sub-markets, suburbs, blocks, and streets. Each of these different market levels could be extremely different from one another for many reasons. Crime level could be high on one block but change to low just a few miles away. This can lead to a big difference between a great property versus a not so great property all within a three-mile radius. With this being said, I am going to divulge the 3-step process I take when choosing the right market:
1. Understanding Market Types
2. Identifying The Right Markets
3. Choosing the Right Markets
1. Understanding Market Types
The first step in this process is to know the types of markets you are looking at. There are three types of property markets: Linear, Cyclical and Hybrid. Knowing the specifics behind each of these market types will assist you with understanding the areas property cycles.
Linear: A linear market is one that exhibits a steady growth curve with no major spikes or declines. These markets are generally seen to appreciate at the rate of inflation. Extreme boom and busts rarely occur as these markets both rise slow and drop slow. This is why many investors consider them “boring” because of their “lower” appreciation. Contrary to this belief, linear markets actually provide some of the best capitalization rates and cash-on-cash returns. Examples of major linear markets are found throughout the Midwest, Southern Texas, and South-Eastern Georgia.
Cyclical: Property values in a cyclical market move up and down like a rollercoaster. These markets display the most volatility with major peaks and valleys, usually over a cycle length of 7 to 10 years. When conditions are at their peak, annual property appreciation can exceed 20-30%. On the flip side, these markets see similar price plunges and volatility when conditions are not so favorable. Specific examples of cyclical markets are coastal regions such as San Francisco, Seattle, New York, New Jersey, and Miami.
Hybrid: As you may have guessed, hybrid markets provide a combination of both linear and cyclical characteristics. These markets can go through linear phases of slow-growth for a period of time, followed by periods of cyclical-style appreciation. They rarely boom and busts like Florida or California, and also rarely seem to correct like more volatile markets. Some examples of hybrid markets include Austin (Texas), Boulder (Colorado), Charlotte (North Carolina) and Phoenix (Arizona).
2. Identifying The Right Market
Population: I look towards MSAs with a population of 500,000 or more, as the higher the population the better your chances of success with an investment. Investors should look at steadily growing populations with positive migration trends.
Demographics and Migration: Demographics and migration trends are extremely important when looking into markets to invest. Demographics such as age percentages are important as this can be the difference between a majority renter or homeowner population. Cities with large millennial populations can attribute to a larger pool of renters. This can be seen by reviewing the Ratio of Owner-Occupied to Rental Properties. Markets with a higher percentage of renters create a deeper pool and demand for quality rental units.
Migration trends are also important statistics to look into when choosing a market. Reviewing the inbound migration vs outbound migration statistics over the past 3-4 years will give you a key indication of the market’s migration patterns.
Job (Growth and doing business): I believe it is important to look at markets that have a mix of three or more different industries. Industries that are a positive market indicator include business services, manufacturing, health-care and technology. It is ideal for a market to not have one employer/industry that employs more than 15-18% of the population. You do not want to invest in a market that is reliant on a single employment sector. An example of this could be seen in many past Southern Texas markets that relied heavily on the oil and gas industry. People constantly moving towards a market for employment opportunities signifies a healthy, vibrant economy.
Affordable Housing Market: It is important to run a rent-to-value (RV) ratio on potential investments. The RV ratio is simply the monthly rent divided by acquisition price, expressed as a percentage. A good target RV ratio is between 1.2-1.4%; anything less is too expensive (will not cash flow), anything above is, probably, a depressed market or a bad neighborhood.
Landlord Friendly Laws: Unfriendly landlord laws can be another major factor when it comes to deciding where to invest. By investing in states with landlord-friendly laws you reduce long-term stress and hassle. A property manager’s job is made easier as they can evict problem tenants easily and the legal process is much less strenuous on you as an investor. Along with this, regulatory factors should come into consideration. Some markets are friendlier than others. Two individual properties with similar dynamics – cost, condition, rental potential – can exhibit very different results based on regulatory factors like tax policy and landlord-friendly laws.
3. Choosing The Right Markets
As a rule of thumb, investors need to analyze at least 25 deals in a selected market before they become a pro. Go online – LoopNet, Realtor, Craigslist – and start crunching numbers in a spreadsheet. This is unsexy work, but analyzing 25 deals will give an investor a feel for costs:
● Avg. $/door
● Expense ratios
● Average rent/sub-market
● Demographic trends
This is an extremely valuable step for anyone looking to vet a potential market and cannot be skipped!
Make sure to also visit the market you are interested in. This will aid you in understanding the lay-of-the-land and establishing your bearings. This gives you a better understanding of the properties you are looking at, their condition and the state of comparable properties surrounding that spot.
I hope this framework is helpful to you, and if you have any questions, I would love to hear from you.
Email: [email protected]
LinkedIn: https://www.linkedin.com/in/josh-oaten-46ab3b135/
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