All too often, an investor stumbles on a deal in a city, town, or neighborhood she knows very little about.
The numbers look good and according to the Realtor, the market is hot and the property will not be around long.
The investor has a well thought out strategy for investing in an entirely different location, but gets caught up in the excitement and completely abandons this strategy without properly researching the new location.
As the story goes, the property is purchased and the investor soon finds that the deal was too good to be true. Employers are leaving the area left and right, the schools are very poorly ranked, and violent crime is out of control. Quality tenants are nearly impossible to come by and vacancy rates are staggering.
The investment quickly turns from a dream to a disaster.
Every seasoned investor has some variation of this story to tell, where too little thought went into choosing the location or they decided to settle on a poor location only to regret this decision as time went on.
Here are a few important considerations that will help you choose not only a good location, but one that is right for you.
Download Your FREE copy of ‘How to Rent Your House!’
Renting your house is a great way to enter the world of real estate investing, but most first-timers (understandably) have a lot of questions. Fortunately, the experts at BiggerPockets have put together a complimentary guide on ‘How to Rent Your House’. All the skills, tools, and confidence you need to successfully rent your house are just a mouse-click away.
Invest Somewhere Familiar
In order to be an expert on a neighborhood, you need to spend a considerable amount of time in and around the area. We are all experts of our own neighborhoods and other places we have lived for several years.
Absent a partnership with a trustworthy expert in a new area, there is no place where an investor will find a bigger advantage in choosing properties.
Even then, you will personally want to gain expertise in the new area through consultation with your partner, time spent walking and driving the streets and additional research so that you can confidently select each deal.
Familiarity with a neighborhood gives you many advantages over an outsider.
You have watched the path of progress (or lack thereof) for years. You know where the “good” and “bad” streets are. You know what happens at night. You have heard about any significant acts of crime.
You know where you would be willing to live long term versus where you would be itching to leave after the first several months. You know where you would be willing to pay more for rent.
Whether deliberately studying it or not, you know what is happening in the local economy, whether strong or weak, whether businesses are coming or going, whether governments are investing in infrastructure and schools.
You have heard anecdotally from parents about their levels of satisfaction or dismay with the schools. You have seen the area grow or decline in population, and any problems associated with that (school overcrowding, dense traffic, slow business in local stores, etc.).
All of these insights come together to give you an edge as an investor, helping you understand when it is a good time to invest and to differentiate good investments from those you should stay away from.
Proximity to your investments is a key to effective management, particularly for those who are new to real estate.
It allows you to visit them on short notice and to drive by periodically to see where the neighborhood is going.
Even if you are not doing the property management yourself, it is important to be able to see the property with your own eyes on occasion and take note of what has changed in the neighborhood since your last visit.
Proximity to your focus location also allows you to be much more effective in seeking new investments. The farther away an investment is, the more rushed you may feel to find a deal on your first visit.
If the location is in your own backyard, not only will it be easier to have patience and wait for the right deal to come along, but it will also be easier to evaluate a larger number of properties with an equal amount of effort.
The more properties you evaluate in an area, the quicker you will be able to spot good versus bad deals.
As with any investment, holding a substantial portion of your assets in a single area generally results in more risk.
Investments in a single location will generally move together so that if a large employer leaves town or the neighborhood takes a turn for the worse it could bring substantial losses to your portfolio.
It can be argued that a lack of diversification can be a winning strategy when you are intentionally picking an area that is better positioned for growth than others. Therefore, there is a balance to be struck between risk and diversification.
In my book, one location is not diversified enough, but 2 or 3 may be all that it takes to increase certainty that a single event will not bankrupt your business.
Diversification does not have to mean investing in different states or even cities.
Simply branching out to a community 15 miles away can provide a substantial amount of diversification if its economy relies on a slightly different set of employers, is in a separate school district, serves a different demographic, and/or is governed by another municipality.
Pay Attention to Employment
Employment is obviously important in almost every community (exceptions are retirement and vacation destinations where most of the money comes from elsewhere).
Low unemployment rates and good paying jobs are two big signs of a thriving community that will generally lead to lower vacancy rates, higher rents, and higher real estate values.
Of course, the idea is to get in on the ground floor of employment growth. If employment is already at its peak, you may have missed out on appreciating prices and be buying at too-high-a price to make a decent return on investment.
My favorite ways to find out about new businesses are to check with the local chamber of commerce, keep an eye on the local newspaper, and of course check with your local Realtor.
The chamber of commerce works with prospective new businesses, and will typically be able to give you a good picture of business activity in the area.
The biggest businesses will get attention in the paper when they are coming to town, expanding, or contracting, sometimes even when these are still just rumors.
The paper also typically contains a legal section where businesses are required by law to post before they open their doors.
Always ask your local Realtor what she knows about the employment picture. A good realtor can be a wealth of knowledge about these things since it is integral to her business.
The employers that are of most importance to economic growth are those that are bringing money into the community from other states, cities, or countries.These are the employers that really drive a local economy rather than those who only derive revenue from the residents themselves.
For example, a steel mill with hundreds of employees may generate steel for use all over the nation and may import product to China. A construction company with the same number of employees, however, may do all of its business locally.
If the steel mill goes out of business, millions of dollars will leave the community and there will be much less demand for construction, causing the construction company to decline as well.
The ripple effect from the loss of these dollars in the community may spread to thousands of other service-oriented jobs such as realtors, retail sales, medical professionals, and hairstylist.
This is a bigger impact to the community than if the construction company went out of business on its own, which has little affect on revenue from the steel mill since its largest customer base resides elsewhere.
Value Good Schools
Find out where the highest rated schools are in your area of interest, particularly if you plan to rent or sell to families with school-aged children.
Schools are a major driving factor that brings families to an area, and they will pay a premium to send their kids to these schools. This, of course, has a positive effect on both rents and prices.
I use Zillow.com to get school information since it also contains value and rent estimates among other information that investors are interested in.
Zillow gets its information from GreatSchools.org, but there are several other good ratings websites that you can explore and compare.
Demographics are also an important factor in real estate investing.
If you own a single bedroom apartment in a community full of 2-child families you will have much more trouble renting it than if the same apartment was next to a university.
If you plan to build an apartment complex in an area that is shrinking in population size, you will be fighting with more and more rental unit owners for the same tenant, and rents are bound to decrease.
One major demographic trend today is the baby boomer generation retiring and migrating to warmer climates such as Arizona and Florida. No matter what type of investing you are doing, this is a fact that you should be paying attention to since a lot of money will be migrating with this generation over the next decade or so.
Another demographic trend is that some cities are experiencing residential growth in their downtown areas as people migrate from the suburbs to live in more urban environments and take advantage of public transportation.
If you are investing in one of these cities, you may be wise to avoid investing in bedroom communities with long commutes and instead look to denser housing near major employment centers.
The Census Bureau and the Bureau of Labor and Statistics are two good sources of demographics data.
Buy in the Path of Progress
Buying in the path of progress involves finding out where investments are being made by governments, developers, and other investors, and buying property in this area before the ensuing appreciation has leveled off.
This is a simple concept, but is not foolproof in practice. There is risk here that progress will stop before reaching the street you have invested in, or that the economy will cool off and other investors will pull out before projects are completed, leaving you with a property that you may have pumped far too much money into relative to its value.
You may also end up in bidding wars with other investors who have the same idea as you, ultimately driving down the return on investment afforded by the listed price.
In general, however, the streets where gentrification is occurring will appreciate in both rents and prices more quickly than their neighbors, and is a factor that should be considered as you search for an investment location.
To summarize, the best place to invest is not the same for every person. It is individualized based on the areas you are familiar with, where you live, and the properties you already own.
It is influenced by employment, schools, demographics, and gentrification among other trends. Study these factors and stick to where they point.
What additional tips would you give if you were scoping out a location for an investment property?
Be sure to leave your comments and insight in the comment section below: