Did you know that the dynamics of markets (a.k.a. cities) for real estate investing changes? They change all the time actually. One year there may be a market that everyone is buying in, like an investor feeding frenzy, but that market will change, guaranteed. Especially if it experienced an investor feeding frenzy.
If you are already trying to tie what I’m saying to your situation and it’s not making sense, it may be because you only invest in your local area. If that’s the case, that is totally fine. This explanation is more for those who are willing, or interested, to invest outside their local market.
A Quick Blurb on Investing Outside of Your Local Area
This could easily turn into a long blurb with a lot of arguments back and forth about whether it’s better or safer to invest in your own backyard vs. invest long-distance, which is likely to forever remain a heated debate, but I’m not going to hit that here. Of course a lot of that debate will hit on too, where is your own backyard? If it’s somewhere in random Arkansas in a cute little suburb, it might be just fine to invest there. But if Los Angeles is your own backyard, it doesn’t make so much sense.
But regardless of all the different sides of the debate, I want to point out one argument for investing outside of your local area, which will lead further into this discussion about the markets. That argument is-
If you always want the best possible returns on a real estate investment, you have to be willing to change what market you are buying in because the best market to buy in is always changing.
The Dynamics of a Real Estate Market
For simplicity purposes, understand that I am talking only to the investing side of real estate. What I say may or may not be different if thinking of real estate as a whole, but know that I am thinking of investing markets. Also to keep it clear, I’m thinking mostly of rental properties. For flipping or any other facet of investing, you’ll have to adjust the information accordingly.
The most basic way to think of a real estate market is by picturing a bell curve.
You’ve probably thought of real estate in bell curve fashion already because of the famous line- “buy low and sell high”. That means buy when the market is at the bottom of the curve and sell when it’s at the top. It’s probably the most fundamental rule in real estate if you are seeking to land a profit. This rule pertains to what I’m about to explain as well, so keep it in mind. What I’m going to do though is change the wording a little bit. I want you to look at this bell curve and think of it as an “Expansion Cycle”. A market is going to expand and contract continuously. The level of that fluctuation is actually what can make a market so advantageous for investors. The fluctuation in the picture above suggests a fairly dramatic growth and decline. If you continue the line on further and that same pattern continues, you have a market that grows hard and dies hard in terms of real estate. The alternative to this pattern is a much flatter line. It still grows and declines, but at much less dramatic levels.
Both versions of the Expansion Cycle, the more dramatic one and the less dramatic one, exist in real life real estate markets. Remember how Phoenix, Memphis, and Atlanta were sooo popular for investors at one point? Investors are even still buying there now, but remember a couple to a few years ago when those cities were all the talk? They were like the hot spots, had to buy there, feeding frenzy markets. Do you know why those cities became so advantageous for investors? It is because those cities followed the more dramatic bell curve version of the Expansion Cycle. Those cities, when the big market crash happened, crashed HARD. What was pseudo different about those cities than other markets that crashed so hard was their potential for extensive growth back up the Expansion Cycle. This assumed growth was due to industry, job growth, population growth, and other factors that showed solid evidence that the city would not only recover from the crash, but recover to very high levels. Some cities around the nation may have crashed hard but they didn’t, and still don’t, have the industry or population to support a bounce-back. Phoenix, Memphis, and Atlanta did.
So during those “feeding frenzies” you heard about in those three cities, the cities themselves were at the ‘bottom’ of the bell curve, and investors had every reason to expect a big bounce-back. That is how a dramatic Expansion cycle works- the bottom of the curve is considered the Infant Stage and the top of the curve is considered the Mature Stage.
What about the more flat-lined bell curve though? Where does that apply? Well, the best example is the Midwestern cities. Indianapolis (“Indy”), Kansas City, places like those. A flatter bell curve-shaped Expansion Cycle suggests a much more stable market. Stable in the sense that a crash there isn’t going to be as dramatic or detrimental as with other markets. For example, Indy only declined about 7% during the big crash a few years ago, which in comparison to most cities, was very minimal. Indy is also considered to be the #1 Most Stable Real Estate Market in the U.S. This conclusion is based on the lack of severity in fluctuation of that bell curve, if you were to draw one. That’s how all of these things tie together.
To further tie these together, let me give you a top-level view. Let’s say you want to buy a rental property and are trying to decide what market you want to buy in. You have two options for markets:
- A market that follows the dramatic bell curve
- A market that follows the flatter version
If you buy in the more dramatic market (and I assume you are buying smart and buying at the Infant Stage of the cycle), you are likely to see a significant amount of appreciation with your investments because it is likely to follow a more dramatic rise to the top of the cycle. If you buy in the market with the flatter bell curve, you aren’t likely to see a lot of appreciation, if any. The trade-off here is risk. While the more dramatic market is likely to grow harder, it is also susceptible to harder crashes as well. The flatter market isn’t likely to help you with appreciation as much, but it’s also going to withstand a crash better too. So in deciding where to buy, you have to decide a) what you want more in terms of appreciation potential and b) how much risk you are comfortable taking. I personally go for the appreciation potential cities over stable markets. Why? Because worst case, if the market crashes, I just don’t sell the property. Value of a property only matters if you are buying or selling. But if a property appreciates, I can use that equity to fund more investments. But that is my personal comfort level, there is absolutely nothing wrong with choosing the stable route if you prefer.
So now you understand how a real estate market works. How does this, or how should it, impact your investment purchases?
Where to Buy Investment Properties
You already know to ‘buy low’, which means, buy at the bottom of the curve. In the Infant Stage of the Expansion Cycle, the potential for growth/appreciation on your investment property is maximized. Also maximized is your cash flow because you bought the property at the cheapest price you could. Excellent! You can also buy at any other point in the Expansion Cycle, especially because it can be hard to time the Infant Stage sometimes (not so much from the perspective of seeing one but maybe you don’t have the money just yet to buy or you aren’t comfortable with it enough yet to hurry and make a decision). So yes, you can buy when a market is not in the Infant Stage, absolutely. It is not as advantageous to your wallet as it would be if you bought sooner, but as long as you are still looking at positive returns, go for it.
In thinking of some real-life examples of the difference in stages of the expansion cycle:
- Chances are you will always be able to buy in Indy and see positive returns, no matter where on the bell curve the market is. There are some exceptions to that of course, but for the most part, whether the cycle is in the Infant Stage or Mature Stage, buying investment properties in Indy is likely to be fine.
- Phoenix was huge for rental properties a few years ago. The returns were high and the appreciation potential was even higher, probably the highest of any market. Once Phoenix hit the Mature Stage on the Expansion Cycle, however, you could no longer get positive returns on rental properties. Phoenix was done as an investors’ market.
- Atlanta, while very much following the same pattern as Phoenix, also experienced a lot of growth following the Infant Stage, but whereas in Phoenix you could no longer get positive returns, you still can in Atlanta. However, fact still remains, Atlanta is now much closer to the Mature Stage than it was a couple years ago which does make it less advantageous than it was when it was at the Infant Stage.
When you are analyzing a market for possible investment, you want to think about where it is in the Expansion Cycle and what that means. Where it is may or may not impact the worthiness of the investment, but regardless it should be considered.
Moral of the Expansion Cycle Discussion
My reasoning for going through this explanation with you, and don’t take this personally if you are who I am about to address, is because I continue to meet several people who are dead-set on buying in Memphis and Atlanta. Now don’t get me wrong, and I should probably put this in bold letters, Memphis and Atlanta are still fine places to buy rental properties, but they are not the same markets they were when you initially heard so much about them as being the best places to buy and everyone was buying there and the best deals were there. If you choose to buy in Memphis or Atlanta and your decision to buy there is based on good reasoning, then I support you all the way. The investors who I am addressing here are the ones who are dead-set on buying in either of those cities simply because they heard that they were the best markets to buy in. That advice was from three years ago. You have to understand that what is accurate three years ago (sometimes even only one year ago) is not necessarily accurate today. Sorry to tell you, you missed the boat. Not the boat of positive returns, but the boat of insanely out of this world returns. If we are talking about Phoenix, you actually did miss the boat altogether, but Memphis and Atlanta still have deals. They just aren’t what they were a few years ago. Which is fine and I can’t emphasize enough that both of those markets are still investor-advantaged markets. But both of those markets have long been taken out of the Infant Stage because of the feeding frenzies that happened there, both by individual investors and hedge funds. Inventory has gotten very low in comparison to what it was, which caused prices to rise significantly, which has caused a decrease in returns from what they were when the frenzy was going on.
Conclusion- Be fully educated on where you are buying and more importantly, why you are buying in a particular market. Don’t rely on expired data or information. Moreover, believe it when you hear that your time is limited to buy in particular market! People aren’t telling you that just to get you to buy fast, it’s a reality in some markets. Dallas? Dallas this year has been crazy! Inventory has gotten minimal to none. Several investors wanted to buy there but inventory ran out. Literally.
Any guesses as to where the next big investor market will be? We know Phoenix, Memphis, and Atlanta happened, Dallas happened this year… where is next?