Eight Factors to Consider When Selecting the Right Real Estate Investment Market
Investing in residential real estate has many benefits, including the ability to create generational wealth and spur local economic development, but how does an investor select the right market to optimize these benefits? While there are many aspects to consider when selecting a new market for investing, the most important factor is the long-term viability of the market.
Measuring the long-term viability, or ‘investability,’ of a market might sound like a daunting task…because it is. The process could take months or even years filled with research to complete. But here are eight helpful factors to consider when selecting a new investment market.
- Job centers/economic diversity
- Pricing and leverage
- Vibrant culture/community
- Median age of the population
- Transportation
- Path of development
- Asset class: single-family vs. multifamily
- Local zoning laws
- Job Centers/Economic Diversity
An investor should identify where the job centers are located when selecting a new investment market. Whether in the CBD (Central Business District) or suburbs, job centers create salaries and wage growth for local workers. The higher the salaries and wage growth in an area, the more consumption, sales and services occur. Vibrant job centers create jobs for hundreds of thousands of people and spur both rental and investment demand. In turn, demand creates supply from developers and home sellers.
Examining job growth over the past 10 years, as well as forecasted job growth in a market’s main job center is critical to selecting a new investment market. Another consideration is the diversity of the microeconomy. For instance, does the market have an array of employment opportunities in varying sectors, such as professional services, transportation and healthcare sectors? Or, is the market too heavily reliant on one particular sector, such as hospitality?
Understanding long-term job growth is crucial when looking at specific markets. If a market is firing on all cylinders with booming job centers and job growth, it will have a major impact on other crucial market demographics. Strong long-term job growth prospects indicate that in-migration and population growth are positive.
2. Pricing and Leverage
A property’s asking price, combined with an investor’s financial wherewithal, plays a pivotal role in market selection. In fact, pricing is the most critical factor for many investors. Many seek out properties with high cap rates—anywhere between 5% and 8%—given the market’s geographic location.
Pricing, however, should only serve as a jumping-off point. A market with affordable real estate could also have low-quality schools and high crime rates, so many other considerations that follow should be factored into the market-selection process.
Given the low cost of debt capital, it may be more beneficial to take advantage of low interest rates and government programs when investing. For first-time home buyers, a U.S. Federal Housing Administration (FHA) loan, or owner-occupied financing, allows a buyer to put down 3.5% of the purchase price as a down payment. This helps an individual purchase an investment property if they are unable to put down the typical 20% to 25%. In addition, this type of leverage becomes extremely helpful in the context of our current housing climate.
- Vibrant Culture
While more esoteric than the other factors, identifying a vibrant culture and community remains important to the market-selection process. For instance, in the emerging Arvada, Colorado market, there are ample cultural activities, including the Tartan Festival, the Blues & BBQ Festival, the Sustain Arvada Festival and the Harvest Festival. More than 100 restaurants and shopping venues are also located in the city, according to the local visitors’ and convention bureau website.
In less than 25 minutes, Arvada residents can travel to Union Station via train to partake in all of downtown Denver’s cultural activities, including the Denver Art Museum, the Museum of Contemporary Art, the Colorado State Capitol, the booming 16th Street Mall and much more.
A vibrant culture and community attract residents to a market, which results in increased demand for rental units.
- Median Population Age
The age of local residents has a surprisingly powerful impact on market selection. Although millennial real estate investing trends have captured countless headlines over the past five years, in reality, this generation has limited spending power. Since they have limited funds and have more debt (student loans and credit cards), they don’t have the ability to put more money back into their community.
Instead, generation X and baby boomers have more disposable income than their younger counterparts. The aforementioned generations also tend to amass more savings. The peak age for spending on housing is 44, according to CoreLogic. Therefore, a savvy investor should research age demographics when selecting a new investment market. - Transportation
Sound transportation infrastructure positively impacts real estate investing. Public transit options like heavy rail, light rail and buses enable employees to quickly and conveniently reach their jobs. Well-planned freeway systems and roadways with short commute times to job centers are also essential to selecting real estate.
The Environmental and Energy Study Institute (EESI), the American Public Transportation Association (APTA), and the National Association of Realtors (NAR) found that mobility options create value for residential, multifamily and commercial real estate investors. Between 2012 and 2016, residential properties with access to heavy rail, light rail and bus transit systems commanded a higher median sales price: between 4% and 24% higher. Similarly, commercial property values grew between 5% and 42%.
Transit-oriented areas also bring lower transportation costs to residents, giving them less reason to own cars and yet giving them better access to jobs.
From a sustainability perspective, bicycle paths and markets with high walkability scores have become increasingly important to renters. As a result, savvy investors should also consider investing in markets with a variety of transportation options.
- Path of Development
To determine whether a site is viable for acquiring a property in a new market, an investor should examine the path of development, or viability of the land. The National Association of Home Builders (NAHB) recommends walking the subject property and taking site photos, considering rock outcroppings, low-lying areas, floodplains, wetlands, high points and ridge lines. Sounds and smells, views and vistas and unique natural features should also be taken into account.
An environmental professional can guide investors if more technical concerns arise. For example, if they need assistance identifying whether the land is characterized or exposed to poor soils, soil erosion, geologic hazards, ingress and egress limitations, surface drainage or a high-water table. They can also determine if the market has a high number of industrial facilities or brownfield sites. These factors play a part in determining how to select the right market. - Asset Class: Inventory of Single-Family and Multifamily Rentals
A buyer should identify the number of single-family rental (SFR) housing units, as well as the number of multifamily units in a new market. Generally speaking, there are more multifamily rentals than SFRs since people tend to be owner-occupants of those structures. A number of online resources should have this data, such as Zillow and multiple listing services (MLSs).
Knowing the percentage of SFR vs. multifamily rentals will help determine which type of product to acquire. Since SFR tends to have more square footage, bedrooms and yard space and is in low supply across the country, an investor can often collect higher rents than they can for a comparably sized multifamily property.
- Local Zoning Laws
Local zoning laws play a critical—but sometimes overlooked role—in the market selection process. Stringent zoning laws often place significant upward pressure on pricing. For instance, San Francisco and New York City typically rank as the most restrictive markets for development. These areas tend to have as many as three or more different entities that must approve a project, according to the National Bureau for Economic Research. In addition, there is a more intense level of involvement in the regulatory process reported on the part of public and local officials in these markets. Also, these cities are likely to have open space requirements and exaction fee programs imposed on builders.
On the other hand, the price of construction tends to remain in line with asking prices in regions with less-restrictive zoning laws. Emerging markets in Arizona, Utah and Colorado fit into this category, although some of these markets have passed sustainability-related zoning laws that aim to protect renters, properties and the environment. So, a market with long-term planning and zoning laws that protect community interests may end up being a seasoned investor’s best choice.
The market-selection process includes many variables and caveats, along with months or even years of research. Utilizing a full-service real estate company that specializes in local market investing and brokerage will simplify the entire process. Not only does real estate have the ability to change the trajectory of an investor’s life by helping them acquire wealth, it has a significant impact on future generations. As a result, selecting the perfect market should be of utmost importance to both first-time and seasoned real estate investors.
____________________________________________________________________________
ABOUT THE AUTHOR Vincent Deorio is Vice President of Growth at Atlas Real Estate, a full-service real estate company specializing in investment brokerage, property management and institutional acquisition. For nearly a decade, Deorio has served as a principal and consultant for a variety of real estate investment and finance companies, including The Deorio Group, PierFund, West Realty Advisors, LLC and Canter Companies. In all, he has deployed more than $1 billion across multiple real estate markets and asset classes, for both institutional and private capital partners. Contact him at vincent.deorio@realatlas.com