Choosing a Real Estate Market
Updated: Sep 17, 2020
Why Even Pick a Market?
Some may argue that "A deal is a deal" and as long as the numbers work, they're willing to invest.
I would argue, whether you are a deal sponsor or passive investor, this is not a very efficient approach. The most valuable resource any of us has is time, and by casting too big of a net, you will waste A LOT of time.
As a deal sponsor, you will likely need to underwrite about 100 deals to find that one deal you'll end up closing on. Those numbers assume that you are already getting deals from brokers, MLS, cold calls, etc. that fit some criteria.
You may have "amazing deal flow" because you're getting 300 emails a day, but that not only wastes your time but that of those who are sending you the deals.
You may lose credibility too. If brokers ask you what you're looking for and you tell them, "B class 50+ unit apartments in the United States" you likely won't be their first call, and they may not take you seriously at all.
Another practical reason for narrowing down your criteria is the vast differences between markets. If you want to syndicate the purchase of a 40-60 unit B or C class apartment building, you're going to need to raise a lot more money to do that in Los Angeles than you will in Birmingham.
So Where Do You Start?
This should come as no surprise, but you should start in your own backyard. It is there where you are most likely to already have a network and a sense of the market. Proximity is also an advantage in that you can visit properties with relative ease.
If your market doesn't make sense, because it is prohibitively expensive or any other of the reasons I'll be discussing, I still recommend starting with about a 2-hour drive radius from where you live to keep things simple, at least in the beginning. I found myself in this situation when I lived in Washington, DC. I was determined to buy a residential multifamily property (2-4 units), but with a 25% down payment requirement, there was nothing even close to my price range in the hot DC market.
After talking to some people on Bigger Pockets, I found out that prices were much lower in parts of Richmond, VA. Over one weekend, my wife and I made the 90-minute drive down there, looking at about five properties in one day with a realtor. We wound up purchasing a duplex for $85k, something that would've been impossible in DC.
For some, there may not be any good options, even within a 2-hour drive. If that's the case, move on to places where you have "boots on the ground." Where do you have friends, family, or colleagues that can check something out for you or know the market?
Once you have an area under consideration, then you need to examine its fundamentals to determine if it's a winning candidate. The following items are in no particular order, but should all be considered when picking a market.
Regardless of product or service, every business needs to clearly understand who their customer is. When it comes right down to it, our customers are tenants. If you don't have a steady stream of renters, vacancy goes up, and revenue goes down.
So, the first criteria are the size and trends of the population. In terms of size, there is no "right" answer. Many investors like to stay out of the larger cities (New York, Chicago) because of the cost and often lower returns. Small or rural areas can run into a lack of demand issue.
What most investors look for is the "Goldilocks" zone, an area with a big enough population to support current inventory, but with a trend of population growth to ensure future demand and likely rent increases. You may see some places where the population has remained relatively steady. While this isn't necessarily grounds for disqualification, it is worth asking why this is.
An amazing tool for analyzing population, demographics, and income is the Census Bureau's Census Business Builder. You can view various statistics for an entire state or drill down to a specific zip code.
Unless your tenants are independently wealthy, they will need a job to pay their rent. We want to make sure there is a strong base of employment that aligns with your chosen tenant class. You want to invest in Class A apartments? That's fine, but you better be sure there are ample employers in the area who offer the salaries required to pay your rents. The same is true for Class B and C apartments, often referred to as "workforce housing".
Besides having enough employment in the area, you want to ensure there is sufficient diversity as well. Having one large employer for a town can be dangerous. What if another city or state offers them favorable tax rates to move their operations? The loss of hundreds or thousands of jobs in your target demographics can be devastating not just to the community, but also to your business plan.
Diversity is also essential in terms of industry. Right now, amid the ongoing pandemic, this has become clearer than ever before. I like Orlando, and given it's so close for me, I certainly would have been willing to invest in that market just a year ago, but right now, not so much. Although there is a large medical services sector that is growing, Orlando is heavily reliant on tourism. Disney World (the area's #1 employer), Universal Studios, and the rest may bounce back quickly, but the uncertainty makes it harder to underwrite and forecast a successful business plan.
The Chambers of Commerce in many cities put out statistics on the employers and demographics of their respective cities. Here is a great example from Tampa’s Chamber of Commerce (https://issuu.com/tampabaypartnership/docs/rcr2020_final).
Tenant/ Landlord Laws
This is one of the most important and overlooked aspects of picking a market. For anyone unfortunate enough to have to evict a tenant, they know it’s not a pleasant or uncomplicated process. Depending on the state in which you own property, eviction may seem downright impossible. As an investor on the East Coast, I can tell you Southern states tend to have more landlord-friendly laws compared to their Northern counterparts.
I want to be clear that no landlord or property manager wants to evicts tenants, it comes at great cost both in terms of time and money. But if tenants are violating their lease to the detriment of other residents or simply not paying their rent, then it must be done as a last resort. As a business owner, you need to know you won’t get bogged down in endless legal wrangling to make it happen when it does become necessary. Click on this link to find the relevant laws for every state (Landlord-Tenant Statutes by State).
Of course, I didn't cover every consideration when choosing a market, but these fundamentals should serve as a starting point.
You also shouldn't get too bogged down in this process. You aren't researching for a Ph.D. thesis, so evaluate the metrics, make a determination, and move on. You can also rely on the wisdom of the crowd. Are you interested in the Charleston market? Hop on Bigger Pockets or a real estate investing group on Facebook and ask someone who lives there!
As a deal sponsor, you need to refine your investing criteria to be efficient and be taken seriously. As a passive investor, you should be able to fact-check sponsors and not be wooed by pretty deal presentations.
There's plenty more to come in future posts, so make sure you click here to subscribe. I'll let you know when new posts are out and provide valuable"pro-tips" associated with that week's topic.
Ready to start passively investing in multifamily real estate and want to see if our opportunities might be a good fit for you? Click here to visit our website to learn more or reach out to me directly at Tim@ZANAinvestments.com.