As a real estate investor who invests out-of-state, I get asked all the time what are the best markets to invest in and how do I go about finding those markets. Over the last couple years I’ve discovered five keys to finding a good real estate market to invest in.
When investing in a city, you want to look for a city that is up and coming, and a city whose population is increasing steadily. One way to figure this out is by looking at the history of the city’s population over the last couple of years. This can be done through city-data.com or the Census Bureau. These will give you population data for the last couple years. Some cities have been declining in population, but they might be starting to level off, and that may be your opportunity to get into that market.
For example, over the last number of years Cleveland has been decreasing in population. Currently we’re going into Cleveland because the population decrease is starting to level off and people beginning to stay in Cleveland. We like that.
We like to invest in cities where we can buy-low, and hopefully sell-high in the future. Our strategy is to buy when markets are at their lowest and hope that over time our properties will increase in value. So watching the population of the city is crucial. The more people there are in the city, the more the demand, and more demand means higher prices, which then means more profit for you.
2. Major Employers
When we invest in a city, we want to make sure that it boasts long-term, solid companies, that hire a lot of people and, hopefully, will hire more and more each year. These major companies can drive a city.
For example, FedEx is headquartered in Memphis and it is constantly expanding its operations in that city, hiring more and more employees. FedEx is likely to be around for the next ten to twenty years as well. Product shipping is not likely to go away anytime soon and FedEx helps a lot of e-commerce websites to ship their products. This is why we would invest in Memphis.
In other cities you want to make sure that the companies are going to be around for the time horizon of your investment. You should also see that there is more than one such company. Memphis has FedEx as a major employer, but there are many other companies that are also starting to move to Memphis and are hiring a ton of employees year over year. So you want to make sure that you’re investing in a place that has some very solid employers.
One way that we check this is with Forbes.com. You can actually just search up the city and then type ‘major employers’ into google, and it will come up with a ton of different companies in that city.
3. Diversity of Industries
When we invest in a city, we want to make sure it has a multitude of industries. For example, FedEx is a major employer in Memphis, but luckily it also has some other major industries, such as health care. This helps level the playing field for the city. Normally when we invest in a city, we want to make sure that no industry has more than 25% of the total employment pool.
For example, in Memphis the transportation industry is about 22% of the total workforce. The reason why we want to make sure of that is because if one industry is to go out of business tomorrow, the whole city is not at the risk of going down. As was the case with Detroit which was run by the automobile industry. We want to make sure we’re protected of that for our long-term rental properties.
We want to invest in a city that has no major industry with more than a quarter of the total employment pool, so that if one industry disappears due to technology or automation, our rental properties will still hold some value.
4. Finding a Market’s Rent-to-Value Ratios
This ratio is very important if you’re in the buy-and-hold space. It is calculated using the median price of a single-family home in a city, and then using the median rent of a single-family home in the city. Ideally this data should be from the same source, but we will use whatever data we can get to gauge this information. Of course, it’s not going to be dead-on, but it gives you a good idea of the city’s rent-to-value ratio so that you can plug that into your calculator and compare different cities based on the median house price and the median rents.
We have a list of 30 cities in the US and we calculate these ratios on an ongoing basis to make sure that if one market has a higher rent-to-value ratio, then that might be a place we want to invest in. The key number that we look for is normally over 1.25% rent-to-value ratios. I’ve seen as high as 1.8%. I know a lot of people say that 2% is where you should target, but if you calculate the other data like the population or major employers or industry diversification, you’ll find that there’s a reason why there’s a 2% rent-to-value ratio in some of these cities.
I would say anything over 1% is a good market to be in. Within those markets you could find tiny little pockets that can get you closer to that 2% rent-to-value number. And the reason why we like it to be over 1% is that we have figured it out after analyzing tons of deals over the last couple of years. For example, if a property is listed for $100,000, it has to be rented for at least $1,000, which is 1% of the value in order for the property to cash flow.
Remember – this is just a rule of thumb. It’s not something that we take to heart. It’s just something that we can use to filter through all the deals coming to our desk and first look at those deals which make more sense on paper.
5. Price Range
If you’re just getting started in real estate, price range is something you definitely want to look at. For example, there are markets like Dallas and Austin, Texas, which are great markets, but you’re going to pay a much higher price. You’re going to pay $200,000, $300,000, and maybe it’s going to rent for $2000, $3000. But is that really what you want to do for your first property, or would you rather buy five or six properties for the same amount of money to diversify a little bit more? That’s something I would look into to find a key market.
When we first started investing, we wanted it to be less than $100,000 price range, and there are tons of markets in the US where this makes sense. If they have a solid population, some major employers, industry diversification, and the rent-to-value ratios make sense, then that is a great market. There are definitely markets out there which can fit all these different factors.
To figure out the price range of a market you can go on go online to just type ‘median single-family home value for Memphis’. Hopefully it will bring up some information about the median house price in that city. From that you can get an idea of what an average home will sell for.
I would recommend staying in markets where that median house value is anywhere from $70,000 to $100,000. Normally these markets are pretty solid blue collar markets, and that’s where we’re investing too. Of course, in the future we may be looking to move up into different markets, a little more white-collar markets, but for now we are staying in the blue collar low cost markets.
I’d rather test my processes in blue-collar neighborhoods where I can have more properties and more diversification.
Those are the five keys that I would use to find good rental markets. Of course there are tons of articles and blog posts out there which share information about markets that are good for investors. Just keep in mind that a lot of other investors are looking at those as well. There are enough deals to go around, sure, but there are tons of markets out there that people aren’t talking about right now that could see a huge jump in the future.