Via Realtor.com, I read a post from BiggerPockets.com about Factors to Consider when Choosing a Market for Real Estate Investment. They listed the three below as being the most important. However, one which they left out I would have to consider at the top of my list, LOCATION.
1.) Employment and Job Growth. In my opinion, monthly cash flow is great, but I would only invest in a market if there is an opportunity for long term growth as well. Historically, the markets with steady appreciation and population growth do so as a result of strong job growth. I look for markets that have a friendly corporate environment, strong employment centers and data that indicates continued job creation in the years to come. This is typically a great indicator that the population will continue to increase, the demand for real estate will be strong and that prices will steadily rise as a result.
2.) Price to Rent Ratio. Some people call this statistic the “Gross Rent Multiplier” which is essentially just the price of a property divided be the gross income. This is by no means a detailed analysis of a particular property, but a high-level approach to begin to understand a market by analyzing average price to rent ratios.
For example, if you were to look at a market in Southern California where a typical investment property would cost approximately $300,000 with rents around $1,500/mo, you would calculate the GRM to be around 200. Contrast this with a market like Atlanta, GA where an investment property could be purchased for $80,000 with rent of about $1,000/mo. The average GRM in Atlanta would look much stronger at 80 compared to 200 in Southern California.
3.) Legal Climate. Thirdly, I would want to invest in a market that was not unfriendly to landlords and investors. Every state and local municipality is going to have differences that relate to interpretation of contracts, time-frame for evictions, lawsuits against landlords, etc. I think it is critically important to invest in jurisdictions that allow investors to evict tenants in a reasonable amount of time. Putting yourself in a situation where a tenant could live rent free for a long period of time while you deal with a cumbersome legal process is a quick way to an unprofitable investment.
I live in the Napa Valley and sell real estate here from Yountville and have been doing so for nearly the last 30 years. Given the world wide notoriety for the name Napa Valley, there is a constant stream of people coming here and wanting to buy real estate. Add to this a limited amount of buildable land remaining, and you have what I call a Napa Valley factor, almost every investment property does not make economic sense and many investment purchases are bought because of what this area is, LOCATION. Thus almost every investment property I have analyzed for my clients do not deliver the best cash flow possible for their investment. Yet a good percentage of these still elect to buy in the Napa Valley.
Even with the recent rise in rents, they have increased here 10 - 20 percent over the last two years, many single family homes and especially 2 - 4 units require a substantial down payment to break even before taxes. Below I have chosen a couple of actual typical examples in Yountville based upon being in good condition, you don't have to put any money into the property initially, and average rents.
23 Forrester Lane, Yountville (click on address to see my proforma) Assumptions: purchase at $540,000, rents at $2,000 per month, loan interest rate of 4.5%. You would have to put 61% down in order for this to break even before state and federal tax considerations.
1 & 3 Burgundy Way, Yountville (click on address to see my proforma) Assumptions: purchase at $800,000, rents at $2,000 and $1,700 per month (this is a duplex with one side with a private swimming pool), loan interest rate of 5.0%. You would have to put 49% down in order for this to break even before state and federal tax considerations.
So why do these properties continue to sale here, LOCATION, with approximately 25% of homes sold as investment sales (rentals), 25% are second homes and 50% owner occupied. Granted about half of the investment properties sold are bought by buyers who rent for some period and eventually move into, often when they retire, and a few get converted to second homes.
If you would like additional info on investment properties or would like me to run a proforma for something you already have in mind, please contact me below.