Summary: In this article, I’ll share my tips and strategies for how to choose a strong real estate market to invest in this year and in every year. I’ll highlight 7 big questions you need to be asking about location, market timing, trends and more to help you understand where you should make your next investment.
Introduction
Question #1 - Is it located near a big city?
Big cities offer lots of jobs, which in turn attract people. If a city has a large population there’s a pretty good guarantee you’ll be able to find a large number of renters (more on that later).
On average, about 40 percent of people rent in most areas. That said, you don’t have to buy a rental property in a big city. It’s best to consider the entire metro area and then decide which neighborhoods would make the best investments.
Plus, suburbs typically have newer amenities, better schools and lower crime. Follow the path of progress. Look to where new freeways, hospitals, and businesses are moving.
Question #2 - Is it in a “good” market?
Determining what makes a strong real estate market or a good real estate market starts with understanding market cycles.
As a general rule: buy in a buyer’s market and sell in a seller’s market.
One easy way to determine a buyer’s vs seller’s market is to check out how long a property takes to sell. In real estate lingo, this is called DOM or Days on Market. Keep in mind that every market will have a different average DOM.
For example: If the average DOM is between three to six months, that would be considered a healthy market. Longer than six months would be considered more of a buyers market. Whereas if homes are only on the market for an average of 30 days, this would be a very hot market for sellers.
Look at inventory levels. Housing markets that have a 5-7 months supply available would be considered balanced. Less than 5 months supply would create a seller’s market and more than 7 months would likely be a buyers market.
Evaluate the average price of existing homes and whether they have been rising or falling. Month-to-month price fluctuations are fairly common and shouldn’t spook potential investors. However, if prices have been decreasing for more than three consecutive months–it would be worth finding out the cause behind it before moving forward.
Rental property investors should also check out rental demand in the area. There are plenty of online resources to find these numbers. You can also reach out to local property managers to get a first-hand pulse on rental demand.
Question #3 - Is it a booming market?
When the price of homes goes up quickly it’s called a booming market. In this type of housing market, there will usually be an influx of people looking to buy to get in while the getting’s good. Because booming markets are unstable and unpredictable, it’s generally a good idea to avoid these areas. Markets always level themselves out, so as quickly as prices went up they could come down. If there’s a sudden drop, those who bought during the boom will now own overinflated homes.
There are scenarios where a booming market could make a great investment–but only if you buy early enough and sell before it’s too late. If you’re not sure if an area is getting to the point of oversaturation, compare the number of building permits to job growth. If fewer jobs are coming to the area than new homes to be built, then you know a housing bubble is already beginning to form.
Note: this rule doesn’t apply to vacation homes and retirement communities because jobs are not what is attracting visitors.
Question #4 - Does the area have low average home prices?
Housing markets with low average home prices can offer tons of affordability. Look at the average price of homes sold compared to average incomes in the area. If the average home price shouldn’t be more than 3 or 4 times the average income to be considered an affordable market.
Affordability affects cash flow potential. In unaffordable markets, like New York or San Francisco, median home prices might be 10 times higher than average income. Owning an investment property in an unaffordable market makes it very difficult to produce any cash flow. The best cash flow markets are those where average home values are just double or triple average incomes.
Question #5 - Does the market have strict local landlord laws?
Before buying in any market, it’s important to find out how strict the landlord laws are. Investors always want to own rental property in places that protect landlords and not just tenants.
Landlord-friendly states can save property owners loads of money and offer a level of security. If your tenant isn’t paying rent, you’re still on the hook to cover all the expenses. And if you can’t afford to own the property without rental income, landlord protections provide a safety net to evict a tenant quickly, if they ever stop paying.
Question #6 - Does the real estate market have job growth and population growth?
I touched on this above, but it’s important so we’re going to dive in deeper.
There are three main indicators to help investors identify strong real estate markets. These three indicators are: job growth, population growth, and affordability (which we touched on above).
Job growth is important for real estate markets because jobs bring people. If there is job growth there’s a good possibility that population growth is happening too. Now, there are a lot of real estate markets out there with huge populations and lots of jobs, but they aren’t a good place for investors to buy. That’s because a strong housing market needs to be not just growing in population and have lots of jobs, it also must be affordable.
Sticking to these three key indicators will help any investor identify strong real estate markets in 2021 and beyond.
Question #7 - Is the market right for your investing strategy?
Before choosing a real estate market, investors need to decide on a strategy. Some real estate investors are looking for ongoing income in the form of cash flow and others want long-term equity growth. A good way to diversify a portfolio is to invest in both cash flow and equity growth properties.
Cash flow comes from rental income and is considered liquid. Equity is the value of a property minus what is owed on it.
Cash flow investments are a good opportunity for anyone, but are best for:
- Retirement – Not working while earning money…that’s passive investing and exactly what retired people are looking for.
- Leverage – Borrowing money to acquire the asset and then having tenants pay off that mortgage for you through cash flow builds wealth quickly.
- Diversification – You can sell an expensive property and exchange it for more affordable cash flow properties, spreading out the risk and creating more income.
It can be difficult to achieve profit from equity growth if you don’t buy a property for less than its market value.
Equity growth strategies in real estate can include:
- Flipping Houses – Buying a property for a discount, fixing it up and selling for a profit.
- New Construction – Getting land for cheap, building, and selling for a profit
- Paying down a mortgage over time.
- Buying in the path of progress, where prices tend to go up over time.
Equity growth can be great for:
- First-time Home Buyers / Beginners – owning your home is a great start to any portfolio–even if you don’t have plans to invest in real estate down the road. Instead of paying rent, you can pay down the mortgage over time and own the home free & clear someday.
- Diversification – If you buy several properties in growth markets, you can put less down and grow more equity over time.
- Professionals looking for tax savings – The money you save on taxes by owning real estate can go toward buying more property or paying down loans
Determining your financial goals should give you an idea of how to determine the best real estate market for your investment. So figure out what you are looking for? Cash flow? Equity growth? Both?
And Finally, Don’t Underestimate the Importance of a Good Property Manager
Finding a good property manager in 2021 has never been more important. With the health implications associated with COVID-19, all necessary safety precautions must be diligently adhered to. Processes that previously took place in person have had to be taken online. Landlords and property managers have had to adapt quickly to these changes and those that haven’t may not survive. A good property manager will work closely with tenants to help them through these difficult times as well. And a good property manager will be well aware of local, state and federal laws to keep you compliant.
