Many investors frequently make the often damaging (or fatal) mistake of buying property with little to no consideration of the neighborhood and market the property is in. This can be one of the greatest mistakes an investor can make because if you buy in the wrong neighborhood or market, you’ll be stuck with the problems that come with it because of its location. Your only option may be to sell the property at a loss.
I’ve literally seen dozens of investors buy nice rental properties that would impress most people, but they happened to be in distressed neighborhoods with blighted properties, and in depressed markets with high unemployment and a decreasing population.
It is more important to be concerned about the overall market health and its future prospects than it is to get lost in the potential cash-flow and other “numbers” on the property. They’re all important of course, but purchasing based solely on the property without considering the bigger picture of the market and neighborhood is like trying to sail a ship against strong headwinds.
If you don’t start with the right market and neighborhood, over time you will experience more tenant turnover, shorter lease terms, increased late payments/defaults, and decreased or negative appreciation.
There are several local economic factors you’ll want to consider before choosing a market to invest in.
Employment is one of the most important economic factors related to the current and future health of a market. Simply put, people who have jobs have the income to afford to pay their rent. Those that don’t will not be able to afford to pay their bills, and may be forced to move to find new employment which often involves moving to another city.
The Bureau of Labor Statistics (BLS) and the local chamber of commerce are good places to start for local employment data and trends.
Are more people moving into the market or moving out? This has a major impact on the market as demand for housing increases and decreases based on the total population in a given market.
Take for example the Dallas, Texas market:
A new report released by the Office of the State Demographer shows the population of Texas could double by 2050. The report, Texas Population Projections 2010 to 2050, highlights a population explosion that may well occur over the next 45 years – with much of this population growth expected to come from the large urban counties – Dallas, Harris, Tarrant, Bexas and Travis — with a projected combined population increase of 5.6 million people by 2050.
Also, these numbers exclude the additional population growth coming from natural child births.
This increased population growth creates demand for more local housing which helps push property values and rental rates up, in addition to an ongoing need for good residential housing stock.
Be sure to put yourself on the right side of the trend.
A market with a diversified range of industries offers less market volatility in harder economic times or recessions. A market driven largely by one or two industries tends to be affected harder than more diversified markets, and takes longer to recover afterwards.
Although many investors do well in “one trick pony” markets, it’s best to mitigate your market risk by focusing on markets with a broader employment base.
It’s good to know the condition of the housing market you’re looking to invest in.
Are you in a buyer’s market or a seller’s market?
A buyer's market is what you get when there's more supply than demand. There are more people looking to sell houses than there are people looking to buy houses. In a buyer's market, sellers may have to accept a lower price than they want to sell their property and may have to resort to providing incentives. This is the ideal situation for buyers because they can get a better deal.
A seller's market is just the opposite. The demand is larger than the supply. People have more money to spend on real estate, so sellers will often see several buyers competing to buy their property, which drives up the price. This means that buyers will have to spend more to get what they want. This is the ideal situation for sellers because they often get a better price on their properties.
Median Price Trends
Median price (the midpoint between high and low) is often a very good proxy for indicating real-time market activity. As the median price changes, this can indicate key market movements.
A rise in median price means that sellers are responding to more sales in their local area which means that the local market might be “strengthening” or getting “hotter” – favoring sellers, so they will ask more for their home. A fall in the median price might indicate the opposite – few homes selling at the current price levels which causes homes on the market to drop their price and for new homes on the market to price more aggressively.
A rise in median price could also mean that homes at the lower part of the market are selling and leaving the market. This means that the remaining homes on the market are at a higher price point, which causes the aggregated median price to rise.
Market Inventory Trends
Inventory is simply real estate lingo for “the number of homes for sale.” This stat shows you how much supply is available in the market you are researching. Inventory levels can ebb and flow frequently due to seasonal effects. There’s usually more inventory on the market in the spring-time as the natural rate of real estate activity picks up during this time of year. Alternately, there’s generally less inventory in the fall or winter as real estate activity slows.
Average Days on Market (DOM)
Simply put, the Days-on-Market tells you how long the active properties currently for sale, in aggregate, have been on the market (a.k.a. “time on market”). In other words, of the active listings currently available for sale, how long have they been for sale?
This factor is the average number of days it takes to sell a house in the relevant price range. For example, a market in which a house sells for $150,000 in three weeks is quite different from a market in which the same house sells in six months. The latter is known as a soft market.
In a soft market, sellers can drop prices, give concessions, or wait longer for their houses to sell. The vast majority of homes are owner-occupied, so there’s generally no negative impact to sellers who can’t sell their houses because they can continue to live in them unless sellers are in dire need to move because of a foreclosure, job transfer, or other firm deadline, they’re likely to hold out to get their prices.
TIP: If you’re working with a good and reputable company to help you find or provide you with investment-grade properties then they should be able to advise you on the various markets and neighborhoods as well as provide you with detailed market information such as local economic data and housing trends.