“Where to buy” is probably the most fundamental question in real estate investing. We’ve all heard the adage “location, location, location.” The concept seems simple enough, but how do you actually identify good locations. What makes a location good? Better yet, what will be good in the future? Here we’ll discuss our approach to market selection, and how we use market data to help us make good investment decisions.
Location is obviously critical. You want to identify good metro-markets, sub-markets, and even micro-markets. Real estate investing can be hyperlocal, meaning that the four quadrants of the same intersection, especially a major intersection, can have very different characteristics and dynamics. We’ve all seen this before, you’re walking down the street in a vibrant area hustling and bustling with people visiting bars, restaurants, boutiques, and living in nice condos, then you go down one more block and you’re fronted with vacant buildings, boarded windows, and front yards eating cars. So, where do you start? We start at thirty thousand feet of elevation, and then we work our way down to ground level.
Metropolitan Statistical Area (MSA) (30,000 ft)
At thirty thousand feet, we’re looking for large macro-economic indicators and trends at the Metropolitan Statistical Area (MSA) level. We use MSA data instead of city data because MSAs encompass the broader market including surrounding cities and suburbs. We look at a long list of variables including job growth, population growth, median household incomes, multifamily rent growth, vacancy, education, and unemployment. To get a good frame of reference for what these variables tell us in the context of market comparison, we use a proprietary data analysis tool which considers over 500,000 data points to rank 382 markets across the country based on the variables listed above. With this tool, we can easily identify the markets that offer the most promising fundamentals as well as see how markets are changing and improving over time.
Our approach is sophisticated and is something we enjoyed building; however, you don’t necessarily need this level of complexity to identify strong markets at a high level. You can easily visit the Wikipedia article “List of metropolitan statistical areas,” scroll to the table of MSA populations from 2010-2019, and sort the table by percent change. This will give you a really good picture of what areas are seeing the most growth. Then you can drill down from there. It’s important to look at more data than just population growth, but population growth is highly correlated with general economic growth, which makes it a good place to start. You can also get job growth and employment data from the Bureau of Labor Statistics.
Source: Wikipedia
Source: Wikipedia
Operational inefficiencies at the asset level such as below market rents, lack of capital investment, and poor property management can create opportunities in any market.
Something to keep in mind: Just because a market doesn’t rank highly in our tool or show strong job and population growth in your Google search, doesn’t mean you can’t find good opportunities in these markets. I like to use Cleveland as an example since I grew up there. Cleveland ranks a disappointing 256 out of the 382 markets analyzed in our tool. Because of this, we are not going to spend our time looking for deals in this market. However, that ranking doesn’t mean that there aren’t good deals to be found in Cleveland for a local or regional investor. Remember, real estate investing is a local’s game. A local investor will have the relationships and local insights to find these opportunities. While the greater market may not be moving in the right direction, movements within and across sub-markets can create opportunities. Furthermore, operational inefficiencies at the asset level such as below market rents, lack of capital investment, and poor property management can create opportunities in any market. So, while there are opportunities in markets like Cleveland, what these markets do not benefit from is a macroeconomic tailwind. It is this tailwind that we use as a safety net should any of our property level underwriting assumptions prove to be wrong. As a general rule, you want broader market momentum on your side.
Sub-Market (15,000 ft)
Once we identify the MSAs we’re interested in based on broad macroeconomic drivers, we start looking at sub-markets. As we know, there are good and bad parts of every town. In many metro areas, you can get a pretty solid understanding of where the different sub-markets are by looking at a map. Sub-markets are usually defined by natural borders, like rivers and mountains, or manmade borders, like major roads and railroads. Google Maps is where I always start when drilling down into a market so that I can get a good picture of the lay of the land. Once we understand the physical layout of an MSA, we can start comparing the different areas that we've identified.
Once we understand the physical layout of an MSA, we can start comparing the different areas that we’ve identified.
Comparing sub-markets is very similar to comparing MSAs since we’re looking at many of the same economic indicators, only now we’re using a higher-powered lens. When comparing submarkets, the metrics we’re most interested in are household incomes, home prices, multifamily rent growth, vacancy, and poverty. Getting good data at this level usually requires a little more effort than at the MSA, state, or national levels, but you can find it without too much trouble. We typically get this information from our professional network and a combination of websites.
We’ll reach out to reputable CRE brokers we either have or want relationships with, and they always offer good and reliable color on sub-markets. They’ll also provide or direct us to reports and studies published by credible regional and local sources. Good relationships with the brokerage community is an irreplaceable source of local information. These folks are market makers and they constantly have their ears to the ground. They talk to each other, to lenders, to sellers, and to buyers. They probably have a complete picture of a market before anyone else, and they will be instrumental to your success in a market. However, tread cautiously. Not all brokers are your friends, though they may assume the appearance. In my experience, most of them are honest and trustworthy, and the bad ones don’t last long because they fail to amass sustainable portfolios of business. Nevertheless, I have encountered unscrupulous brokers who are looking to take advantage of new buyers and sellers. The best way to flush out the bad apples is to build relationships. You’ll be able to tell pretty quickly who’s selling snake oil.
You can also get good reports from mortgage brokers. Every mortgage broker we’ve worked with has access CoStar, the industry leading data source. A CoStar subscription costs around $30,000 per year, so if you’re just getting started, or even an established boutique shop, you may want to have your network pull these reports for you. Our mortgage brokers have always been happy to provide reports on markets and specific properties. These reports will compare similar properties in an area and give you an immense amount of information. They give you property details like building size, number of units, true ownership, previous sale date, and previous sale price, and they provide rent comps, sales comps, new construction data, demographics, market reports, and submarket reports. These reports are typically around 120 pages long and include helpful data visualizations. We will never make an offer before first looking at a CoStar report.
We also use various websites to help us bring our image of submarkets into better focus. Websites like Craigslist, Zillow, and other rental platforms are great resources for finding real time multifamily asking rents across sub-markets. Another great website is City-Data.com. City-Data is free and has a seemingly endless amount of demographic information. Most of the metrics we’re looking for can be found here, and their map viewer is particularly helpful. This viewer lets you look at “data-blocks” which are demographically distinctive areas within a market and range in size based on population. The images below are an example of some of the information that can be found on the site. Their data, which is “collected and analyzed from a variety of government and private sources,” is slightly dated, but it is current and accurate enough for our needs. We’re looking at relativity across markets and sub-markets, and for this, City-Data serves us well.
Micro-Market (Ground Level)
To learn a micro-market, you simply have to be in it. You should drive the area, walk the streets, and underwrite deals.
A micro-market is a very focused area within a submarket. Each data-block or a combination of adjacent data-blocks in the map above can be considered a micro market. It can also be viewed as the immediate surroundings of a target property. To learn a micro-market, you simply have to be in it. You should drive the area, walk the streets, and underwrite deals.
Underwriting deals is an invaluable way to learn both submarkets and micro-markets. It is the closest you’ll get to owning and operating a property without actually owning one. When you underwrite a property, you scrutinize the economic drivers and operations of the property, and you get access to really good data. You’ll have a rent roll for the subject property, which will show you occupancy and actual rents over time, and you’ll get to look at the property’s income statement, which will give you a good picture of what operating expenses are likely to be in the general area. Underwriting deals that you aren’t necessarily going to make offers on can be a tedious exercise, but the information and insights you’ll gain will be well worth the effort.
As a byproduct of investigating submarkets, you’ll start to see the micro-markets. One stoplight or stop sign is all it takes for an area to make a dramatic shift – to go from strong incomes and home values to high poverty and crime. As you do your research and underwrite deals, these characteristics will become very clear, and before you know it, you’ll be a market expert from 30,000 ft down to ground level.
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