How to Choose the Best Market for Your Real Estate Investment
Investment real estate is one of the best options for a self-directed IRA. The principal of the retirement plan is secured by a real asset with the potential to generate consistent monthly cash flow. If things work out and the property appreciates at a rate better than inflation, then all the better. If you play the game properly, you can acquire a nice pool of solid assets that throw off regular income. You can use this income to acquire new properties and grow your portfolio if you are younger, or take distributions in retirement without having to reduce the core invested principal in doing so.
Successful real estate investments rely on several factors, but as the old adage goes, “location, location, location” is tops on the list. But “location” is a broad term, and evaluating the right place to invest your IRA dollars in real estate means identifying the right market in both the macro and micro senses. Some cities simply provide better opportunities than others based on factors like the relative cost of housing to average incomes, availability of good jobs, and demographic trends. Within each metro area, however, there are many local real estate markets, and at that level factors like the quality of schools, neighborhood safety, access to amenities like parks, shopping and entertainment and a host of other variables come into play.
Choosing the right markets for your investing needs involves several considerations, some of which go beyond just the property & neighborhood itself. Following are some guidelines to help you ask the right questions as you determine where to invest.
Start with your Goals
Are you investing for the long term or trying to achieve a shorter-term boost in value for your IRA or 401k plan? Various markets throughout the country will produce more consistent cash flow per dollar invested, but the properties may not appreciate much. Other regions will exhibit strong trends for appreciation in value, but may not cash flow well due to the high costs or properties relative to rental rates. Investing for cash flow tends to be somewhat more reliable and predictable, while investing for appreciation tends to be more speculative in nature. Where you are at in your retirement savings path and how your retirement plan fits into your overall wealth portfolio, as well as things like risk tolerance and amount of available capital will all help shape this decision.
Investing Locally vs in Remote Markets
Many investors want to be able to see their investments or rely on their own expertise and local network to manage properties. This is great if your market and your investment goals match up, but that is not always the case. If you live in a high cost city like San Jose or Washington, DC, the real estate market can produce some very positive opportunities, but only if you have significant capital to work with. One option is to participate in partnership with multiple investors to acquire properties, but that comes with its own set of challenges. In many cases, it may be better to evaluate other markets that fit your goals more cleanly.
If you do choose to look beyond your local market, it can be helpful to consider cities where you have connections or may have lived in the past, but that should not be a deciding factor. An economic analysis of a market is much more important than feel good reasons like “My cousin Mike lives there and could keep an eye on things”.
Top Down Analysis
When evaluating a region or city to invest in, start at the big picture level to determine the right geography for your needs, and then drill down to the neighborhood level.
When looking at a metro region, there are a wealth of statistics available to help you determine the overall viability of that market. Following are several categories of data to look into:
- How many people live there? Is the area large enough to provide a diverse rental population?
- Is the population expanding or contracting? Cities experiencing growth are a good thing. A declining population is generally a sign of economic decline and may bode poorly for your investment prospects.
- Is the economy diverse? A one company or one industry market can take a big hit if that one employer base goes through difficult times. A city with multiple economic drivers will be more stable and more likely to grow.
- Are wages rising, falling or stagnant?
- What is the unemployment rate?
Real Estate Factors
Once you find a market or couple of markets that look positive at the economic level, it makes sense to start looking the general housing market in that area. Some of the questions to ask here include:
- What is the ratio of owner occupied to rental properties? Areas with a higher percentage of renters will obviously create a bigger pool for you to choose from and more demand for quality rental units.
- Price-to-Rent Ratios. A general rule is that monthly rents should be at least 1-1.5% of the property value. If you buy a property for $250K and can only rent it for $1,800/month, the likelihood you will see positive cash flow if slim and you will be banking on appreciation.
- Vacancy Rates and Time on Market. A property purchased at a bargain rate does you no good if you cannot find a renter. Evaluating trends in the number of vacant properties and average time to fill a vacant rental can be critical.
- Housing Sales Statistics. Even if you are looking at a long term buy and hold, the ability to sell a property and receive a reasonable price is critical to your exit strategy. This can also be a solid indicator of the overall health of the real estate market. Look at trends in month’ supply of inventory, time on market, and asking vs sales prices.
Once you have used the above metrics to identify a possible market at the regional or city level, you can then hit the zoom button and start focusing on the local or neighborhood level sub-markets that fit your criteria.
Some areas are more friendly to real estate investors than others. If you take two individual properties with similar dynamics such as cost, condition and rental potential, you can see very different results based on things like taxes and whether landlord/tenancy laws are more or less favorable.
It really pays to understand the following factors:
- Property tax rates
- Property insurance rates
- Municipal landlord taxes – an IRA or 401k may not be exempted from certain local taxes or fees
- Local landlord tenant law – how easy is it to evict a tenant, for example.
Local Market Factors
You will want to reevaluate most of the above mentioned real estate factors at the more local level. In addition, you will want to look at things like neighborhood safety, quality of schools, access to transportation, proximity to shopping and recreation and other factors that drive desirability.
Investing in real estate is not really that different than any other type of investment. You want to identify opportunities that present the maximum potential with the least risk possible. Understanding a real estate market is a lot like evaluating a particular industry sector when you are investing in equities. You would not just decide to invest in Nike because you live in Portland, or Coca-Cola because you live in Atlanta. You would evaluate how that company’s stock is likely to perform based on many factors related to the industry, competition, regulation and the like. If you apply the same kind of analytical reasoning to real estate markets, you are more likely to find properties that will produce success for your Checkbook IRA or Solo 401(k) plan.[Photo by unsplash.com via pexels.com]
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