Investing Outside Your Home Market? Do This First!
I once had a student come to me with a 40-unit property in Eden, North Carolina for an unheard-of $13,000 a unit. The seller claimed he was getting $650 per unit in rent, but when we looked closer, we found only 40% of the property was occupied. Red flag #1.
We decided to investigate further. As it turned out, the major employer in town had just shut its doors, the area was sliding into a depression, and 3-bedroom houses were renting for $395 a piece. Red flags #2, 3, and 4.
We could’ve made the property work, but in the end, we decided to pass.
When you purchase a commercial multifamily property, you’re investing in a future income stream. It’s not enough just to see cash flow today. You need a reasonable level of assurance that your income will grow over time or, at the very least, remain stable.
Eden offered no such assurance, so we decided to let it go.
Why Analyzing Income Growth Matters to Your Multifamily Business
Income analysis is especially critical when you start looking to buy outside your home market (what I like to call your “backyard”). When you branch out into other markets, the stakes are higher. You can’t rely on anecdotal experience or personal knowledge; you have to dig into the numbers and get to know the market on paper.
It helps to think from two angles:
1.) the property;
2.) its context.
As you analyze a property, it’s important to know the specific ways you could improve it after closing. Where can you add value? How far are your rents off of the market? As I’ve written elsewhere, there are plenty of ways to increase your net income on a property. Scout out those possibilities beforehand and factor them into your analysis of every deal.
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But looking at the property isn’t enough. You need to understand its room for growth in context—i.e., its neighborhood. You’ll never be a fortune-teller, but with patient attention to the relevant data, you can forecast an area’s stability and potential for growth.
Looking at income growth from both angles will give you important insight on every potential deal. More than that, it’ll help you grow in your market knowledge for a given area. Over time, you’ll be able to check your forecasting against actual market performance and learn to judge that market’s behavior more accurately.
Better judgment = stronger deals.
Where to Find Reliable Income Data
In a moment, we’ll talk about what you need to look for when analyzing a market’s income growth potential. Before we do, here’s a list of the best sources for the data you’ll need:
Some of these sites (Costar.com, Geometrx.com) charge for their services. They may not be necessary for the early stages of your multifamily business but are definitely worth pursuing as you grow and expand into markets outside of your home territory.
What to Look For
It’s important to reiterate here that you’re not trying to tell the future. There’s a difference between reading data and reading the stars. More than your “gut sense” of a healthy market, you need a set of specific indicators to look for when evaluating the data.
That said, here are the most important questions to ask:
- What is the current population in this market/neighborhood?
- How have the population levels changed over the last 10 years?
- Has the population grown consistently over the past 5 years?
- Do you see job growth in the neighborhood?
- How have unemployed levels shifted over the past 5 years?
- What are the income demographics of the area?
- How have per capita income rates changed over the past 5 years?
- Do those changes correlate with the broader region (city, state)?
- How does per capita income compare to the area’s cost of living? Is income trying to catch up? Or has income surpassed the cost of living?
It’s important to look for the story behind the numbers. If there is job and/or income growth, what’s causing it? What’s the draw? Are jobs opening up at a new factory? Has the state university opened up an extension site nearby? Is there a new soccer stadium going in? These are the sorts of developmental events that drive growth.
When it comes to cost of living, you ideally want to see a rent-to-income ratio of 30% or less. This indicates that the area residents have room in their budget to spend more on housing. Anything higher than 30%, and the market will be less willing to reward your efforts to add value to a property and increase rent over time.
As you continue to invest in an area, revisit the economic data periodically. Look specifically for changes in the data you analyzed above. Here are more questions to ask:
- Has anything shifted significantly?
- Has the market grown or contracted?
- How does the present reality compare with your initial forecasting?
- Is the are still a good investment? Why or why not?
Again, it’s important to look for the story behind any of these changes. What’s the force behind the change? Has the new factory shut down? Has a new one gone in? Have folks decided to commute into the local university from another side of town? Has there been an uptick in crime?
You’re never going to be able to tell the future with 100% accuracy. None of us has that ability. Nevertheless, there is an abundance of data out there on every market in the U.S. If you’ll take a little bit of time to look hard, ask insightful questions, and seek out the story behind the numbers, you’ll set yourself up for plenty of future growth.
As always, if you need help learning what to look for, or if you have a specific question about the data you’re seeing, head over to our Facebook Community. We have thousands of professional investors who are eager to connect and help you succeed.