As you begin your journey as a real estate investor, it’s normal to feel intimidated by the decisions you face and get trapped in analysis paralysis. Yes, your real estate investment holds the potential to build significant wealth – but if you buy in the wrong place or at the wrong price, you can also lose money.
As is often the case, the best plan of action is to take action. While you eagerly anticipate that future stream of mostly passive income, the fact remains that no money flows until you purchase your first rental property.
Here’s some information to help you break out of the analysis-paralysis cycle and choose a market with good opportunities to help you meet your investment goals.
Look for these 8 key traits to select a strong market.
1. Population growth
Population growth is a natural indicator of a strong real estate market. The national average population growth is 6%. If you identify a market growing more quickly, that’s great – but such growth may also signal upward price pressure on available property. Realistically, as long choose a market where the population demonstrates a consistent growth pattern, it means your base of potential renters will also be growing.
2. Job growth
Look for data that indicates businesses in the area are creating new jobs. That may be tough to find in the short term, as 2020 job growth nationally was at -6% for the year. Ideally, you want to see a pattern of steady job growth in your target market.
3. Year-over-year price appreciation ( 3+ years)
If you see housing market prices that have increased over the past three years, you could benefit from strong appreciation in the value of your property. Many areas in the U.S. have been in a strong sellers’ market since 2019 and continue to offer the promise of good appreciation.
4. Year-over-year rental rate growth (3+ years)
Using an online tool like Rentometer Pro, you can easily see if rental rates in your target area have grown year over year. Your best investment scenario will include a target area where rents are likely to continue to increase each year.
5. Rent-to-income ratio
An industry-standard to qualify renters looks for applicant monthly income at least 30% greater than the monthly rent amount.
(Gross Annual Income ÷ 12) X .3 = Maximum monthly rent. Following this standard, an applicant whose annual income is $60,000 can afford to spend up to $1,500 per month on rent.
($60,000 ÷ 12) X .3 = $1,500
If economic data for your target area shows that household income for a large portion of area residents falls into the correct range, you should have a pool of tenants who can afford your rent.
6. Price-to-Rent
Calculate the price-to-rent ratio by dividing the area’s median home price by the median yearly rent. According to Investopedia, a “price-to-rent ratio of 1-15 indicates it makes more financial sense to buy than rent; a price-to-rent ratio of 16-20 signals that renting is the money-smart decision. A price-to-rent ratio of 21 or more indicates it is much better to rent than buy.”
7. Diversified economy (vs. a one-industry town)
Using the U.S. Census Bureau website, you can research the area’s industries. This will help you understand if the economy is diverse enough to be attractive for rental property investment. Look for at least 2-3 different industries, rather than an area where everyone works at the one large company in town, and any layoffs would create a disaster in the rental housing market.
8. Landlord-friendly housing laws
Search for a state that has:
- balanced landlord-tenant laws
- a reasonable eviction process that allows eviction for breach of lease
- limited or no rent control laws that could force you to maintain rents even while your costs increase
- no licensure requirements to lease rental property.
- reasonable property taxes and insurance rates
Your efforts to research this type of information will help you compare various locations, choose a market and decide where you should investigate actual rental properties.
Run a property analysis
When you’ve zeroed in on an area and searched the real estate listings for potential properties, it’s time to analyze the numbers. Run your purchase price through a mortgage calculator to come up with your monthly mortgage costs.
Then estimate your gross rent to arrive at your potential operating costs and reserve amounts. The safe rule of thumb says that 50% of your gross income will cover these costs.
But don’t just guess at your gross rent.
Rentometer is one tool you can rely on that is accurate and easy to use. With Rentometer, find your target city and enter any property address, the number of bedrooms, and bathrooms. You’ll get average numbers for low, medium, and high rents for your property type. Rentometer Pro offers further options so you can pull data for comparable properties, historical trends, and specific timeframes to inform your decision.
Use the area’s median and average rents to help you understand if you’ll clear enough each month to meet your goals for cash flow. You can also evaluate if the subject property can command higher rent if you invest in upgrades like granite countertops, new hardwood floors, bathroom updates, and general kitchen improvements. Or can you still get the average rent with new paint and new carpet? With a realistic estimate for gross monthly rent, you figure out your cash flow and decide if you want to make an offer on the property.
Build a team
After you determine a desirable market, you need to focus on building a team. Unless you expect to travel yourself to manage your rental property.
An ideal local investment team will include a realtor, property manager, lender, and contractor. These professionals will be a valuable on-the-ground resource and function as your informal advisory board.
You may click with the listing agent for the property you plan to purchase. Interview other local real estate agents over the phone. Try to find one with a track record of working successfully with out-of-state investors. Do the same due diligence to find a suitable property manager and the right lender.
Look for a property manager with a list of preferred contractors or one who also provides maintenance services.
Share your investment goals and communication style with each team member. Then clarify how they operate in similar relationships to ensure a successful partnership. You can own property anywhere if you have a reputable, high-integrity team that communicates well.
Don’t let yourself be overwhelmed when you choose a market. Good research and due diligence can help you move past your analysis paralysis. Then you can start to build your real estate empire.
This article was written by the Rentometer Content Team. The Rentometer Blog features fresh takes and insights on rental housing topics, services, and technology.