We’ve talked about cycles and we’ve talked about stages. We know the amenities we should be looking for in a location. We’re ready and rarin’ to go. So…where exactly, in this great big country of ours, do we start?
First off, let’s prioritize the indicators we’re looking for. One thing and one thing alone trumps all else: Employment. Without employment, we have nothing. Without employment, we have no population. With employment, we have at least a static populace. With growing employment opportunities, we should have rising population. Without employment, or if employment has recently left an area, we have loss of population. Loss of population means empty houses—houses that you can probably buy cheaply, but which you cannot rent because you have no people to rent them to.
I check out major news sources that frequently comment on areas that have rising employment. This may include, but is not limited to, Money magazine, Forbes, US News and World Report, Kiplinger’s, Investor’s Business Daily, the Wall Street Journal newspaper, even a national newspaper such as USA Today. I’m looking for those annual articles on “best places to live” or “hot areas.” I’m also searching these same sources looking for articles on job trends and industrial trends in general. Where are the growth areas in the national economy?
Now, I realize I’m using the word “area” in two ways, and both are highly relevant. If I can find sources that identify a geographical area (“Atlanta is the new, hot growth city”), that’s a home run. I know if I hear this that I have to take a good hard look at Atlanta. On the other hand, if I read, “Voice Over Internet Protocol (VOIP) is the hottest new technology trend,” I want to find out who the major players are and where they are located or locating to. Once I’ve identified the major players in a hot industry, what I really want to find is news that one of them is expanding into a new geographic area and bringing along major employment.
This isn’t as hard as it sounds. With the Internet, we have the world at our fingertips. The only warning with ’Net data is that you must be careful to check the date on the information. If it’s on some daily Internet news report, you should be fine. If, on the other hand, you do a web search, make sure you haven’t unearthed an article from 1998. That news is way past its expiration date. This is one area (there I go again with “area”) where sometimes you can be a little better off with a hard copy of a magazine or newspaper. Much less chance of getting old information there; the dating tends to pop out at you more easily. Some things you find on the Internet will simply place today’s date at the top, for whatever reason, teasing you into believing it is today’s news when, again, it may be an article from years ago.
I can’t over-emphasize the importance of timing on all of this. You want to hear about hot trends, not old news. I don’t want to know that someone built a big new corporate headquarters somewhere two years ago—that city is already hot and will not be at the point in our cycle that we are looking for. It will be overpriced. I want to know what the “next big thing” is, and where it’s looking to locate.
“The Top Suburbs.” “Best Places to Retire.” Internet search engines like Yahoo, Google, and AOL toss up articles like these all of the time. Check them out. Not only investigate the places they are hyping, but find out why. Oftentimes it is in association with some sort of positive employment trend in the area—even the “places to retire.” Such a designation may occur because the sorts of amenities that retirees look for— top notch adult communities, golf courses, spas, etc.—may have recently come into the area. With that, they attract new residents. With that, these amenities themselves attract new employment. That gigantic adult community—and yes, some of them can be like enormous theme parks—needs younger people (with families) to work it. So even if you find you cannot buy into the big adult community itself for investment’s sake, the workers from there have to have a place to live, too.
On the other hand, sometimes it’s not a new industry or company that needs to come into an area, but rather an existing industry that is heating up. Space exploration, for example, seems to be getting closer to the front burner again in our federal budget, after many years of decline. That means that companies with a hand in moving that venture forward will be booming again, possibly expanding their operations where they already exist.
Realize, these are simply indicators—leads—and you don’t go “all in” simply on the say so of some list or one newspaper article. But leads are always where we begin. They point us in a direction to look for further information. The data we find there may lead us to a dead-end, which is frequently the case. Oftentimes by the time these lists and articles hit the major media, the cycle there has already peaked. Going in now would only mean buying at the top of the market—not good at all.
A lot of these lists and other data are based upon median incomes and job availability. Nothing is worse than high unemployment when it comes to evaluating an area. High unemployment is the death sentence—although it is a flag to government and industry to look to such an area to relocate or to develop. When you see areas like this— high unemployment areas—check back every once in a while. These are areas of opportunity for industries looking for workers. It is also where government’s
“invisible hand” frequently steps in to try to revive an area, providing incentives to employers and developers.For other leads, don’t discount the TV evening news. All the info they may be able to squeeze into their “sound byte” format may be on the order of “Boeing is closing down a plant in Such and Such, and moving to an even larger facility in This and There,” but that’s news you can use and you can follow up by doing some independent research to get more details.
Median Home Price
Once you’ve gotten a lead on an area, one of the first things you want to acquire is the Median Home Price. City-Data.com is an on-line database that will usually have this information. The primary source for this data is the U.S. Census, although there are frequently other entities—sometimes state or county governments—that update this information far more frequently. That being the case, try to gather more than one number for this, unless they all seem to be quoting the same figure. Your last resort—or shall I say you confirming source—should be a local Realtor®. They are often a wonderful resource, although you may not want to begin with them, since they are sometimes reluctant to give out “free” information before you make a commitment to contract with them.
What you are trying to do by getting this particular information is, coupled with other information, finding out how incomes compare to home prices. I recently got a “hot tip” about a city in Southern Connecticut. While a lot of other data pointed to this being a good market (some positive employment trends, etc.), the average home price was still very, very high. This is not good, especially coupled with a low…Average Household Income.…
Average Household Income
Average Household Income goes hand-in-hand with Median Home Price. In the Connecticut city I was turned on to, the median home price was still rather high (around $250,000 to $350,000) while the average household incomes were rather low. Put simply, as a market, this means that if you bought a house there, you would be buying at the top or near the top of the market, while there simply weren’t high enough incomes for there to be enough renters for you to rent to at the price you would have to charge. That spells trouble. There’s nothing worse than paying a lot and getting stuck with a vacant property you can’t rent.
People can only afford to pay about a third of their yearly income on housing. More than that will choke them. Renters typically will not pay much more than thirty percent of their income towards their Housing, simply because if they are consistently late or miss payments they will be evicted immediately. It’s one thing for a family to choose to undergo that sort of financial suicide if, in the very least, they are purchasing a property from emotion and growing equity. But to go out on such a limb simply as a renter makes no sense at all. There are crazy people in this world, but we don’t bank on them or aim for them with this system. We assume instead that people are intelligent, rational and sane.
If the median home price is $300,000, I need average annual household incomes of $100,000 or more in order to feel comfortable buying into this market. This is a quick and easy mathematical formula to gather together and do literally in your head. If median home prices are $300,000 and average household incomes are only around $45,000, this is not the market for you. Smile and walk away. What may disappoint you at first is that you will find yourself walking away from an awful lot of areas. But this is what this program is about. This is not about how to take enormous risks. Using poker terms, I’m not here to teach you how to draw to an inside straight. I’m here to tell you not to bet unless you’re holding four of a kind.
Again, you will feel frustrated. You got a hot tip on an area. You did your due diligence and gathered a lot of demographic information. You’ve just read this book or attended one of my seminars and you are just dying to get into real estate investing. And then you run the numbers and before you’ve even visited the area or looked at a single property, here I am telling you to walk away. Just walk away. Because you can’t make money simply on raw enthusiasm. This is all about numbers. The numbers either work or they do not. All else is emotion, and emotion is what costs people money. If you’re gambling, you don’t bet on your favorite team to win; you bet on the better team to win. That is, if you’re out to honestly make money.
Now, you may be wondering, “If these numbers don’t pan out, why would anyone consider the area ‘hot’”? The answer is that some people evaluate an area looking for different things than what we are looking for. That Connecticut city I checked out was, in fact, appreciating, meaning that home prices were rising. That’s good if you are simply a real estate speculator. But pure speculation, which we will talk about in later chapters, is not for the faint-hearted. A pure speculator usually has enough in the bank so that he can sustain months of carrying a mortgage without a tenant to help him out. A speculator is looking for that one big hit of buying low and selling high fairly quickly. And bear in mind—“low” is relative. For a speculator, buying a $500,000 house and selling it soon after for $600,000 is great. But you can’t buy and hold—rent—a $500,000 home. There’s no market for that. You will hardly ever find an area of the country where people will pay $5,000 or $6,000 a month in rent. My program is all about having the insurance of cash flow from renting, and then, perhaps, selling for a gain.
Now, the one-third formula does not always have to be taken literally. It is, of
course, our very safest bet, but if it’s close, the area may certainly warrant further investigation. Another example where median home price is $150,000 and median incomes are around $48,000, that’s getting pretty darn close. In that case I will take further steps to see if I can expect appreciation in the housing market. If I have good reason to believe that my property will resell at around $220,000 in two years, for one tangible reason or another, then I’m very, very interested.
We want to get into a market before the speculators can beat us to it. The speculators, as you will soon find out, are looking purely at home price appreciation. If they find out that home prices are appreciating at over ten percent annually, they’re going to jump in. Incomes will eventually catch up, but cycles, you will learn, do not always go in unison. Home prices may rise faster and sooner than median household incomes. The two may eventually catch up, but we want to beat the speculators before they gobble up all the best properties, leaving us with greater risk or perhaps, even worse, leaving us simply buying at the top of the market with nowhere to go but down.
I find it interesting to track trends once I’ve identified a market. I discovered one market once where the median home price was $85,000 and the median household income was around $40,000. This is a great ratio. A year or so later, the median home price went up to $110,000, but the income levels remained the same. This, again, was still a good ratio, but, obviously, not quite as good. Still and all, it merited buying more into this particular geographic market. This market ultimately increased one hundred percent in less than three years, although it illustrates what happens when more and more investors and speculators find out about an area.
Major mention of a new technology or industry should always pique your interest. Oftentimes, it does not mean a mad dash for buying up a particular geographic area, but it does merit tracking and watchful waiting.
Green Technology is a perfect example of this. The word is not truly new, but the more we hear it, the more our ears should perk up. It’s like being in the wilderness and hearing drumbeats. It begins off in the distance, but since we’re lost, we follow it. As we get closer and closer, the drum beats get louder and louder. Finally, we’re there, where the drummers are drumming. In business trends, if we hear about some “new thing,” we may hear about it once and then never again. Consider the drumbeat in the forest that we hear and then never hear again. That’s never worth pursuing—if we go to where we thought we heard the drums, by the time we get there we realize the drummers have long gone and we’re just wasting time alone in the wild. Economies work the same way.
Green Technology is something we hear more and more and more about each day. That means that with each passing day, there is more reason to believe that more investment and exploration is going into “Green” production. With production comes jobs. Today, wind farms are springing up in the Midwest, where the wind and land are plentiful.
All of this means good news to you if you have taken the time to find out where these Green industry-related jobs are popping up. That’s where the people are heading. That’s where the jobs are. That’s where the houses are that we want to buy and rent out to those workers.
Tomorrow, there will be another word like “Green” on the nation’s lips. Keep your ears open. Once you hear it, target it and listen for it again, just like those drums in the wilderness. The more you hear the word, the more you should be on the move toward it, finding out where it is, discovering if office buildings or factories are being built.
Once you’ve found an area where employment is rising and your median home price and household income ratio works in your favor, there’s little reason to investigate longer—jump in and get wet. But I believe that an informed consumer is the best kind of consumer.
A lot of the publications I previously mentioned will also list the rates of real estate appreciation in an area. Look and listen for that as well. It will help you determine where in the cycle a place is at when you are getting ready to buy. As I mentioned before, while there is one absolute optimal stage at which to enter a market, the stage or two before and after that will also be good bets. But don’t just jump in blindly; find out. This will indicate to you whether you should plan to be in a market for a significant amount of time before it will be time to get out (early in the cycle), or whether you should be thinking about your exit strategy shortly after you have gotten in (toward the end of the cycle). Sure, it’s great to make money—any amount of money.
But isn’t it better to make $100,000 than $5,000? At least if I figure I may only make $5,000, I’d like to know it from the outset, rather than start looking up Maserati prices on-line, only to find out it’s only a pipe dream. Rates of real estate appreciation help me to understand where I’m at in the cycle, how long I should plan to hold onto my investment property, and how much I might stand to make if I buy in today. It may not be a pristine crystal ball, but it’s better than flying blind.
A good ratio between average household incomes and median home prices will usually spell “cash flow.” Remember, there are two ways we plan to make money—cash flow and appreciation. Cash flow is immediate and obvious—if we have $900 in monthly overhead (mortgage payments, property insurance, property taxes, and average property upkeep), and can rent for $1,400 per month, we are cash-flowing $500 per month on average (I say “on average” because property maintenance will vary from month to month depending upon circumstances). This is great. It’s a business that grosses $6,000 per year, without even taking into account depreciation. By the way, in case I haven’t already covered it—even though real estate, given an infinite amount of time, literally always appreciates in value (there’s a finite amount of land on the planet), on your taxes it is an asset that actually depreciates—the structure upon the land, but not the land itself. That’s another reason real estate is such a great investment.
Two big pieces of the cash flow puzzle are household incomes and average home prices. But for appreciation, I, of course, would also like to know that I can eventually break out of that $6,000 a year business and make a big hit by selling. I mean, let’s face it, you can’t retire on $6,000 a year income—that’s below the poverty level. This being said, when we come into a market, we may find a good cash-flowing situation, but the average real estate appreciation (the local real estate market) may be stagnant, increasing only slightly, or may even be dropping. Sure, if I can find an area where my cash flow analysis is in great shape and it is appreciating ten percent a year, wild horses couldn’t keep me out of that market. But friends, those markets are few and far between.
It is far more common that you will be finding areas that are either not appreciating or are appreciating only slightly. This is not a bad thing. The appreciation will
come. Remember, remember, remember: You are NOT a speculator. You are a real estate buyer and holder.There are a lot of ways to track population trends in an area. In this, the Internet age, nearly every town in America has its own Website. If the town itself does not have one, the local or local area Chamber of Commerce will have one. One of the most important things that will usually be posted on these Websites is population trends. Even Wikipedia, another on-line source, will have a page for literally every town in America. Population and its trends will usually be posted there.
What I obviously mean by trend is not that you simply learn the town’s population, but that you have its current (or most currently available) population and can compare it to a recently previous number. If a small town has forty-five thousand residents today, but only had thirty-eight thousand five years ago, that is a HUGE increase. That’s seven thousand more people, in a place where seven thousand is about one-sixth of the total population. Check that town out! Something’s happening there!
Some of the better sites really stay on top of this information. If I can find out year by year population comparison, that’s a home run. Some sites will even give you employment tracking, telling you the number of jobs in the area. If you can track that against previous, older information, that’s an incredible plus, maybe even more valuable to you that population. Whereas population can be deceptive due to family size (babies don’t own their homes), jobs are what we are really looking for. If there are one thousand more jobs today than last year, unless we are talking about some urban megalopolis like New York City, population eight point two million, this is the kind of increase we are on the lookout for.
An increase in building permits is also a great indicator. Usually if building is up, it is because demand is up, or about to come up. But, remember this, Builders in many areas are three to five years behind the market trends. So, if you are dead on the market or early permits will be low or even decreasing.
You can often get building permit information from the local census. Look for a five year history. Another good place to gather this information is by calling the county in which the city is located, or the town itself. Again, local or regional Chambers of Commerce may also have this data and are, unlike some other sources, highly motivated to provide this information if they have it. Some may even get it for you. Chambers are about growing business in an area, and once you become a real estate investor, you become a businessman, if you weren’t one already. You become a valuable part of the local landscape, even if it is a place where you don’t even live.
Now, remembering what we said about cycles, we want to buy when housing inventory is up and sell when housing inventory is down. This may sound like a contradiction from what we said about building permits. It isn’t. It’s the difference between investment in the local economy and home ownership. There are often cases where a builder will plan out a thirty-five-unit development and will be able to presell each and every unit. That means thirty-five new building permits but zero percent vacancy. That’s one heck of a hot area. Demand is way beyond inventory. We are looking to buy in what I refer to as the wholesale market. This means that I do not want to pay market value for a property. I want a piece of that thirty-fiveunit development when there are some vacancies, and perhaps one of them is even in foreclosure. I want some of those units to be on the market for a while. I want them to have dropped their price because there was no mad rush to their door. I don’t want to get into a bidding war for a property. If I come into an area and there’s a bidding war, I’m in the wrong place at the wrong time.
Here’s something that happens a lot and can benefit you. Sometimes developers will over saturate a market. They know that people are coming in—usually because of some employment increase. But they get some of the numbers wrong. They build two thousand new homes when only one thousand new jobs have been created. Investors seeing, like the developers, that there will be an increase in jobs, will gobble up those new homes, expecting to speculate on them and flip them for a profit. Then they realize they calculated wrong. For you, this is good. Now you can buy that new-ish property for a lower price and rent it. The numbers should now work in your favor.
Absorption rate has to do with the amount of homes on the market in a geographical area and the actual number of home sales per year. A high absorption rate is bad for you, the investor, because it means that the market has peaked.
This information is fairly easy to find. You can contact any Realtor or a local Realtor’s association to find out, on any given day, how many homes are on the market. You can also easily find out how many homes sold the previous year. If there are three hundred thousand homes on the market today and only one hundred seventyfive thousand sold last year, this means that there is almost twenty-one months of inventory on the market. People will be practically giving their homes away. This is when you buy. This is a low absorption rate.
Remember, though, that we are trying to track multiple things at the same time. You don’t want to buy simply because things have hit rock bottom. You may never find tenants in that market and you’ll have to hold onto that property forever, waiting to A) get a tenant to help you carry your overhead, B) sell at a profit, and C) sell at a high enough profit so that all the money you initially lost when you weren’t able to cash-flow has been made up. This could be forever or maybe even NEVER! Thus, bear in mind that all of these factors we are taking into consideration in finding a location meld together with finding the stage in the cycle and determining that the cycle is, in fact, moving.
I mentioned before that cycles do exist, and that twelve years is a common cycle. But there are exceptions. Some areas may stay down in the dumps for a very, very long time. They could take twelve years simply to move from one stage of the cycle to another, let alone complete a cycle. This will most commonly happen when an area is extremely depressed. So make sure you never forget the single most important factor you are looking for first and foremost: employment. Areas with a high number of jobs are moving in a positive direction.
A question I get sometimes is, “But what if the jobs are in a really terrible area where no one wants to live?” Good question. There are two possible answers. One is gentrification. That lousy area may, in fact, because of the influx of employment become a nicer area. Developers may get incentives to knock down old homes and build newer, nicer dwellings for the employees. This is good.
In other cases, people may only use the area where the new jobs are as an employment destination. Thus, you must get out your maps and look at your local
transportation routes. Maybe everyone is now working in Slumville, but they are all living in and picking up the train to work in Suburbia. If that’s the case, you want to look into buying houses in Suburbia.
I had mentioned before that I usually look for a three-bedroom, two-car garage, three to ten-year-old home as my guide when I come into an area. This is meant only to be a guide, not a hard and fast rule.
I don’t love duplexes or four-plexes. Too often they have common area maintenance fees or shared utilities. They also tend to be revolving doors and I want stable tenants. This being said, I have to take what a market gives me. Some areas where all the indicators add up in my favor simply do not have three-bedroom, two-car garage, three to ten-year-old construction. In that case, I don’t bail out on the area; I look to see what they do have.
Some areas have nothing but newer construction. New Mexico. So much of this state was undeveloped until fairly recently. Thus, most of what I will find there will be new. This is where I am most likely to find that type of property I’ve been rhapsodizing about. On the other hand, I may not be able to find anything like that in
older areas of the Northeast. There, I may find tons and tons of condos or townhouses. Or I might simply find older homes. Admittedly, I have some reservations
against homes that are simply too old. There is a reason why the IRS allows for depreciation on housing structures. They simply don’t last forever. Some folks will move into them and do massive upgrades—new bathrooms, larger closets, etc., but there will eventually come a time when the need for major upgrades is so compelling that it is just cheaper and more practical to knock the whole thing down and start from scratch. See, while real estate—land—will almost always increase in value, the structure on the land will eventually lose its value. For that reason, I do get scared off by, really old, or poorly constructed buildings. While a person may be motivated to do major upgrades if they were living there, only a fool would invest that kind of money into rental housing. You would have to hold onto it for decades upon decades to recoup that sort of money. I believe in buying and holding, but not buying and hoping I don’t die of old age before I can sell at a profit.
Let’s talk again about the overall quality of the area. This may again sound a little contradictory, but it’s not. You are going to be buying where people tend to rent. Say that to yourself a few times. Think of some really gorgeous neighborhood where everyone takes great care of their property. It could very well be a very old neighborhood. But if people are all taking great care of what they have; if every lawn and garden looks like a pretty picture, there is almost no likelihood that there are renters in that neighborhood. Why? Because renters do not invest that kind of time and money into something that they do not own. And landlords do not invest that kind of time and money because it would make them unprofitable.
You must take what a local market gives you; specifically, you must take what the local rental market gives you. This means that the neighborhood will not be that great. The lawns will not be plush. How bad is bad when it comes to a neighborhood? Cars up on blocks in people’s front yards are okay. Cars burned out and blocking the street are not okay. It’s all a matter of degree.
What kind of houses are in the “rental neighborhoods”? If I’m in New Mexico, it could be my three-bedroom, two-car garage, three to five-year-old construction. If I’m in Boston, it is more likely to be an eighty-year-old, three-story brownstone. You don’t want the areas that will never be nice again. I know, it’s a fine line, but you have to think things through and yes, even if you are investing a thousand miles away, you really should take a look at things with your own two eyes in order to make a proper assess