Investment Locations - Do Not Forget Jobs
The profitability of any investment property is totally dependent upon the tenants remaining employed at a similar level of income. Despite this critical requirement, few investors take the time to consider the long term viability of the major tenant pool employers. In this article I will discuss the investment location evaluation process I would use and show where employer viability fits in the process.
So we start on the same page, I believe any investment property must meet the following criteria:
- Sustained profitability - Properties must generate a positive cash flow today and into the foreseeable future.
- Likely to appreciate over time - You would never buy a property just for appreciation but appreciation is very desirable. Especially when using a 1031 to reinvest equity or adapting to market changes.
- Located in an area where you can make money and business risks are low. Key factors include state income tax, property tax, insurance cost and landlord regulations. Regulations include property related laws like the time and cost of evictions, rent control, code compliance requirements, etc.
While the above sounds simple to meet, in reality it is not. Very few locations will meet all three criteria. Plus, the location must continue to meet all three criteria into the foreseeable future. Below are a few of the factors I considered when I chose to move to Las Vegas (from NYC) to sell real estate:
- Stable or sustainable population growth. (No boom towns)
- Population >1M. It must be a location with sufficient stability to weather changes.
- Low crime - Not one of the top 100 most dangerous cities.
High rates of crime and long term profitability are not compatible. Plus, I do not believe employers looking for a new site location would choose a high crime city.
- Limited urban sprawl potential. Urban sprawl can change great investment properties to money-pits over time.
- Business/landlord friendly regulations.
- Reasonable insurance costs relative to return.
- Reasonable and stable property taxes.
- Job quantity and quality must be stable or increasing.
- per capital income, adjusted for inflation, stable or rising.
While there is no perfect location, I found Las Vegas best met the criteria of all the cities I considered. However, since I do not gamble, drink or smoke, Las Vegas was not a place I would have chosen for "life style". Fortunately, and to my surprise, Las Vegas is an excellent place to live once you get away from the strip.
I am a visual person so I put together the following graphic of the process I will outline.
Using a basic set of selection criteria such as I outlined above, reduce the number of potential locations to a relatively small number and rank them.
Working with local experts (property managers, Realtors, etc.), determine answers to the following four questions.
- What type rents well? Condo, high rise, single family, duplex, single story, two story, etc.
- What configuration? Two bedroom, three car garage, mud room, etc.
- Where is the best location in which to invest?
- What rent range best matches the pool of tenants most likely to provide good tenants?
Also ask about average tenant stay, typical rehab costs, typical turn costs, major employers, etc.
Now that you know the type, configuration, location and rent range, you can easily determine the cost of properties that will meet these requirements (Zillow, Realtor.com, Redfin, etc.)
Now that you know the approximate cost to acquire and rehab properties (from a local Realtor, property manager, etc.) that match your target tenant pool, you can determine whether you can make an acceptable return. Remember to include realistic costs for:
- Insurance - Landlord insurance can range from $300/Yr to $3,000/Yr. Call a local insurance agent for a typical cost.
- Property taxes - You can get the property taxes for sample properties from real estate web sites.
- State income taxes - Check the state site.
- Maintenance costs. This can vary significantly so use the guesses from the local property managers and Realtor.
If after including all major cost factors the return is acceptable, the next step is to determine the job quantity and job quality of the city. Remember that even if all the tenants are employed today they could all be unemployed a year from now. The initial sources of information I would check is the chamber of commerce and city/county web sites. Next, research the current and long term viability of these employers and their respective market segments. Every business and industry will be different but below are some ideas:
- Healthcare - Evaluate the stability of the local (and metro area) population and economic demographics.
- Check Yahoo Finance and other such sites for corporate information and for business and market investment recommendations.
- If the metro area's economy is dependent on a few major industries (even if your tenant pool does not necessarily work in these industries) check these as well.
- Talk to property managers and Realtors about how rental properties did during the 2008 crash and which group did best. However, general information can be very deceiving. For example, during the 2008 crash the A class properties our clients owned had almost zero change in rent or time to rent while C class properties suffered 30% or higher vacancy rates. (See, Case Study - Las Vegas and the 2008 Market Crash).
- Check the $/SqFt trends over the last 15+ years. Falling $/SqFt prices are a symptom of ongoing economic distress or outer factors like crime, urban sprawl, etc. Whatever the cause, you are going to be hurt by it in the future. (See Investing in Declining Markets).
- Cities with economies based on manufacturing look scary to me. See US Manufacturing: Understanding Its Past and Its Potential Future, Pew Research - AI, Robotics, and the Future of Jobs and Competition and the Decline of the Rust Belt.
- Check the population trends. See Mapping America's Futures
What and how you will research the probable economic future of you tenant pool and the local economy depends on the specific businesses and industries.
Once you decide that your target tenant pool is likely to remain employed for the foreseeable future it is now time to compare this location to other potential locations. Remember that there are no perfect locations (or perfect properties). The tool I would use is called SWOT Analysis. Google "SWOT Analysis" and you will find many information sources. One good article I found is, "SWOT Analysis - Do It Properly!"
The short and long term profitability of any investment property is dependent upon the tenants remaining employed at a similar level of income. Determining the short and long term odds of your target tenant pool remaining employed is critical. However, it is just one component of factors to consider when evaluating locations. Use a tool like SWOT to compare potential locations. You will not find a perfect location but you can eliminate potential disasters before you invest.