Selecting A Good Investment Location
As long as you buy property in a good location, all but the worst mistakes will be corrected over time through appreciation, inflation and rent increases. If you buy in a bad location, there is little you can do to recover. A good location and investment property must meet the following criteria:
Sustained profitability - The property must generate a positive cash flow today and into the foreseeable future.
Likely to appreciate over time - Properties appreciate in locations that have increasing demand, which is the key driver for sustained profitability.
Located in an area where you can make money and business risks are low. Only in such an environment can you achieve both current and long term profitability.
A few comments on the above:
Returns (ROI, cash flow) are only a snapshot in time. These calculations only predict what the property is likely to do today; it does not tell you how the property is likely to perform in the future. Take a look at the diagram below.
The red line represents a declining market (rents and prices are constant or declining) and the green line represents an appreciating market (rents and prices are increasing). Both have the same ROI today but will perform very differently in 10 years. You need to carefully consider how the location is likely to perform in the foreseeable future.
Static prices are not static. Official inflation is running at about 3%, which does not include food or energy. I will use 5% as a more realistic inflation rate (if you drive a car, use electricity or eat). If you are renting out a property today for $1,000/Mo. and rents are not increasing, what is really happening?
|After X years||1000|
This is why appreciation, at least equal to inflation, is critical.
Appreciation is also a good indicator of economic health. If a location is not appreciating or is static or declining, it would be unwise to invest in such a location. Also, rents lag prices by 2 to 10 years so the trend you see in property prices today is what you can expect rents to do in the future.
An Area Where You Can Make Money
This is a big factor. In some places it is very hard to make money due to the cost of doing business and regulations such as rent control or eviction laws. Significant cost factors include: property taxes, insurance costs, state income taxes, property age and construction, climate, and eviction cost and time.
As an example, we own homes in both Las Vegas and Austin. Below is a comparison of three cost differences:
|Cost Item||Austin||Las Vegas|
|Property Tax Rate||2.5%||0.55%|
|Property Tax Increase 2018||10%||1%|
|Landlord insurance ($300,000 property)||$2,000||$400|
|State Income Tax||0%||0%|
Remember that it is not how much money you make, it's how much money you keep. Construction and climate are also major cost drivers. When I owned properties in Houston and Atlanta it seemed that I was always replacing roofs, siding, wooden windows and dealing with landscaping issues. Below is a typical Las Vegas property. Not a lot of maintenance cost with Las Vegas properties due to the climate and construction.
The cost and time to evict is also a good barometer of how owner friendly the location is. In Las Vegas, a full eviction is $500 and less than 30 days. In comparison, in some cold weather states you cannot evict people during the winter or if someone is sick or over 65. In other locations it can take 1 to 2 years to evict. Tenants are very aware of such laws and know how to work the system.
Some people might comment that nightmare evictions are rare. I agree. I view nightmare evictions like cancer. As long as someone else has the cancer, it is a statistic. If it happens to you, it is a nightmare.
Location Selection Criteria
With all the above said, below are my criteria for selecting an investment location:
- Appreciation - I covered the importance of appreciation due to inflation and as a health barometer. Make sure to check the property price trends for the location.
- Population size - I would focus on cities with a population of 1M or more. Small cities tend to be reliant upon a single industry, which makes them vulnerable to economic changes.
- Population growth - If people are moving into a location, it is probably a good location for jobs and a desirable place to live. If people are moving away, demand will drop and prices will be static or declining.
- Urban sprawl - Not talked about much but you have only to look at any major city and you will see locations that were once the best in town and are now distressed. This is usually the result of urban sprawl. You need to be very aware of which way the city is expanding and buy in newer areas. See this site for time lapses. Try: Memphis, Atlanta, Austin and Las Vegas. Las Vegas is surrounded by federal land so there is little room remaining for expansion or urban sprawl.
- Demographic trend - Be aware that the population of many locations are aging. You need to match the property to the demographics. For example, if the median population age has risen from 35 to 40 over the last ten years, buying a three bedroom home targeting young families may not be the best option.
- Crime - High crime areas and long term profitability do not go together. I would not consider any city on the top 100 most dangerous cities list. You might know one of these cities well and know that there is a great area near the city. The problem is that companies looking to open new locations will not choose high crime cities. Also, people with sufficient funds will leave these areas and the area will go into decline.
- Climate - Properties in areas with hard freezes and excessive moisture will tend to require more maintenance than in milder and dryer climates.
- Age of the property - The older the property, the more maintenance it will require, unless all the major systems and components have been updated recently.
- Property cost - There is a tendency for new investors to choose locations with very inexpensive properties. Remember that price is a function of demand. No demand, low price. High demand, high price. Of course, you need to hit a balance. If your budget allows a maximum of $250,000, do not consider coastal California.
- Taxes - Both income tax and property taxes are a direct hit on profitability. Look carefully.
- Insurance cost - Insurance cost is a good barometer of the likelihood of damage, usually due to climatic or seismic events. Be certain to take the cost of landlord insurance into account when comparing locations.
Choosing the right location is critical. You must consider what the market is like today and likely to be in the foreseeable future. This article covered the major selection criteria we would use in selecting a good investment location.