Neighborhood Analysis for Real Estate Investors

Let’s face it: When we ask for advice on a new idea, we are often looking for someone with experience to validate our ideas. That can be especially true when it comes to residential and investment properties.

As a beginner real estate investor looking to purchase residential properties, you will more than likely come to a point where you start seeing single-family houses in a very low price range, and find yourself tempted—or maybe even a little concerned.

Though people might warn against certain neighborhoods, you should be skeptical about these assumptions without ever visiting a property or checking out the neighborhood characteristics. Sometimes, a neighborhood deemed, falsely, “bad” might actually be a great fit for your portfolio.

Before diving into real estate investing, make sure you understand how to compare markets and properties. Whether you’re trying to decide between investing in Boise or Sacramento—or you’re just comparing two similar homes—this guide will walk you through all the numbers you need to know. From calculating cash-on-cash return to running a comparative market analysis, the experts at BiggerPockets demonstrate the steps you need to follow and the statistics you must know with The Beginner’s Guide to Real Estate Market Analysis.

It can be a good idea financially to own property in an area that is appreciating. You might even want to look for areas that have a high likelihood of appreciating. As real estate investors, we always need to look for deals that make sense numbers-wise and offer a cash return.

Opportunities aren’t just sitting there waiting for new investors to grab, though—they go very quickly. When quickly evaluating a new neighborhood, here are some things to look for overall and some common traps.

Normalcy bias

Every investor is different and so is every market. Some investors have access to a lot of credit, some investors don’t. Some cities have a plethora of foreclosures, and some areas just have older homes. As a new investor, it’s going to be up to you to find those sweet, sweet deals for your flip or buy strategy.

In business and in real estate investing, those who stay “safe” don’t always get the best returns. Doing what everyone else does won’t necessarily lead you to financial success, and commonly accepted wisdom on money is often misguided.

For the last 40 years, hundreds of people have put trillions of dollars in their retirement accounts, stocks, bonds, and mutual funds. They are betting their entire financial retirement on this investment vehicle. That’s normal—it’s what everyone does, right? If you asked the majority of people about the details of their investments, they would not be able to tell you specifics.

Despite this lack of knowledge, people will still entrust their retirement to fund managers who get paid 2.3% of their money whether the stock loses or gains. That’s a clear issue of normalcy bias, and when people say to only invest in certain neighborhoods, even if the returns aren’t there, that is part of the same normalcy bias where you make financial decisions that won’t always lead you to the gains you are looking for.

Is a neighborhood up and coming?

As a new investor, take the time to see if an investment property is a good opportunity—even if the “experts” don’t agree with you. You’ve probably heard this before: “Real estate investing is all about location, location, location.” And it is, to some degree.

So what does this mean exactly? Each location has so many different factors that cause the price to rise or fall, which means that you need to vet the locations personally. Avoid taking investment strategy advice from people who do not know an area intimately.

There is no such thing as a “good” or “bad” neighborhood. There is only “good” or “bad” for your specific portfolio. What degree of development of a neighborhood feels right to you? Are you looking to be the first investor in a future hot spot, or to find a location where the trend of property values is increasing?

Do your research, talk to people, and get a feel for the neighborhood characteristics with some firsthand experience. You can also do some research about the demographics and crime statistics. The results of a neighborhood analysis will tell you definitively if this location is a yes or a no. Here are some factors and sources to consider.

1. Public information

There are a number of websites with virtually all kinds of information for cities, ZIP codes, and even subdivision statistics. The best of these sites—at least the best free one—is City-Data. Remember, you want to look at the data as a film and not a snapshot.

For example, Grandview, Missouri, is a small suburb of Kansas City. In 2008, Forbes listed it as the eighth fastest-dying city in the county, but it has since stabilized—and that bears out when you review the population information on City-Data.

Of course, there are paid sites that can provide even better research. Many brokerages and local real estate associations release helpful reports for cities as well.

There are other factors to investigate, too. While good schools might seem like a solid indicator of a location and the trends of the area, public education should not be a driving factor when purchasing real estate—especially if you’re looking to invest in up-and-coming areas.

Consider using the “leveraged analysis technique,” which leverages available resources so you can find working-class neighborhoods for investment and cut search time in half so you are not wading through dud properties.

2. Renovation or construction

If you see a lot of homes being remodeled or repaired, that is a very good sign. The same goes for construction, although be forewarned. there is certainly such a thing as over-building.

On the other hand, lots of vacant, boarded-up, or burnt-out buildings are a sign that the neighborhood is either declining or has already declined.

3. “For Rent” or “For Sale” signs

Improving neighborhoods usually have low vacancy rates and an abundance of demand rather than supply. A lot of “For Rent” or “For Sale” signs should be a red flag.

4. Major developments and new businesses opening

There’s nothing like a major business development to turn an area around. Indeed, this is one of the most important things to look for (as are, in the other way, large businesses closing down). These new developments not only bring in a lot of jobs, but they bring in something like two to three support jobs (such as cashiers for retail stores that open nearby) for every high-paying job. And all of these people need somewhere to live.

It’s important to get out ahead of these developments as quickly as possible, so pay attention to the local business news. And if your city has an economic development plan, that would be wise to read up on.

5. Local chatter

There’s no better way to get a feel for a neighborhood than to talk to the people who have lived there a long time. Has it improved or gotten worse? Are people generally moving in or out? What is it with the kids these days?

Of course, don’t just rely on one or two people’s opinions. Some opinions have been jaundiced for whatever reason and are at odds with reality. But the law of large numbers suggests that if you talk to enough people, you’ll get a good idea of where the neighborhood is heading.

And if you run into a bunch of people who just recently moved there, that might tell you something about the growth of that area as well.

Figure out what makes sense for you

Part of properly analyzing a neighborhood involves taking a deep look at the market data. What’s the average price per square foot? For that matter, what’s the average square footage in that particular area?

A proper real estate market analysis won’t tell you if the neighborhood is good or bad. It will tell you precisely what investments can make that neighborhood a winner and help you pinpoint underappreciated gems.

Find out what particular property types are more common. Some areas are filled with ranch houses; others have townhouses. Investing in multifamily in a neighborhood where renters expect single-family homes may lead to lower rents and decreased equity. Pay attention to age range, too: An older house surrounded by remodeled gems can be a great opportunity for a flip.

Pay attention to the proximity of the property to major amenities. Homes close to public transportation or a main strip filled with restaurants and shops may be more likely to appreciate—especially if the location truly comes up. You just don’t want to be too close, otherwise the noise may reduce property values.

Using leveraged analysis

Leveraged analysis is powerful because it uses the right metrics for analyzing properties. When looking at the supply of houses in working-class neighborhoods, three crucial metrics are primary indicators of market condition: crime, photo counts, and rents. Just remember “CPR.”

If someone who is new at real estate investing mentions a house where the property prices are very low, the first response should be, “What do the crime rates, photos, and average rents of that neighborhood say about the subject property?”

Knowing these nuances can help make your neighborhood analysis more applicable and accurate. You can leverage the resources available to you and make sound decisions that take a number of factors into consideration, in addition to running a comparative market analysis. Expanding your scope to other neighborhoods and areas has the potential to increase a property’s value and secure the highest return for you.

Crime

You have a wealth of resources at your fingertips. Look at crime reports online and call the local police department. These resources can help you determine if a low-priced property is in a high-crime area, which can affect value moving forward.

This data helps you filter through locations and properties so that you can make an informed decision based on what type of crime happens in that location. Is the crime typically misdemeanors, or is there a rash of more violent crime?

Photo count

The more pictures, the better! You can use websites such as Trulia and Zillow for this type of work. If the MLS sales data doesn’t have a large photo count, this might signal that the property is a dud. Plus, if there are only one or two photos, you are not getting a good idea of the property’s amenities, square footage, architectural style, or environmental factors.

If the listing shows a low price range but has limited photos it probably means that the property is burnt up or terribly destroyed.

Now, if there are a number of photos to browse through, it is a good indication that the property is in decent condition, but perhaps located in a distressed area. If you’re not looking for a major fix-and-flip project, focusing on properties with a variety of photos is a big time saver.

Rent

In certain parts of the country, you can buy a property in a cheaper neighborhood for $30,000, but end up with $300 in rental income. That’s not great cash flow. Buying in a working-class neighborhood might guarantee you $700 to $1,000 in rent.

Calculate the cash flow of each property before buying to make sure it makes sense. But remember: Cash flow isn’t the end-all, be-all of buy-and-hold investing. Up-and-coming neighborhoods can create incredible equity. While it’s important to be cash flow positive, a good eye for potential may lead to enormous gains.

Don’t forget the MLS

The leveraged analysis technique helps you consider the real estate investment property more holistically in the context of neighborhood. But the multiple listing service (MLS) is the best source for the hard data. Once you know what numbers suit your investment strategy, you can fine-tune your search to make sure you’re buying the right properties for the neighborhood.

Look at comparable sales to make sure you’re not under- or overpaying. Comps provide another benefit, too. Paying attention to recent sales for several months will give you a deep understanding of the local market. You’ll understand market forces implicitly, know the expected supply of properties, and easily identify competitive properties when you’re ready to invest.

We all have investing experience we can share. New investors should keep in mind that there is so much diversity of experiences. Some suggestions don’t apply to particular locations and endeavors.

Get in the car, do a little driving, and talk to some neighbors yourself. You will get the picture immediately. It’s even likely you’ll find a gem of a neighborhood off the beaten path. That’s why doing a neighborhood analysis is key—you use the resources at your fingertips while engaging with the neighborhood characteristics of an investment property.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.