Hello @Tyler Brown,
You asked an excellent question but not one with a simple answer. I will tell you the process I would follow and some of the concerns I would have.
So we are on the same page, I believe all investment properties must meet three criteria:
• Sustained profitability - The property must generate a positive cash flow today and into the foreseeable future (10+ years).
• Likely to appreciate over time - You would never buy a property just for appreciation but appreciation is very desirable. And, rents usually rise along with appreciation because appreciation is the result of increased demand.
• Investor friendly state/county/city regulations - Evictions, rent control, code compliance requirements, etc. This is a critical factor. In some states it can take more than a year and cost thousands to evict a non-paying tenant while your mortgage payments and costs continue. Few investors could handle such a loss. If you think eviction regulations and landlord rights are not critical, you have not seen the movie Pacific Heights.
While it is relatively easy to satisfy one or two of the above criteria today you need to satisfy all three for the foreseeable future (10+ years). Too many new investors only consider how the property will perform today using metrics like ROI. However, ROI tells you nothing about how the property is likely to perform in the future.
The overall process I would follow to meet all three criteria is illustrated below.
Below is a description of each level.
Metro Level Considerations
I would only consider metro areas with:
• Reasonable access (flight/drive) from where you live. Sooner or later you will want (or need to) inspect your properties.
• A city where you would like to spend time. One of the many advantages of investment real estate is that travel expenses to inspect your properties are deductible. I live in Las Vegas and many of my clients (especially the ones in Canada) "inspect" their properties between January and March.
• A population exceeding 1M will have sufficient historical data so you can evaluate trends. Also, larger cities have more stability than smaller cities because they tend not to be a one-employer economy.
• Financially stable - Cities that are in bankruptcy or near bankruptcy are not good places to invest. If you look at inflation adjusted $/SqFt prices in such cities you will find that property prices have fallen as well as rents. And, they are likely to continue to fall because the business environment that caused the fall is not likely to change. For more information see, "Investing in Declining Markets" on my profile page.
• Metro areas which do not experience hard freezes or significant moisture. Ongoing maintenance costs are significantly higher in areas with hard freezes and moisture.
• No or limited urban sprawl - In every metro area I've seen there are areas that were once prime areas and over time become distressed areas. The reason is that people with money will tend to move to newer areas with newer floor plans, etc. You do not want to buy in areas that are trending down.
• Stable or increasing job quantity and quality - The value of a property is no better than the jobs around it. In many parts of the US, manufacturing and similar jobs are going away and what remains are service sector jobs. Service sector jobs tend to pay much less than manufacturing jobs so the families of these workers have less disposable income. Less disposable income means that they cannot afford to pay the level of rent they did in the past so property prices and rental rates fall.
Location Level Considerations
If you selected a number of potential metro areas and filtered them through the metro level considerations you will likely have a relatively small number of potential metro areas to consider. Now you need to focus deeper into each one remaining. To do this you need detailed location level information. Where can you get such information? Local property managers. Every day property managers deal with marketing properties, maintenance, tenants issues, rehab, local regulations, finding and screening tenants and many other rental property related issues. Local property managers know what works and what will not work. Google the name of the city plus the words "property management" and you should get a number of hits. Go through the web sites and look for a mid sized property manager. Select 3 or 4 and call them. The minimum you need to know is:
• Where - Specific location within the metro area that rents the best.
• Type - Condo, multi-family, single family, etc.
• Configuration - Singe story, two story, number of bedrooms, etc.
• Rent range - If the most desirable tenant pool can only afford to pay between $800/Mo. and $1,000/Mo. you should only be looking at properties that you can purchase, rehab and profitably rent within that rent range.
• Regulations - The most important will be the time and cost to evict.
• Typical rehab costs and issues to avoid.
• Typical time a tenant stays in such properties and typical turn costs.
Have a list of well formed questions before you call and take notes. (I created a list of property manager interview questions. If anyone would like a copy, send me an email.) If you hear the same information from multiple property managers, then it is probably true. When you finish your property manager interviews you should have a reasonable guess to the answers to each of the following:
• Where
• Type
• Configuration
• Rent range
• Regulations (like eviction cost)
• Typical rehab costs
• Typical time a tenant stays
• Typical turn cost
• Insurance cost
• Property tax rate
• Probable property manager you would like to work with
• Probable ongoing maintenance costs
• Probable recurring costs
• Purchase price range - When you know where, type and configuration, you can easily determine the sales price range using Zillow or a similar site.
Time to dig deeper.
Detailed Location Investigation Considerations
With the property profile you created during Location Level Considerations, you should know what you want. The next step is to contact a local Realtor. Provide them with your selection criteria (where, type, configuration and purchase price range). They will send you conforming properties and you can do further analysis. If everything still looks good it's time to go see the location yourself and start to assemble your investment team.
Your Investment Team
It is imperative that you have a trusted local team. At the minimum you need a (good) property manager and a Realtor. For more details on the investment team check out this BP post.
Tyler, my response ended up being much longer than I originally intended. However, you asked an excellent question and I believe the answer will be of importance to many BPers.
