Assess Any Market With These 5 Data Points

Decision making in this business is difficult. There is no standard measurement that can always be used to verify potential returns for a potential acquisition. This makes due diligence the critical component in the buy decision. Eliminating no-go deals quickly creates more time to focus on the deals with a higher probability of closing- deals that fit into your business plan in terms of yield, positive market attributes and return on investment. Asset review often includes more than the current cash flow of the subject asset- rent and sale comps, market trends, and other factors are very important as well.

When reviewing a subject asset, its market and comparable assets, the following data points set the stage for an asset review that is market specific. It’s as important to understand the market that your subject asset competes in as it is to understand the asset itself. Each one of the following is important individually, but collectively they paint a picture that shines a bright light into the corners of a potential acquisition and the market where it competes.

Rent Distribution - While finding Effective Gross Rent (EGR) is important- understanding the range of rents within a market area is just as important. Do asking rents at the subject asset fall into the norm for the market area or outside of it by a small or large percentage? When estimating EGR, it is important to reflect on whether or not the market can tolerate the same increases you are underwriting. Value-add investments are especially dependent on their surrounding market. Paying attention to where the subject rents fall on a distribution can clarify whether or not a property is a candidate for value-add by renovation.

Owner/ Renter Ratio - The historic base for the home-ownership rate in the United States is 63%. This rate almost touched 70% in the early 2000’s before crashing back to the historic norm. Every market area has its home ownership “norm”. Recognizing changes in this metric can provide insight about changes in rental availability, rental product type and pricing. An area where 50% or more of housing stock becomes rental property provides more choices to potential tenants, and as a landlord you will have to be even more mindful of competition to be successful.

Resident/ Commuter Ratio - There is always a correlation between rents and their distance from job centers. Market areas with fewer commuters, or market areas with more jobs, are less exposed to risk of vacancy due to length of resident commutes. The marginal cost of time lost on a lengthy commute often outweighs the marginal benefit of lower rents, causing people to pay more for greater convenience. Bottom line: high area job concentration creates greater potential rent growth.

Age of Subject Asset and Comps - The age distribution of area properties indicates the potential income of a property. With rare exception, a property built in the 60’s or 70’s cannot generate the same amount of income as a property built after 2000 even after undergoing a significant renovation. To expand, if you are looking at purchasing older product in an area with a lot of new product, with amenities, finishes, and location constant you will not be able to achieve your neighbors rents. On the other side, when underwriting a new construction asset in an area with all older product your rents should be higher than the competition. Just keep in mind that your new property will be an outlier for the market, for which there is less data and, therefore, less certainty in your assumptions.

Number of Units - Knowing the number of units currently, absorption and population trends (such as median household size) can provide insight as to whether a market is under-supplied or over-supplied in aggregate and at the unit type level (1,2, 3 bedrooms.) In acquisitions and new construction, it is important to match demographics and current inventory. Recognizing a mismatch in demographics and inventory is a great way to determine what should be built on a given site. If an area is full of empty nesters, with household size decreasing, it would make sense to build smaller, one or two bedroom units.

This snapshot of your market, derived from the above data points, can be worth a million dollars when you can see, digest, use and implement a course of action from a single page of quality information. As a real estate acquisitions professional, or a developer, a constant flow of information is required for predicting outcomes and delivering recommendations. Sitting down to a complete market “snapshot” can save hours, even days during the critical due diligence phase.