I Know Your Neighborhood Better Than You Do

We all know that when investing in real estate location is perhaps the most important thing to consider. Investing out of state in a market that you’ve never lived in can be particularly challenging when you know so little about a property's location. I currently live in San Diego, California, but due to market conditions in coastal markets such as these I elect to invest out of state in the Midwest.

One of the first objections I get when I tell people this is “how do you know you’re investing in a good neighborhood when it’s so far away and you’ve never lived there?” This is a fair question, and for people unfamiliar with the process involved in underwriting a property it just doesn’t make sense to invest somewhere outside your own backyard. The answer is that I use quantifiable data to support my investment decision, rather than speculating based off of gut feeling or a hunch. In fact, once I’ve researched your market I feel comfortable saying I know more about your neighborhood than you do. At least as far as information that matters for investing.

It sounds crazy at first, but how many people can say they know the median household income in their neighborhood, what the crime rate is, what the unemployment rate is, or what the home ownership rate is? These are the statistics that matter for making investment decisions, not whether or not it has good coffee shops or neighbors that wave when you drive by.

I’m going to show you what key metrics and demographics we use to determine whether a property is located in a neighborhood worth investing in. This isn’t meant to be an all-encompassing guide on everything you should research in a market, but one that covers the basics. 

The Fundamentals

There are many sources out there to collect the data you’ll need, but I find the best and easiest to be Neighborhooscout.com. It’s a paid subscription and it’s worth every penny. All of the data points I mention can be found there.

The three metrics you’ll be researching are:

1. 1. Median household income
2. 2. Crime Rate
3. 3. School Ratings

Median household income is always the first thing we look at in a neighborhood. You can find this on Neighborhoodscout.com under the “Demographics” tab. Our minimum acceptable income level is $40,000 per year. We set this benchmark because below that income level your tenants simply can’t afford much rent increase no matter how much value you add. Additionally, you can expect higher crime rates, more problem tenants, evictions, etc. Looking at this metric first we can usually rule out a property in seconds.

If the property makes it past the income hurdle we next look at crime rate. Crime seems like an obvious one, but a high crime rate means you’ll be dealing with a worse pool of tenants on average, and it will also be more difficult to find quality property management. We learned this the hard way when we had a property under contract in a bad neighborhood and all the top property managers in the area flat out refused to take on the property. We ultimately backed out of that deal.

Neighborhoodscout.com uses a crime index number between 1 and 100, with 100 being the safest. We look for an index above 30. That may seem low, but you’d be surprised how difficult it is to find neighborhoods with high ratings, especially around major metros. I encourage you to look at your own neighborhood and investment properties for comparison. We’ve generally found neighborhoods above an index of 30 to be relatively safe for our investments.

The last fundamental metric we look at before diving deeper is school ratings. This is especially important if you have a property with units that have two bedrooms or more, because parents that can’t afford to purchase a home in a good school district want to rent in that district, making your units highly desirable. The Neighborhoodscout report gives an index rating between 1 and 100, just like the crime index, with 100 being the best. We shoot for an index north of 80.

Additional Metrics for Consideration

While my list of three fundamental statistics helps weed out bad properties quickly and identify good neighborhoods, it’s not the full scope of statistics you should be looking at. Here is a short list of additional stats to consider when making your investment, all of which can be found on the Neighborhood Scout report:

• - Employment industries breakdown. You want a mix of several employers and not just one big one. If that one big employer leaves then most of your jobs leave (see Detroit or small oil towns). You generally don’t want any single industry controlling more than 20% of your jobs.
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• - Home ownership rate. We like neighborhoods where home ownership is low relative to the number of renters.
  
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• - Average annual rent price trend. This statistic shows your average rent percentage increase. You want rent trending upward year over year, not flat or negative.
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• - Unemployment Rate. Shoot for unemployment that’s below the national average, and if investing in a sub-market, ensure it’s less than the nearby major city.
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• - Crime trends. This is an interesting statistic if your neighborhood just barely doesn’t meet your benchmark for crime. If crime has been trending downward over the past five years that’s an indicator the area is becoming more trendy and on the rise.

Conclusions

The three fundamental metrics I detailed above are a good way to quickly weed out properties or neighborhoods that don’t make sense to invest in. Generally speaking, each of those metrics are closely related. If a neighborhood has a very low median household income, you can expect high crime and bad schools to go with it, and vice versa.

Subscribe to a service like Nieghborhood Scout and ensure you look at this data before purchasing a property. It may cost you $30 or $100 per month depending on which plan you purchase, but that small investment could save you thousands in the long run and even more in pain and stress.

Start geeking out on as much data as you can and make the most informed, data driven decision possible when purchasing your next investment. Happy hunting!