Selecting An Investment Location Part II - Follow the Money
This is the second of a series of articles on selecting a good investment location. In this article, I will talk about taking advantage of others research.
Corporations spend a lot of time and money deciding where to open new facilities. You can take advantage of their research. But, before I get to leveraging corporate research, I will explain why behaviors, not the underlying data, is not only the easiest to obtain but in many cases the most reliable indicator.
Behaviors, Not Raw Data
Finding good investment properties is not easy. The days of an individual cruising real estate sites and driving around looking at properties are largely gone. There are few good investment properties in a sea of poor investments. How do we consistently find good properties? Data mining.
We use data mining to find the very few good investments from the thousands of available properties. However, some of what we mine for are behaviors, not the underlying data. An example might help explain the difference between data and behavior. Suppose your job is to determine which of two ice cream flavors would be the most popular. Two ways to go about this:
- 1. Analyze the data - You could look at the ingredients of the two ice creams and compare and contrast it with popular flavors. Based on this, you could make your prediction. This would be a complex task and not necessarily reliable.
- 2. Take the two ice creams to a location where there are many people. Offer free samples of the ice creams and see which flavor most people buy. You need no chemistry or analytics for this and yet it is far more reliable because you based your recommendation on behaviors of your target market.
The same data/behaviors option applies to real estate. For example, we know of subdivisions where the median tenant stay is just over 1 year. In a nearby subdivision, the average tenant stay might be over 4 years. I do not need to analyze why tenants stayed longer in one subdivision than the other. The why does not matter. Based on such behaviors, we only select properties in subdivisions with long tenant stays.
We can apply the same process to locating good investment locations. Before I talk about selecting good investment locations, I want to emphasize the importance of jobs. First, the math is easy:
Tenant has no job == Tenant does not pay rent
A property is no better than the surrounding jobs. So, you could just consider locations with jobs and be done with it. Right? Not necessarily. You are buying a property you may hold a lifetime, which depends on jobs. However, jobs do not last.
The Life Span of Companies and Businesses
The S&P 500 is a stock market index that measures the stock performance of the largest 500 companies listed on stock exchanges in the United States. In short, these are big companies. What would you guess is the average life span of an S&P 500 company? Would you believe it's less than 18 years1? How long do you expect a typical business survives? About 10 years. Businesses are like people, they start, mature and die.
The reality is that the majority of the current (non-government) employers in any location will be gone in 10 to 20 years, from the day they started. As the current employers die out, your tenant pools jobs will vanish. Unless companies are moving in to the area creating new jobs that replace the dying employers, your investment will drop in value and rents will follow. Below depicts a market where current companies are dying but there are a stream of new jobs to replace them.
How can you determine which locations are dying and which are constantly regenerating jobs? We are back at the two ice cream problem. You can either do all the research to predict which locations companies are likely to open new operations in or you can simply follow the money invested by these companies.
Follow The Money
Note that the number of roof tops determines retail locations. Proximity to markets and transportation determine distribution location. Such business segments are not good indicators of locations of where to invest. Focus on companies setting up people intensive operations.
Companies do not roll dice to choose where they will set up new operations. There is too much at stake. Companies do extensive research concerning how the location is performing today and likely to perform in the future. After reading several articles about how businesses select expansion locations, I found the following common characteristics (not in any specific order).
- • Safety/Crime - Businesses will not set up operations in cities or areas perceived as unsafe. A good list of places companies avoid is NeighborhoodScouts Most Dangerous Cities2020.
- • Cost of doing business - Companies must generate a reasonable and sustained profit, or they die. The necessity of consistently generating a profit is a large factor in selecting a location. One of the best ways to accomplish this is to choose a location with a low cost of doing business. For these reasons, high-tax states, states with excessive regulations, Blue states, and pro-union states are not likely to see businesses setting up new operations.
- • Area trajectory - Is the population growing or shrinking? Is per capita income rising? What is the regulatory environment? Housing prices, schools, entertainment, and many other factors are considered.If these and other factors are not stable or improving, the location will be eliminated from consideration.
- • Accessibility - Unless companies can easily access the location, they are unlikely to be considered. Would you like to make a weekly trip to a location where, after a 2 hour flight, you have a 3 hour drive? The easy access requirement equates to cities of around 1 M population or more. Only larger metro areas will have enough direct flights to make traveling time efficient. Unless a company is setting up a mill or similar operation, odds are that they will not choose a small town.
Photo by Monica Bourgeau on Unsplash
- • Existing local skill base - Unless the location already has the workers with the needed skill sets, businesses are unlikely to set up new operations. It is too expensive to move everyone that they will need to a new location.
Photo by Branko Stancevic on Unsplash
- • Climate - If you look at migration maps, you see that it is largely from colder climates to warmer climates. This is for business and life-style reasons. For example, what are the odds of getting the management team to move from southern California to Minot North Dakota? Plus, it is more expensive to operate in snow country than in a warmer climate.
Photo by Alberto Restifo on Unsplash
Where Are Companies Moving To?
A little searching on Google will provide a list of locations to consider. For example, here is a Kiplinger article: 10 States With the Fastest Rates of Job Growth, 2020. You will find other such articles. These would be the starting point of developing a short list of locations to consider.
Summary
An investment property is no better than the jobs around it. Companies do extensive research before they select a new location. You can take advantage of their research when you are looking for a good investment location.
Note that while jobs are critical, jobs alone are not the only important factors to consider when selecting an investment location. In the next article in this series I will talk about the impact of urban sprawl on real estate investing.
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