Hello @Christine Vasquez,
Many investors choose real estate markets based on gut feelings or popular trends. In this response, I will outline the process of selecting an investment city based on financial goals.
Financial independence
Financial independence goes beyond reaching a specific dollar amount, like replicating your current income. In a world of constant inflation, maintaining your lifestyle over time requires an income that meets four key criteria:
Rent Growth Must Outpace Inflation
If a basket of goods costs $100 today, in ten years, with 5% annual inflation, that basket will cost $162. If your income grows faster than inflation, you'll have the $162 needed to purchase the basket. If not, you must get a job to cover the difference.
Lasts Throughout Your Lifetime
Your rental income relies on your tenants maintaining stable employment at comparable wages. However, since the average lifespan of a U.S. company ranges from 10 to 18 years, most private-sector jobs your tenants hold are likely to end within that timeframe. Suppose new companies do not establish operations in your investment city to create replacement jobs with similar pay. In that case, your rental income may decrease as more workers transition to lower-paying service sector roles. Consequently, your financial stability hinges on the emergence of new companies generating equivalent employment opportunities.
Sufficient to Replace Your Current Income
A single property is unlikely to generate enough rental income to replace your current income, so you'll need multiple properties. The capital you'll need to accumulate depends on the appreciation rate in your chosen investment city. If there is little or no appreciation, every investment dollar must come from your savings. For example, if you need $7,000/month to replace your current income, and each property costs $250,000 and generates $300/month in cash flow, the amount of cash you'll need just for 25% down payments is $7,000/$300 × $250,000 × 25% ≈ $1,458,333. That's a significant amount of after-tax savings to accumulate.
Investing in a city with an average annual appreciation of 8% can be a game-changer. By holding the property until its value increases significantly, you can execute a cash-out refinance to fund your next purchase. This strategy has allowed my clients and me to expand our property portfolios with minimal upfront capital. It closely aligns with the principles of the BRRRR method.
Low Risk of Natural Disasters
Natural disasters can wreak havoc on your property and the surrounding community, causing job losses and the closure of businesses, which often forces residents to relocate. Although insurance may help rebuild your property, the community's recovery could take years or never fully happen. In the meantime, expenses such as debt payments, taxes, insurance, and maintenance persist.
Characteristics of a City That Enables Financial Independence
To maximize your chances of achieving financial independence through real estate, focus on cities exhibiting the following characteristics:
- Significant and Sustained Population Growth: Rental rates are driven by supply and demand. Population growth creates increased demand for housing, pushing rents higher.
- Rapid and Sustained Appreciation: In cities with abundant, low-cost land, new construction is often preferred over existing properties, limiting appreciation potential. Focus on cities where demand outstrips supply, driving up property values and rents.
- New Companies Create Replacement Jobs: A growing economy is crucial for tenant income stability. When companies consider new locations, they look for specific factors:
- Population over 1 Million: Companies need a large, skilled workforce and robust infrastructure.
- Low Crime Rates: High crime deters businesses and residents.
- Low Operating Costs: Companies seek locations that allow them to remain competitive, avoiding areas with high taxes and regulations.
- Low Risk of Natural Disasters: Companies are wary of areas prone to natural disasters that can disrupt operations. State average homeowners insurance rates indicate the risk of natural disasters.
Information Sources for Data-Driven Decision Making
Utilize these resources to gather the necessary data for your city selection process:
The Importance of Local Expertise
While research and data are essential, remember that general knowledge only goes so far. Each property is unique, requiring specific renovations and compliance with local regulations. An experienced investment team can provide invaluable assistance in finding, vetting, inspecting, renovating, and managing properties effectively in your chosen market. They bring local knowledge and expertise that can significantly increase your chances of success.
Christine, I hope this helps.
