People ask me all the time why I invest where I do. I don’t live in Kansas City and I don’t have a personal connection there. When I did my research though, I realized that it had strong real estate fundamentals so I looked to build a team there.
I always tell people not to pick a real estate market based solely on personal preference or circumstance. Instead pick a market using objective factors that actually impact real estate demand and value.
I look at 5 major fundamentals to understand a real estate market. These help me determine whether it’s a good market to invest in and they include:
- Local Economy
- Housing Market Cycle
- Cash Flow Potential (e.g. Rent-to-Price Ratio)
- Rental Laws
This is part 2 of an educational series on Real Estate Market Fundamentals. In part 1, we covered how a real estate investor should conduct population research.
In this post, we tackle how to research and understand the local economy.
In part 1, we talked about investing in a market where there’s net positive migration. Well, one of the biggest factors that cause people to move is economic opportunity.
A strong local economy will have employment opportunities that will attract people to move there. By local economy, I’m talking at the MSA (Metropolitan Statistical Area) level. We discussed MSAs back in Part 1.
So in essence, we’re looking for a market that has jobs. Jobs leads to population growth which leads to increased housing demand. Therefore jobs play a critical role in the real estate market.
Let’s dive deeper into what a strong economy looks like. The following economic indicators in a market will ensure there’s a growing demand for real estate.
- Trend of Continued Job Growth: A major factor of net migration is economic opportunity, in other words, new jobs. Both an employer adding new jobs or new employers that move into a market will fuel net migration of people who will ultimately need housing. The type of housing will depend on the income levels and types of jobs that are being created. For instance, a surge in temporary contract laborers may only look to rent during the duration of their work instead of buying a permanent home. On the other hand, professionals in law or engineering may instead look to purchase a residential home. Workers’ age also plays a factor. So if the market you’re looking into has a vibrant urban center and the new jobs are primarily millennials, then luxury apartments around downtown may see a surge instead of home purchases outside of the city.
- Business Friendly Environment: Nationally recognized employers often select their headquarters and major operations centers strategically. States with business friendly policies, regulations, and tax incentives will continue to attract major employers and new startups. This business friendly environment translates into new jobs, which stimulates the local economy, and ultimately promotes further population growth. All big positives for anyone investing in the local real estate market. According to a 2016 Survey on Small Business Friendliness, states such as California, Connecticut, and Illinois ranked as one of the worst states to operate a small business. By contrast, Tennessee, Texas, and Utah ranked as the most business friendly state of 2016.
- Declining & Low Unemployment Rates: Look at the unemployment rate over recent years and months. Markets that have a declining unemployment rate and one that’s lower than the national average will indicate a local economy that’s doing relatively well. The below graph shows the unemployment rate for several cities since 1990 according to the Bureau of Labor Statistics.Lastly, different property types will be more or less sensitive to unemployment rates. For instance, what kinds of tenants does your property target? Is your rental near university housing that targets students or in an urban city geared towards housing working white collar professionals? Perhaps your rental niche is in housing retirees. The unemployment rate will have less of an impact on you as a landlord if your tenant is not dependent on the local economy. Retirees who have a fixed retirement income and college students are not affected by the local economy as much as the working class.
- Several Industries And Employers Should Be Represented: The local economy should be well balanced and supported by many different industries and employers. A market that is heavily employed by a single industry or employer increases the risk to your real estate investment should something happen. Take for example, the collapse of the automotive industry in Detroit drove (pun intended) the city into a downward spiral because there was very little economic diversity.
- Recession-Resistant Employment Base That’s Unlikely to be Outsourced: Some industries remain fairly stable regardless of how the economy is doing. Jobs in education, government, and healthcare tend to be resilient to hard times like a recession. Additionally, jobs that are highly unlikely to be outsourced is another good sign to look for. For instance, if a significant portion of a town’s jobs are in manufacturing, then there’s a chance that the employer may someday find a lower cost labor force either in another state or abroad.Investing in a real estate market with such jobs offer stability and lower risk.
- Types of Jobs That Match Investment Class: If your target investment property is on higher end luxury rentals, then you need to see data that supports the existence (and hopefully growth) of professional employment.
Comprehensive Annual Financial Reports (CAFRs)
If you’re seriously considering investing in a market, I highly recommend that you read that city’s Comprehensive Annual Financial Report (CAFR). The CAFR is published yearly by the city and provides a lot of great insight for investors.
“A Comprehensive Annual Financial Report(CAFR) is a set of U.S. government financial statements comprising the financial report of a state, municipal or other governmental entity that complies with the accounting requirements promulgated by the Governmental Accounting Standards Board (GASB).” – Wikipedia
The CAFR is a lengthy document, but here’s how to get the most out of it in a short amount of time.
Kansas City CAFR
Consider the Kansas City CAFR from 2015-2016 for example. With 385 pages, there’s a ton of information here.
First, scan through the introductory section. Notice on page 9 of the pdf, there’s a section titled Local Economy. Bingo! This section usually describes top level highlights of the city in terms of employers, industries, and any national rankings that the city may place.
Continuing further, the CAFR has several sections titled Major Initiatives, Economic Development, and Public Infrastructure. Here, you can get a list of major projects at varying stages of planning and development that the city has underway. These give a great, quick summary of where you may want to focus your research further. Perhaps there’s a new highway under development or a large public transit system in work that will connect neighborhoods to the city center. You can imagine how real estate prices adjacent to this development may improve over the years.
Lastly, I flip towards the back of the CAFR to see who are the top employers in the city. In the KC CAFR, the top 10 employers are listed in a table on page 379. Beside each employer, statistics such as the number of employees and the percentage of total employed are shown. This table gives a great snapshot for any investor worried that the market they are considering is too heavily reliant on a single employer. This list provides insight into what industries are employed as well.
So whatever city you’re interested in, just Google “City Name CAFR” and download the latest report.
Here are free resources that are great to continue your research into most markets across the US.
- Bureau of Labor Statistics (BLS) – Essential statistical data on labor and economics such as key figures on unemployment, inflation, earnings levels, projections of occupational and industry growth, productivity trends, etc. All of this data is provided here for free.
- BLS Economic Summaries – Excellent economic overviews for major metropolitan areas. These are fantastic snapshots of the local economy and will provide you a quick idea of where the unemployment rate is at, job market trends and whether jobs are increasing, along with employee wages, and the types of jobs available in that market.
- BLS Unemployment Rate – Current rates in each state and metropolitan area
- 2016 Small Business Friendly Survey – Most and least friendly states/cities across several categories.
In this 2nd post of the Real Estate Fundamentals series, we covered the local economy.
So what makes a market’s economy strong for real estate investors? In essence, you’re looking for continued job growth in a variety of industry sectors. The unemployment rate is a helpful indicator to assess the current job market and you’re looking for a downward trend that is lower than the national average. A market where the local government is pro-business is also a positive driver for stimulating the economy.
One great resource I recommend you check out to learn more a particular city is that city’s CAFR. There you’ll find highlights about that city’s economy, outlook, and top employers.
I hope this post helps you the next time you’re evaluating a new market or when keeping up to date on existing markets you invest in.
What indicators are most helpful to you when studying the local economy of a market? I’d love to hear from you. Leave a comment below.