8 Ways to Identify the Best Places to Buy Rental Property
How do you find a market with high and steady rental growth for the next decade? If you’re simply searching for markets with the highest rental growth for the past few years, then you’re starting off on the wrong foot.
A strong past performance in rental growth doesn’t guarantee a strong future performance.
You need to pay attention to the fundamentals that are driving the rental growth. Sometimes the fundamentals are there, but the rental growth hasn’t started yet. Those are the hidden gems that you want to invest in.
Investing in a real estate market solely based on strong historical performance is like blindly buying a growth stock. The investment has been doing well, but it can turn sour very quickly when the demand decreases. Like how people sell their stocks when they think the company is becoming overvalued, residents can get priced out of a market when the city becomes unaffordable.
Here are eight fundamentals to explore that will help you spot the best real estate markets.
Note: It’s always a good idea to cross reference the statistics by using different websites or resources as a double-check.
8 Factors to Focus on When Searching for a Great Market
1) Population Growth
What to look for: Cities with 1.5 percent minimum year-over-year (YoY) growth for the past two decades and more than 100,000 people.
Resources: US Census, Data USA, City-Data or Google
When I was first researching for a market that I’d like to invest in, I looked at population growth as my first step, because it’s great for narrowing down the list. Rank the cities with more than 100,000 people from highest to lowest YoY growth in the last decade, and then look for 10 markets that you’re interested in. Markets where relatives or friends are living or those that are located near you should be high on your list.
2) Household Income Growth
What to look for: Household income growing at 1 percent minimum YoY for the past two decades.
Resources: US Census, City-Data, or Data USA
Without substantial household income growth, there won’t be healthy rental growth. If a city has a strong rental income growth but a weak household income growth, then it’s a sign that its residents are getting priced out of the market. The population growth will start slowing down.
3) Crime Rate
What to look for: A crime index that has been decreasing consistently for a decade.
Resources: City-Data (If you know another good website for cross-reference, please comment below.)
A decreasing crime index is a sign that the city is improving. Companies also study the crime index to make sure that their office locations are attractive to workers, especially those with families.
4) Household Income to Rent Ratio
What to look for: Minimum current median household income to median rent ratio is 4x or more.
Resources: US-Census, Data USA, City-Data, HUDuser.gov
This is a great metric for measuring affordability in the area. Make sure you use median, not average, because high household incomes can significantly affect the average.
5) Employment Growth
What to look for: Minimum employment growth of 2 percent YoY for the past two decades.
Resources: Data USA, HUDuser.gov
Employment growth is a key indicator of the economy. A growing population is not sustainable without good employment growth. However, you should find out what sectors or companies are growing and whether the growth will continue or stop.
For example, a factory that manufactures Boeing Max 737 airplanes—probably not going to grow…
6) Employment Diversity
What to look for: Compare current local employment ratio to national employment ratio.
Resources: Data USA, City-Data, HUDuser.gov
You should look for cities with good diversity in terms of employment. This means the city’s local ratio should be within a few percent of the national average across all industries.
You want employment diversity to mitigate risks associated with certain industries declining.
For example, in Wichita City, Kan., 18.3 percent of jobs are in manufacturing, but the national manufacturing job ratio was only 7.9 percent in 2016. This means that manufacturing is a significant industry in Wichita City. However, statistics show that the number of employees overall in Wichita City has been declining.
I personally wouldn’t worry if the local employment ratio is higher for the education or professional services sectors, because I think these two are either stable or have a great long-term outlook.
7) Median House Value
What to look for: Look for 2.5 percent YoY growth in median house value in the past two decades.
Resources: Data USA or City-Data
This is a good indicator of the overall wealth in the city.
Additionally, if the median house value has been increasing consistently for 20 years, then that means it’s expensive to buy a house, forcing renters to stay renters longer.
8) Landlord Friendly States
What to look for: Although this is not a deal-breaker, try to avoid states that have tough rent control and tenant eviction policies.
Resources: Rent Cafe or Google
If you’ve chosen a market that’s not landlord friendly, then make sure you account for this in your underwriting and projections. Get with a seasoned property manager to understand realistically how quickly you can renovate your units and raise your rents.
The Bottom Line
Everyone does their market research a little differently, so I’d love to hear what additional statistics you look for.
Lastly, I have an Excel worksheet that can help you get started available for download here.
What’s missing from the list above?
Add to it in the comment section below.