6 Red Flags That Disqualify a Real Estate Investment Market
We post a new question to the Best Ever Show Community on Facebook every week. The Best Ever Show Community is where real estate entrepreneurs of all experience levels can come together and network with each other, me, and the guests featured on my real estate investing podcast. The idea is that everyone can help one other reach the next goal in their businesses and personal lives.
This week, the question was “what is the biggest red flag for you when evaluating a market?”
We’ve all heard the investing cliché “real estate is all about location, location, location.” While I believe the ability to execute the business plan is more important than the real estate investment market, the quality of market comes in close second. So, what factors should you analyze in order to determine the quality of an area? First, I recommend reading my ultimate guide to evaluating a real estate market. Then, read on to learn the 6 red flags active real estate investors said will disqualify an area when conducting real estate market research.
1 – No Job Diversity
If the dominant industry employs too large of a percentage of the population and that industry collapses, many people will likely become unemployed. And when people become unemployed, their ability to pay their rent or purchase a home is reduced, which will reduce the amount of rent you can demand or price you can sell a property at as an investor.
When I evaluate a market, I want to see that no single industry employs more than 25% of the population – 20% or lower is ideal. Then, if any major industry is negatively affected, the damage to the real estate market is minimized. Visit the US Census website for job diversity information.
Similarly, Garrett White would disqualify a real estate investment market that lacks a diverse economy or has major employers leaving the area. A quick Google search of the real estate market research already completed will show you if any major employers have left or are expected to leave the market.
John Jacobus puts a small spin on the job diversity question. He will disqualify a market if one or two dominant employers derive their revenue from highly cyclical sources. This is determined by finding the business sector (i.e. manufacturing, technology, medical, etc.) of the top employers in the market and seeing how that sector fairs during the high and low points of the economic cycle.
2 – High Rent to Income Ratio
People can only spend a certain amount of their yearly salary on home expenses. Therefore, if the ratio of the median home expense to the median income exceeds a certain threshold, housing expenses are too high or the median incomes are too low for the population to afford housing expenses in the long-term.
When Theo Hicks evaluates a real estate investment market, if the annualized median rent is more than 35% of the median income, the market is disqualified. Matt Skog has a similar approach – if the annualized median rent is more than 40% of the median income, he won’t invest.
Both the median rent and median income data can be found on the US Census website.
3 – Population Decline
The most basic and obvious red flag to look for during your real estate market research is a decline in population. A declining population likely indicates a declining overall economy, which includes a declining real estate market.
There are a few factors that indicate a population decline. Hai Loc and Neil Henderson look are the overall population trend, with a negative trend disqualifying a market. Garrett White looks at the trend of the number of households, with a negative trend disqualifying a market. And Youssef Seamaan looks at the net migration, with a negative net migration disqualifying a real estate investment market.
Population, household and migration data can also be found on the US Census website.
4 – No Job Growth
Another basic and obvious red flag is no job growth. Again, if fewer people have jobs, the lower the demand for real estate. Hai Loc and Neil Henderson look at both the population and job trends. A lack of population and/or a lack of job growth will disqualify a location during initial real estate market research.
Yearly job and employment data can also be found on the US Census website.
5 – High Inventory
“Supply and demand” is one of the golden rules of economics. The higher the supply, the lower the demand and vice versa. And the lower the demand, the lower the price. Therefore, markets with high inventory indicate a low demand.
Harrison Liu analyzes the supply of apartments in within real estate investment market. If there is an oversupply, he disqualifies the market.
Luke Weber also analyzes the supply of real estate in a market, using the factor “months of inventory.” Four to six months of inventory is bad, while six or more months of inventory is even worse.
The number of apartments in a market can be found on the US Census site or on the local county auditor/appraisal site. In order to determine the current “months of inventory” factor, reach out to your real estate agent.
6 – Local Regulations
Something that some investors may forget to think about during their real estate market research is the local regulations governing the real estate market. But not Blaine Clark. As a note investor, he says local government processes and regulations trump the economic environment.
So, prior to putting time and money into a real estate investment market, obtain a basic understanding of the local regulations governing the real estate market and how they positively or negatively affect real estate investors.
What about you? Comment below: What is the biggest red flag for you when evaluating a real estate market?