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7 Steps for Picking a Strong Real Estate Market (Part 2)

In part one of 7 Steps for Picking a Strong Real Estate Market we discussed the first four litmus tests required for investing in a suitable market.  In this second part we will cover the last three tests to consider as part of your investment due diligence:

5) Healthy Ratio Between Rents & Purchase Prices

Common sense dictates that there should be a small premium attached to home ownership compared to rent.  However, there are many high-priced real estate areas where it is drastically more expensive to own than to rent the same house.  Why buy when there is such a huge pricing disparity between renting and ownership?

When the home ownership premium is too high it encourages foreclosures; if your home is declining in value and it is much cheaper to rent than own, you will be more willing to walk away from your home.

The inverse of this statement is also true.  If it is cheaper to own than rent and home values are stable, you will do everything possible to keep paying your mortgage.  In most of Dallas, for example, it is the same cost or cheaper to own than to rent.  This substantially reduces the temptation and need for an owner to walk away thus further perpetuating a cycle of stable home values and rents.  Stable appreciation and positive cash flow over the long haul result in hassle-free investment performance compared to the roller coaster of price speculation that many ‘investors’ get caught up in.

In the most recent real estate boom and bust in California, Florida, Arizona, and Nevada many speculators ignored the fundamentals of cash flow and overpaid for properties relative to the cash flow those properties could produce.  There was a buying frenzy that drove prices up.  When the prices peaked, speculators ran to the exits and prices crashed.  Yes, you can make a lot of money in a short time, but you can also get creamed.  Slow and steady wins the race.

6) Access to Quality of Life Amenities (arts, entertainment, low crime, warmer climate):

People will move to a new area for a job, but they and their family will stay longer if there is high quality of life: an arts scene, amenities, restaurants, good school, low crime rate, nice weather.

The United States is experiencing a population migration away from the colder parts of the northeast and Midwest into the warmer climates.  Not only are warmer climates more desirable to live in, they often result in less expensive real estate maintenance.  Freezing temperatures are harder on real estate than hot summers.

7) Comparatively Low Cost of Government

When you pay more taxes you have less money to spend on other things.  Businesses are attracted to areas with a low cost of government.  In places where taxes are low, businesses are generally more prosperous.  Profitable businesses are good for real estate owners.

There are seven states with no state personal income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.  How can Texas, a state with no income tax, finish the year 2008 with a $11.7 billion SURPLUS when the national economy is in shambles and forty-four states finished the year with major deficits?  Texas has a history of conservative spending, balanced budgets, a reluctance to borrow money, and a very stable economy.

If a government is continually borrowing to fund its operations, the cost of that borrowing is passed on to the taxpayers in the form of higher taxes and/or lower services.  When you own real estate, your silent business partners will always be the taxing authorities of the federal, state, and local governments.  I prefer that business partner to be as silent as possible.

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