A rental property is only valuable to you if there is a person willing and able to use your property and pay you rent. If you buy a house standing by itself in the middle of a desert, your prospects of finding a paying tenant are poor. You want a hassle-free cash-flow property near lots of well paid people. Those people want to live near their jobs and the amenities they enjoy.
For a property to be a suitable, it must be located in a market that passes the following litmus tests:
1) Large and Growing Population
Population centers have upwards or downwards momentum. If a city is growing, it will likely continue to grow. A city losing population has a hard time stopping that trend. As a population center starts to grow, the growth fuels itself. More people attract more people and the rate of growth can be dramatic.
The current population is moving away from small towns and towards urban centers. There is a highly educated, entrepreneurial segment of the population that is moving from urban centers to small towns and telecommuting, but in terms of total number of people the safer bet is that big cities will keep getting bigger.
You can find lots of information on population trends and housing trends at www.census.gov and www.ofheo.gov.
HINT: If a specific geographical area doesn’t have enough population to be studied by www.ofheo.gov, you might call that a clue and stay away.
2) Diverse Employment and Job Growth
People are attracted to an area primarily because of jobs. Many people would prefer to live in the beautiful mountains than the suburbs, but there are very few jobs in the mountains. If you look for job growth, you will find population growth and increased capacity to pay. Where there is population growth you will have increased demand for housing. Increased demand along with increased capacity to pay means higher rents and sales prices. If you are an investor these are good things.
3) Low Cost of Living Compared to National Standards
In tough economic times, companies that do business on a national level will save money by relocating to low cost, business friendly areas of the United States (and abroad). For example, many Americans are relocating to Texas because the cost of living is low, the quality of life is high, and that is where the jobs are headed. Workers and employers are leaving California, New England, and other high cost areas in the US and relocating to where it is more affordable.
Housing in many parts of Los Angeles costs about twelve times the annual wage of its occupants while in Dallas housing is only about three times its occupants annual wage. Americans are tired of being house poor and they long for a return of the day when a single income was enough to be middle class. Today’s families are making housing choices primarily on proximity to their job and secondly on the overall affordability of the area.
Dallas Affordability Ratio
$243,100 median home value / $67,900 median household income = 3.5 times
Los Angeles Affordability Ratio
$635,000 median home value / $54,514 median household income = 11.6 times
4) Natural Resources / Cash Injected into Baseline Economy
Every town needs something that draws outside cash into the community. Economist Richard Maybury calls the injection of cash into a community a “cone:” “Conventional wisdom says that when the government expands the money supply, the money descends on the economy in a uniform blanket. This is wrong, the money is injected into specific locations causing hot spots or cones.” Excerpt from The Clipper Ship Strategy by economist Richard Maybury: www.RichardMaybury.com. Examples of cones: recipients of federal stimulus packages, natural resources (oil wells), destination tourist attractions (Disneyland), agricultural exports (Napa Valley). Cones draw money into the community.
Every city needs firefighters, nurses, librarians, waiters and waitresses, but these support and service occupations exist to serve a local population; they do not import fresh cash into a local economy. They service the cones, but do not create them. Without a natural resource or commodity to import cash into a local economy, the service and support jobs will quickly dry up. Service and support jobs recycle money between themselves, but a large percentage of what these workers spend leaves the local economy in the form of food and clothing imports, taxes, traveling abroad, etc.
Without a regular injection of cash from the outside world, all of the cash and jobs will eventually leave a local economy, leaving behind one of those desolate gas station towns that cling to the side of an interstate. Get your investment dollars as close to the cone as possible. An oil field worker is closer to the cone than an oil field worker’s barber. The injection of money (cone) created by oil consumption will keep the oil worker employed, but when the general economy gets tight, the oil field worker’s personal spending may not be enough to keep the barber in business.
I like investing in lower middle-class, blue collar areas close to manufacturing and distribution centers. Manufacturing and distribution centers are somewhat reliable cones. The jobs and tenants they attract are fairly stable, semi-skilled and well paid. The government has unlimited ability to inject money into specific locations, creating some of the largest cones. However, government spending comes and goes at the whims of politicians. If you are investing near a large government cone, make sure there are at least four additional cones (baseline industries importing money into a local economy) so when the government cone moves on you won’t be stuck in a decimated housing market.
I’m sure you can name quite a few single-cone towns where the sole employer is a military base, college, or steel mill and every other job exists to serve the population of that baseline employer. The housing values of those ‘one horse’ towns are tied entirely to the success of a single industry which is never a good environment for your real estate investments.
Click here for part two of 7 Steps for Picking a Strong Real Estate Market.
