Every real estate investor performs some level of research before buying a property to ensure they are making a wise investment decision, but what should that research entail?
Understanding a property’s operating potential requires a deep understanding of the local market including competitor properties, employment and retail opportunities, and demographic trends. Evaluating the location not only helps the investor avoid any unforeseen post-acquisition, but it also helps identify and quantify the growth potential of the property. There are many factors to consider when evaluating a market, so this article will consolidate the process into five critical steps to help determine if the property’s market aligns with your investment strategy.
1. Visit the Property
While a broker’s marketing package has its value, there is nothing like being able to visit the property and the neighborhood in person, which provides the ability to touch and feel the real estate. It’s important to see if the property is being well-kept and well-managed, understand the quality of the construction, and determine any potential deferred maintenance items or updates that may need to be addressed as the new owner. Beyond visiting the site, it should be a priority to drive around the neighborhood. This is an opportunity to learn the access routes to nearby highways and freeways, determine access to public transportation, understand the traffic and visibility of the property, and get a sense of the neighborhood culture. Driving around is a must; however, to thoroughly get a feel for the area you should also explore on foot. Go into local shops, the grocery store, or a restaurant to determine if the area appeals to you. Part of our process is to view the market at a high-level and determine if it is a place you or a family member would potentially live. Are these places walkable from the subject property? Are there good schools, parks, and public transit nearby? Why would someone want to live here or visit here? These are all questions we ask and answer by putting ourselves in the shoes of a prospective resident.
2. Determine the Economic Health of the Market
As an investor with a long-term perspective, the current and projected economic health of the market is a vital factor when considering an investment. We want to ensure the long-term outlook of the market and submarket demonstrates strong growth potential. It is understandable to favor the most in-demand markets, but these rarely make the best investments as they attract the most buyers and command the highest purchase prices. Instead, a way to stand apart from other buyers is to find the submarkets and neighborhood “pockets” of larger, in-demand markets that are slightly less discovered but demonstrate equally strong growth prospects. When learning about new markets and discovering neighborhood pockets, identifying some of the major employers and universities/colleges in the market and near the subject property is a good place to start. Nearby companies and colleges provide jobs to residents within the market. Additionally, the operating performance and job growth of these employers is a good indicator of how the market itself may be performing. Seek out markets with a diverse employment base, where businesses and jobs are growing, new development is taking place, and apartment rents are increasing. A promising market is marked by high occupancy and unit absorption, and where jobs, amenities, and attractions are plentiful.
3. Understand the Demographics Trends
Several online tools can help to gather and analyze demographic information on a specific market and submarket. CoStar Group is one of the primary providers of analysis and demographic information, along with resources available through the US Census Bureau, city, and county websites. The information gathered is typically broken down by a 1-, 3-, and 5-mile radius from the subject property, which helps provide a good sense of the target renter and who makes up the population at the property and surrounding area.
To begin, look at the total population and both the historic and projected growth patterns. If the market is expecting strong population growth, there are typically new jobs and/or city development taking place that is going to support market growth. As you look into (i) who the major employers are, and (ii) how those employers have been performing, you should consider the education and income levels of the workforce to understand the target renter and what they might be able to afford. The goal is to ensure that the statistics are strong enough to support the future rent levels at the subject property. Home values and home affordability also factor into the ultimate investment decision. A rental property is only able to grow rents so far when the prospect of buying a home becomes a relatively affordable alternative for the prospective renter(s). Also, whether a potential resident is purchasing a home or renting an apartment, school districts are likely to be a key decision factor for many families with children. A strong school rating or ranking becomes very desirable for those families as they go through the process of finding a place to call home.
These collective demographic data points should be compared and contrasted to the economic outlook previously reviewed, as well as viewed against data from nearby or other major markets, and nation-wide statistics. We ideally want to see better-than-average growth prospects, complimented by a compelling economic story.
4. Analyze the Sale and Market Rent Comparable Properties (“Comps”)
Given an attractive property, a positive economic outlook, and strong demographic trends, the next step in reviewing a market is the analysis of comparable properties. Significant competitor analysis can be accomplished ahead of visiting the market given the extensive amount of data online; however, there is always additional value in touring the comps in-person. Similar to visiting the subject property, it allows for you to see how the various properties compare to one another in terms of both the properties themselves, as well as the neighborhoods in which they are located. Comps are identified through proximity to the subject property or a similarly performing submarket. The properties are typically similar in terms of year built, number of units, unit finishes, amenities, and the overall condition of the property. More simply put, if you were a prospective resident, what other properties would you consider in your search for an apartment? One of the best ways to obtain information on another property is to put yourself in the shoes of a prospective resident and “shop the comp.” Shopping a comp allows you to obtain information on real-time rents and current rent specials or concessions that may be taking place at the competing properties and is not always available online. Getting a tour is the best way to see the quality and finish level of an apartment unit and to see first-hand all of the amenities the property has to offer. Paying close attention to curb appeal, landscaping, neighboring buildings and houses, and any necessary deferred maintenance items or updates that are needed is also highly informative when seen in person.
Many times, the comps identified have recently been sold or “traded.” Knowing when the property sold and what the sale price was is helpful when determining what purchase price is appropriate for the subject property. When assessing comps, you should also consider any new developments in the area, as well as the current supply of units and communities in the submarket. New developments that struggle to lease-up or an oversupply of apartments can lead to lower rents and higher vacancies as the prospective renter will have many alternatives. The appropriate supply for a market is supported by strong occupancy trends, rising rents, and a high absorption rate.
At the end of the day, the goal is to see how the subject property stacks up to others in the market while also identifying any potential obstacles and/or opportunities that may arise. Properly assessing the market and sale comps help determine market rents for the property and to provide support and guidance to the purchase price of the asset.
5. Understand the Market-Specific Costs
Lastly, it’s critical to look into expected ownership and operating costs at the property as these may differ widely between markets. Properties are operated differently in various markets, and it’s important to understand not only how the current owner operates the property, but how you would be able to operate the property based on the market in which the subject property is located. This can be an area of opportunity if the current owner is running high expenses, but it is also important to look at costs that may be low and determine if those costs are sustainable once your management team takes over. For each acquisition, non-controllable expenses must be identified and understood when underwriting potential investments; for example, the tax liability related to the sale of the property varies by county, utilities vary by city, and insurance has many factors that go into the rate based on its location. Build from what you know and apply what you learned from the market to determine how you can manage the property differently than the current owner before making an investment decision.
While these five steps don’t constitute a comprehensive analysis, they provide a solid overview of how to evaluate a market when considering an apartment acquisition. There is a lot to consider when working through the analysis, so be sure to utilize any and all resources available to you. However, it’s imperative to remember that a large part of evaluating the market and making a decision to invest is to rely on your gut when making your final decision, which often comes with experience. The data needs to make sense on paper and align with the investment strategy, but it also needs to feel right. As an investor, you can often increase the appeal of a property, but you can’t alter the appeal of a market.