The real estate industry is a sensitive sector where, for an investor to succeed, sufficient due diligence is necessary. When choosing a market to invest in, the choice of the geography is important. Here are some tips on how to identify the markets with the highest probability for success.
If you want to find the optimal place to make real estate investments, you need to analyze that market. There are various factors to look into to help ensure you make the best decision. Two of these factors are: capitalization rates and gross rent multipliers.
Capitalization, or CAP, rates are one of the most commonly used ways to determine if a real estate investment is worthwhile or not. The CAP rate allows an investor to estimate the profitability of a property and its yield. The CAP rate is calculated by dividing the NOI (net operating income) by the purchase price. This percentage statistic gives you the unleveraged yield.
The gross rent multiplier (GRM), is a mathematical formula used to express a property’s potential income based on the ratio of the property’s price to gross rental income. Insert the fair market value (or the asking price) and divide by the estimated annual gross rental income. As an investor, you’re looking for the number of months or years it’s going to take for this investment to pay for itself.
When analyzing the market, emphasis should be put on evaluating the area’s overall economy, growth rate, the presence of businesses in the neighborhood, and the largest employers. These factors help investors determine whether or not an area will be desirable to potential buyers. When evaluating the area, make sure the largest employers are in sectors that are healthy and likely to exhibit further growth; you do not want to invest in an area only for the largest employee to go out of business or stagnate and drive down the entire local economy.
When looking into investing in an area, evaluate the demographic profile. Are population growth trends growing and show the need for new real estate? Are people moving to the area or leaving? Is the median age young or old? White collar or blue collar? These factors, when paired with information like the fastest growing employers, will provide insight as to whether the market is likely to continue to grow or runs the risk of stagnation.
Median home price vs. national average
Often investors will use this metric to determine the appreciation potential in a market. If the demographic and economic growth of a market is above the national average, yet the median price of a home is still below the national average, this is likely a market that has the potential for long term above average price appreciation.