Why Buying Investment Property In Undervalued Markets Is Paramount
Perhaps the most common question any real estate professional gets asked is, “How is the market?”
The past 5-7 years buyers have been like a kid in a candy store. There have been plenty of properties to choose from and it has been pretty easy to find deals that make sense. Now with prices rising along with rising rental rates the candy shelves are sitting pretty empty and the remaining candy is running stale. Yes, like the candy shelves the good real estate deals are picked over and the deals that remain are not making a lot of financial sense
Find real estate with a long shelf life
Having coached several hundred of investors over the years what I find over and over again is investors having just short term investing criteria. Investors want a particular rate of return on a nice property. Sounds reasonable right?
While that sounds like a great and fair goal it only looks to the short term return of a property. The missing link that most investors overlook is identifying if a property has sustainability. In other words if you are looking for a cap rate of 10% return are you looking to see if you can maintain this 10% return over time. If not how do you know those returns will stay strong and not dwindle in time as markets shift.
Markets rise and fall
Everything in this world is cyclical, what goes up must come down. Like a pendulum on a clock the markets will rise till it hits a peak point and then reverse order to start its decline. When you buy an investment property that performs at your desired 10% rate, what measures have you addressed to insure you are able to sustain the return and perhaps the rise of the economic prosperity of this investment. Do you know that this investment is not at its peak value and about to reverse order?
When the pendulum begins to swing the other direction often the returns will reverse order as well. rental rates tend to go hand in hand with market conditions. If a property stalls out in growth it will most often stall out in your return on investment as well. Your best way to insure your investment is sustainable is to invest in under valued markets
Undervalued Real Estate Markets and How to Determine Them
The Median Home Price to a particular location is important to know when making investing and buying decisions: However it is important to use the information correctly.
To take a deeper look, we want to look at the market (city) as a whole, we know a market is said to be a good investing market when the median home value will easily be paid for by the area’s median income.
For example the typical lender will want you to apply only one third of your household income (33%) to your mortgage. If one third (33%) of the median income will easily pay for the mortgage of the median home’s value, then that market is said to be a balanced market.
When you can purchase a median priced home in a market that takes only say 20 or 25% of the median income to pay for the property then the market is said to be an undervalued market. The opposite holds true if indeed one third of median income will not pay for the mortgage of the median home price, this area is deemed to be an overvalued market.
As many of you may know there are markets such as most cities in California where it takes as much as 50% to 70% of your median income to buy a house. These are very much over-valued and unsustainable. There are also markets in the Mid-west where you can invest in property where you can buy the median priced home for 20% to 30% of the median income.
Knowing this, which markets would you like to invest your investment dollars into, which markets do you feel have the best chance of offering long term sustainable returns?
Top Tips For Researching An Undervalued Market
Investors do not want to purchase over valued property, so watch median incomes in the markets where you are looking to purchase investment properties. Your equity growth and appreciation depends on finding strong markets and undervalued markets will offer you the best opportunity.
Market information is a moving target, so watch closely. You can read many reports that talk about the median home price going up or down, month over month (this has no real merit) this is too short of a time to gain any perspective whether the market is improving or not. Simply put, it shows that for a variety of reasons the value to the homes purchased over the past month was either higher or maybe lower than the month before.
This can happen for many reasons. Maybe a different segment of buyers bought one month over another month. Maybe interest rate changes prompted a slightly different purchase price. There can be a number of factors that play into this. To understand whether a market location has an increasing or decreasing median home price you need a minimum of 3 to 6 months trend to see if indeed it is trending up or down or is it just short term market fluctuations.
When indeed a Median Home value is trending downward the market is becoming better suited for the investor. When it appears to hit bottom and stabilize for a duration of time it is a strong indicator that that market’s location is bottomed out. (Note: this one indicator alone is not sufficient evidence of a great time to buy) it does however give strong appeal to look further into the location and how that location is positioned for the investor to capitalize on it.
When a market is considered undervalued you will then need to see if the market has strong, diverse employment.
When a market is undervalued and indeed also creating jobs, you are wonderfully positioned as an investor to ride a wave of upward moving values. As jobs are more and more plentiful, the supply of workers for these jobs diminishes. When this happens, salaries rise. When salaries rise, median incomes rise, when median incomes raise the properties values can now easily and safely raise as well. This lends to a longer sustainable growth period for the real estate (property investor) or homeowner.