Deep Dive: The Golden Insight for Market Selection

By Anish Patel

Does this sound like you:

• Inbox is flooded with automated Zillow reports from multiple markets and agents you’ve engaged from various markets around the country. 

• You hear about a certain market worth investing in, but once you start looking, you just can’t seem to make the numbers pencil on any deals. And by that point, you’ve probably heard of at least one other market that supposedly has all the cash flow positive deals.

• You wonder how on Earth you’re supposed to decide on a market before everyone and their mother starts looking at it, snatching away the best deals, and driving up prices in those areas. 

• You find a deal within a market that seems to pencil, but you have low confidence in whether the market itself is worth investing in. You can’t seem to find much discussion about this market elsewhere, but you also don’t quite know how to determine whether this market is going to become the next great market to invest in. You move on to another market.

If the above is you, the single biggest thing that will bring focus to your efforts is picking a market and sticking with it.

In this deep dive, we’re going to walk through:

• The golden insight that forever changed my approach to market selection

• What makes a good market a good market (stick around for a cheat sheet with data sources at the end)

• Why you should stick to a good market before exploring another

This post is largely geared towards those pursuing long term rentals. We’ll do another deep dive on short term rentals in a future newsletter.

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The insight that forever changed my approach to market selection

In the early days, completely informed by word of mouth and BiggerPockets blog posts, I was looking at Escondido, CA; Sacramento, CA; Austin, TX; Raleigh, NC; Indianapolis, IN; Columbus, OH; probably five others; simultaneously. I was the guy who had my inbox flooded with automated Zillow reports on on-market deals that I would spend time each day reviewing. I would use the Zillow rental estimator and some rough back of the envelope math to assess which market had the highest prevalence of cash flowing deals. Shortly thereafter I learned that Zillow rental estimates were basically useless (perhaps they’ve improved their algorithms since). I couldn’t figure out where to place my bets!

I came up with a new tactic: ask the professionals. I had dinner with a close friend who works for a real estate private equity firm that buys single family homes at scale and asked him where his firm is looking, thinking I’d get some insider secret about that next hot market. He shared the usual suspect cities that most were excited about; he also shared that cities in the Southeast, such as Atlanta, Charlotte, etc., were performing particularly well for the firm (this was in 2019 if I remember correctly). Bullseye - just what I was looking for…or so I thought. What he shared next put my reactive approach of selecting markets to the grave.

He said that when his firm is selecting markets, they’re looking for where they can acquire up to 10,000 (!!!!) single family homes. At that level of transaction volume slight differences between markets can materially impact performance. However, for those of us who are buying 1, maybe 2 properties at a time, trust that there are gems in every market with solid fundamentals.

I’ll say it again, there are gems in every market with solid fundamentals. This statement forever changed my approach to market selection. While real estate private equity firms have many advantages relative to the retail investor, one disadvantage is that they can’t go for the one-off single family home or duplex. They need to take much bigger swings to meet the needs of their investors. Fortunately, for my purposes, I was only seeking one small property. I realized at that moment that trying to rank multiple markets against each other was an unnecessary step. The reality was that all of the markets I was looking at had solid fundamentals, and I really just had to pick one that suited my needs and wait to find a gem. 

What makes a good market a good market

You’re probably wondering what “solid fundamentals” are. Well here you go:

• Large, growing population

• Diversified economy

• Strong university infrastructure

• Not exposed to frequent natural disasters

• Long term reasons to believe

We’ll also dive into a couple additional metrics you’ll want to assess at the sub-market level.

There are of course additional considerations that can clarify whether a given market is good for you, such as ticket size (i.e., a market may check all the above boxes but if the lowest you can pay for a home is $1,000,000, it may not be the right fit) or familiarity / existing relationships (i.e., if you already have some team members (e.g., property manager, agent, GC, etc.) there that you trust or familiarity with the location, those are real advantages). 

We’re going to dive into each of the fundamentals that are agnostic of who the investor is. Specifically, we’re going to answer for each fundamental: why it matters, how to find the data, and what good looks like.

Large, growing population

Why it matters:  Let’s consider the extreme opposite. A small, dying town. You don’t want that. Being small and or declining in population is likely a symptom of the rest of the fundamentals not being there. So you can view a large, growing population as an indicator of overall market attractiveness. 

How to find the data: The gold standard resource is U.S. Census Data. It’s not too difficult to navigate once you have the hang of it, but it’s certainly not the most user friendly tool. Fortunately, there are websites like DataUSA.io that extract data from the census bureau in a more user friendly format. If you type in a city, you’ll find population data (and as you’ll shortly see, many other useful data points). You can then download the corresponding CSV file that includes data from the past 10 years.

What good looks like: A population of at least 250,000 can be considered “large”. One that has been growing not just for a year or two, but has demonstrated a consistent growth trajectory over the past 10 or 20 years is a good sign that growth is unlikely to be transient and likely to continue. 

Diversified economy

Why it matters: Again, consider the opposite. A single employer or single industry town. One global competitor or broader industry shifts in the wrong direction, and there goes your town. Think of the ghost towns along Route 66 or the long, continued struggle of Detroit since the collapse of its auto industry dominance. The best way to protect against this is by having a diversified economy that can more than absorb macroeconomic or industry shifts within specific sectors that are completely out of your control. 

How to find the data: DataUSA.io is once again the tool to use here. If you type in a city and then scroll down, you’ll see a section for “Industries”. You’ll see a nice graphic that provides a sense of the distribution of employment across industries. Additionally, you’ll see another section called “Establishments by size”. You can use that data to confirm whether a single employer is driving the bulk of employment in a given sector.

What good looks like: I’ve always tried to avoid any single industry or employer driving more than 20% of the local economy.

Strong university infrastructure

Why it matters: A solid university infrastructure drives the local economy with not only many employment opportunities within the institutions but also a fresh batch of ready-to-work employees each year. Furthermore, large employers tend to invest in markets that have a skilled, educated workforce, which further drives the economic flywheel. The higher quality the university the more skilled and highly paid the employees, the higher the rent potential, the likelihood of in-migration from and expansion of F500 companies. All this drives housing valuations.

How to find the data: Again, DataUSA.io is your friend here. The “Universities” section of their market specific reports can provide a sense of the largest universities in the area. You may still want to do a little digging beyond this to get a sense of the relative prestige of the university. While biased, it’s helpful to look at the website of the leading university and see their promotional messaging around their institution and the city itself. 

What good looks like: This one is a bit more subjective, but having a large university is a fairly binary metric. You can assess the strength of the university or surrounding ecosystem through online rankings for both undergraduate and graduate programs and confirming the presence of innovation ecosystems for startups.

Not exposed to frequent natural disasters

Why it matters: You don’t want your investment destroyed by a hurricane, tornado, flood or something of that nature. A force majeure as the lawyers call it. Sure you might be made whole through insurance, but I can promise you that your property insurance premiums will more than account for the risk of owning property in a danger zone. That will impact your cash flow. 

How to find the data: I really like Risk Factor, which has a great UI and quickly provides for a given address or market risk of flooding, wildfire, and wind (e.g., hurricane, tornado, severe storm). Note that flood risk is something that isn’t as useful at the market-level and something you’ll want to assess by address.

What good looks like: This one is fairly binary. Don’t be in a coastal city directly in the path of hurricanes coming from the Gulf of Mexico. Don’t be squarely in tornado alley. Don’t be in a flood zone.

Long term reasons to believe

Why it matters: It is always good to develop a perspective on a market and where it’s headed over the next 5 - 10 years. This is what will help drive continued population growth, economic growth, university growth, and declining crime rates, which in turn all drive increased demand for housing. 

How to find the data: ChatGPT can be your friend here if you ask “What are some key growth drivers of [insert market] over the next 5 - 10 years? Please provide sources and links for the articles you reference”. It is important to fact check by reviewing the links it provides. Additionally, many cities develop a “Strategic Plan”. Here is an example of one developed by the City of Columbus. Lastly, a very quick google search of news in the area can get you a sense of what is top of mind within the city. 

What good looks like: This is very subjective of course and it’s impossible to predict with 100% accuracy what the future will hold. Ultimately, you will have to be the judge of whether the data you find is compelling enough for you.

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You may or may not have heard that real estate is a hyper local industry. Meaning that looking at metrics across an MSA or even across a city will not always provide the big picture. Take San Francisco for example. If you look at the metrics across the San Francisco Bay Area, you may reach certain conclusions. However, those metrics average across completely different parts of the area including the Tenderloin, Presidio, Marin, and Palo Alto. 

So when assessing markets, it’s also important to understand the submarket dynamics. There are a couple additional metrics that you will need to evaluate when looking at specific properties that can’t quite be done at the overall market level:

Crime rates

Why it matters: People move away from areas with high and or rising crimes. Your management expenses will be higher in cities with high crime. 

How to find the data: If you have a local property manager in the area, this should be your go-to resource to understand what type of neighborhood a given property is in. However, if you don’t have a property manager in the area yet, City-data.com  is a very user-friendly tool you can use to assess a range of metrics, including crime rates. What’s particularly great about this tool is that it can help you get a feel for the most recent value and the change in that value since 2000 at a zip code level. As is probably the case where you live, there are certain pockets of cities that are safe and others that are dangerous. Additionally there are some pockets that used to be dangerous but are in the process of gentrifying. Sometimes City-data.com can be a bit finicky. If it’s not working for your target market, ADT Crime Maps is another helpful resource; however, it lacks the trending feature.

What good looks like: Avoid being in a high crime area; you’ll find these are often the locations that have high cash flow opportunities. Be wary of that! In regards to the long term trend, similar to population growth, you want to look at where pockets are on a positive trajectory (i.e., not worsening).

Median income

Why it matters: Median income is correlated with rent potential, but rent potential is not correlated with operating expenses. The more rent you can charge the more margin you will keep. Areas with lower levels of income also tend to have higher levels of crime.

How to find the data: Rich Blocks Poor Blocks is a really snazzy, easy-to-use tool to assess median income of a given sub-market. 

What good looks like: Generally, you want to be in areas that are at median income or higher.

Last but not least, at the property level you’ll want to assess rent potential as well. I won’t go into why that matters as I think its self-explanatory and in terms of what good looks like, that really depends on a market by market basis. Spot checking apartments.com, using rentometer.com, and most importantly, confirming / validating with a property manager are the best, free approaches to obtaining this data.

Why you should stick to a market

Above I said to not just pick a market, but to also stick with a market. There are many reasons, but in writing this I realized it really comes down to relationships and expertise. Isn’t that all we have at the end of the day?

Relationships: 

• Many people are good at selling themselves. Oftentimes, it’s only after you’ve had an opportunity to work with them for a while that you can assess whether they are a good fit for you. This is true for agents, property managers, contractors, inspectors, lenders, handymen, and everybody in between. 

• Over time, the more trust will develop between you and your team members. This increased trust will yield opportunities that would never have surfaced in the early months of your relationships. This means more deals, better banking relationships, better pricing, etc. Do yourself a favor and invest in the relationships with your team members.

Expertise: 

• Real estate is hyper local. The more time you spend focusing on the market the more nuanced your market understanding will be. You’ll be leaning on your property manager to understand street-by-street dynamics, but it certainly won’t hurt for you to also begin to develop an intuition around these dynamics as well.

• You’ll develop an intuition of market rental and sale prices. 

• As you invest in more properties you’ll have increasingly robust data around operating expenses, which will help you underwrite future deals with much more accuracy.

• You’ll start to deeply understand local market seasonality and how that impacts marketability and operations for your properties. 

• You will have increased bandwidth to keep up to date with local news in the area. You’ll get a sense for what is happening in the area, what is likely to come, and what neighborhoods and surrounding towns you should be investing in.

All of the above will give you significant advantages over the more distracted investor looking across multiple markets.

Conclusion

Hope that was helpful. If you have a certain market that you are focused on or plan to focus on after reading this article, please respond to this newsletter! If we get enough responses, we’ll share the results in a future newsletter. 

Also, we summarized the key tips around market selection in the below cheat sheet. Enjoy!

Bonus

Looking for a market that checks these boxes? Start by reviewing the markets in Zillow’s 2024 Hot Housing Markets, and remember, just pick one!