Investing in Real Estate in 2021
A friend recently asked me the same question, noting how much housing values have already risen over the last few months (well, unless you are living under a rock, you have already come across scores and scores of articles talking about it).
Well my answer was and is, it depends. It depends on where you are investing and it depends on what you are investing in.
Always invest in a growing or an appreciating area with strong economic fundamentals. Just like how you would invest in stocks i.e. you would want to invest in something exciting; like in a company with a lot of growth potential like Tesla or Zoom. The same goes for real estate as well. You should carefully choose where to invest (the region and the neighborhood) and which property to invest.
On a side note, if you don’t have the time to read this blog, watch this 1 min video. I know 7 mins is asking too much especially when you are accustomed to 20 sec Tik Tok videos but bear with me as I do have some interesting insights to share.
Why invest in real estate?
To give you an example and to also show you why the careful selection of the region matters, I am going to take you on a autobiographical journey. When I was looking to invest in real estate back in 2017, the hottest housing markets at that time were Seattle and San Francisco. Being a die-hard fan of the magical San Francisco (well, back then, it was magical to me) and being a resident myself, my natural decision would have been to invest in San Francisco. But I didn’t – because of two reasons.
One, I was convinced like some of the other rationalists living in San Francisco at that time that the SF market was in a housing bubble. I certainly did not want to partake in the frenzy and the ensuing stampede to live in some of the most overvalued houses in the country. People bid over each other even when the property required a lot of TLC. And even if that meant living in a gritty neighborhood amidst the splattered needles and human faeces. Regardless of how paltry my investment amount was going to be, I decided SF wasn’t going to get it.
And two, the more appropriate reason was that I couldn’t afford buying one of them. Being a single guy, I hadn’t mustered enough savings to get into the local property market. And every year I saved, the prices jumped even more, making it out of reach for millennials like me. And thus started a quasi obsession with the real estate market in the USA. Being a MIT grad myself, nerding comes naturally to me; geeking over statistics and numbers is my speciality. So I set about rediscovering real estate, with a fine Sherlock-esque lens to look for numbers and statistics that held clues.
And like a true geek, I prepared an excel sheet to keep track of all the metrics and the individual performance of cities. At the end of my research which included both quantitative and qualitative components, I decided that at that time the best places to invest were Charlotte, Orlando and Atlanta. The lure of zero state income taxes led me to Orlando.
Fast forward to late 2021, the prices in the downtown SF neighborhoods where I was initially considering have either stayed the same or gone down slightly since 2017 whereas Charlotte has clocked in a price increase of 30%, Orlando – 30% and Atlanta – 25% in the same time period. Finally Seattle, another hot market from 2017 days clocked in at 10%. Although Covid19 did give a nice little corona-bump, the prices in those 3 cities were heating up even before the pandemic too. Though the percentage increases might not seem that much given the increases in tech stocks in the corresponding periods, you have to understand that most of the residential property investments are leveraged investments. So for an investment property with 20% down and remaining being loan/leverage, a 25-30% increase in property value would translate to a 125%-150% return on the downpayment/actual investment, just from capital gains (and not considering the rental yield). Whereas a 10% increase, as was in the case of Seattle, would return a 50% return on the actual investment. Not a bad return % per se, but it could have been better. Another key point to note here is that contrary to the popular perception, there could be significant gains from not just the monthly rental income but also from the capital gains perspective when the capital is invested in the right properties in the right places at the right time.
Is now the right time to consider buying investment properties?
My unequivocal answer is ‘Any time is the right time’. All you need to do is just make sure that you find the right places and the right properties for that time. As CNBC’s inimitable Jim Cramer would say in his intro, “there is always a bull market somewhere…..and we promise to find it just for you..”. In this blog, I am going to try and put together a list of factors that helped me find the right places back then. In my subsequent blogs, for all those of you who don’t want to be Excel-monkeys, I shall crunch the numbers and tell you what are the best places right now and also how to find the right property.
So without further ado, let’s dig in.
Factors you need to consider when looking for places to invest (in the following order):
- Job growth rate
- Population growth rate
- Rental Yield
- Median Home price to income ratio
- Geographical constraints for regional growth
- Local and state level Landlord Regulations
Job Growth Rate:
For a region to continue growing at a healthy pace, the role of the local job growth rate simply cannot be understated. If you want to pick your winners, try to find regions that have been growing at around 2-3x the national employment growth rate. And preferably they have been growing unvaryingly at the same pace for the previous 3-5 years. And here is where you can find the information. Regions with job growth in multiple industries score more brownie points than those that are one-trick ponies. You can find that information here: https://www.census.gov/quickfacts/fact/table/US/PST045219
Population Growth Rate:
Job growth rate has to be accompanied by a healthy population growth rate. If there is just the growth in jobs without a commensurate growth in population, then there is something else going on. It could be just a recovery period after a recession or people might not be willing to move to the locality despite there being jobs. Once again look for areas that are growing in population at 2-3x the national growth rates in the previous 3-5 years. You can find that information here: https://www.census.gov/quickfacts/fact/table/US/PST045219
Be wary of regions that are growing too fast too. Boomtowns that grow too rapidly are more susceptible to busts.
Some people like to invest just for the rental income whereas others invest purely for the capital gains. Correspondingly you can allocate weightage to this factor. Regardless, there should be enough rental yield to satisfy at least the recurring expenses like mortgage, taxes, insurance, HOA fees, property management fees, etc. If not, the investor is going to be burdened with a negative net cash flow and that would be a drag on the investor’s finances.
Now what would be a good rental yield now %? Once again, it depends on the mortgage interest rate (if the property is mortgaged), tax rates, etc.. As of Jan 2021, with investment property interest rates being around 3-3.5% and a tax rate of 1.5% annually, a rental yield north of 7% would be healthy. And once again, be wary of properties that have very high rental yields (15-20%+). More often than not, there is something else going on behind the scenes.
A good place to get the average rental yield data for a region would be https://www.numbeo.com/property-investment/rankings.jsp
Median Home price to income ratio:
This metric is a good indicator of how undervalued or overvalued a regional market is. Numbeo.com is a great place to start for this info. While high numbers doesn’t automatically mean that we will be immediately seeing a repeat of the 2007-09 housing crash (oh yeah, remember that one?), high numbers usually mean that the rental yields are likely to be less and that by itself is indicative that such markets are not going to deliver the best bang for your buck, unless you are purely speculating that the housing prices will keep going up and up like it did in Vancouver the past decade. Anyways, what’s a good number for this metric? It should be around 80% to 150% of the national average. If the national median home price to income ratio is 5, then look for regions with ratios between 4 to 7.5.
Geographical Constraints and Local Landlord Tenant Laws:
Once you have arrived at a list of regions through the above quantitative factors, you can then vet your list using the following qualitative factors.
- One often overlooked factor is how constrained the region/city is from growing. If there are geographical limitations like for example, the city being situated in a valley with mountains or reserved areas all around or the city being covered by water on most sides. If the city/region experiences job & population growth but doesn’t have much space to grow, the housing prices are likely to keep rising until it becomes kind of unaffordable to the majority of the population. Limitations need not just be physical. They could be in the form of anti-development regulations too.
- One other key factor to check is whether the local landlord tenant laws are highly adversarial to either of the parties. If it’s very landlord unfriendly, then that’s increased risk and if it’s very tenant unfriendly, then repercussions could manifest in other forms (like tenants moving out to other areas, etc.)
So, hopefully this has been helpful. In my future blogs, I will be talking about what areas are currently good places to invest and how to find the right property.