Steps to Success in Real Estate Investing – Selecting the Right Market

The old adage of location, location, location still rings true in most areas of real estate. However location isn’t the only thing that matters and it doesn’t necessarily guarantee your success or failure. There are too many factors involved to try to simplify that much.

Selecting the right market to invest in depends heavily on what your goals are. Are you looking for long term cash flow, rent appreciation, price appreciation, future redevelopment opportunities, or something else altogether? Answering that question will help to narrow down your focus for what market, and even a submarket to invest in. There are 3 main market types, primary, secondary, and tertiary. Then each market will have it’s own submarkets (downtown, suburbs, etc).

Primary markets are the largest MSAs in the country. These are cities with 5mm+ in population, very solid long standing fundamentals, and typically very high density. For example Los Angeles, New York, Chicago, Dallas, Atlanta. These markets generally have high demand for properties, therefore high prices. On average the residents are more afluent compared to smaller markets, and the more this is the case the less likely it will be to find properties that generate cash flow since high net worth investors don’t necessarily need cash flow (or even debt) to make their investments work. With the exception of the lowest income submarkets you should expect your investment returns to come in the form of appreciation and principle paydown rather than cash flow since the monthly cash flow tends to be negative, and in some cases the income is significantly less than the debt service. Redevelopment opportunities are sometimes the only way to make an investment make any sense in these markets.

Secondary markets are the medium sized MSAs that still have strong fundamentals. They are typically 1-5mm in population and slightly less dense than primary markets. Examples of secondary markets would include Denver, Las Vegas, Portland, Minneapolis, Cleveland, etc. These markets will still have higher property values, but the ratio of income to cost will be much better than in the primary markets. There is typically less competition for deals (although still plenty of competition) and the submarket will determine whether your property is likely to cash flow or not. Appreciation will still be present, but much less so than in primary markets. Secondary markets tend to be hit the hardest in economic downturns because they tend to have less extremely high net worth investors operating in the area that maintain their operations regardless of the economic climate. Core submarkets in secondary markets are likely candidates for redevelopment opportunities, either immediately or in the long term.

Tertiary markets are the rest of the country. There isn’t really anything specific that determines whether a city is a secondary or tertiary market, but often they are less than 1mm in population, and are more spread out than a typical primary or secondary market. Examples include Omaha, Nashville, Charleston, Baton Rouge, Jacksonville, etc. These are the markets that are easiest to find cash flow. The purchase prices are lower and the income to price ratio is even better than secondary markets. These markets tend not to attract as many institutional or large scale investors because of the lack of scale in available projects. For these reasons appreciation is definitely less prevalent than would be expected in larger markets. Another factor for investments is the availability of raw land in the suburb areas, and also often times in the city core as well. This allows for very cost effective new construction projects since redevelopment is not necessary. The flip side to this is that redevelopment is rarely a long term option since the market tends to gravitate towards “sprawl” due to lower land costs in the suburban areas. Often times tertiary markets are most stable in economically volatile times, and sometimes even have an inverse relationship to the national economy because they can benefit from the migration away from primary markets when times are tough.

Living and investing in Shreveport, LA I can speak to the benefits of investing in tertiary markets. There is a low barrier to entry, lots of opportunities, and fantastic cash flow. The flip side is that my properties have barely appreciated in value in the last 10+ years, although the rent has increased somewhat. As my scale increases I definitely see the appeal and benefits of larger projects in larger markets, and I do expect to explore those options further in the near future.

Your goals and aspirations are really what determine what market is best for you. You have to balance risk, cash flow, and appreciation. Risks tend to be higher in primary markets since the prices are higher. However tertiary markets are often less economically diverse than larger markets and carry the risk of a major employer shutting down which affects rent prices and property values. Cash flow can be achieved in any market with enough time and ability to carry the negative cash flow, in some cases for many years. There is typically some element of appreciation in all markets, just because of the natural inflation of the economy, but if a town in shrinking in population the values can drop rather quickly. I hope this has been helpful and as always feel free to reach out to me with any questions you might have!