Real Estate Market

 

Although I consider real estate income to be passive, there can be some upfront work before the time you put in is no longer proportional to the scaling income you earn. Much of that upfront work is detailed research—sometimes called due diligence—on a particular market or property. 

As you consider a particular market with your team of professionals and investment community, here are some fundamental things to look for. 

Rent-to-mortgage ratio.

This ratio compares the cost of a property’s monthly mortgage against its expected rental income. Ideally, the rent should be paying off the entire mortgage and providing additional profits in the form of passive income. The higher this ratio trends toward profits, the more favorable the market is.  

In some circles, this ratio is called the price-to-rent ratio, and it calculates annual prices rather than monthly prices. Either way, both indicate a specific market’s potential return on investment. 

High occupancy

Another determining factor is the market’s occupancy rate, sometimes tracked as a vacancy rate. This rate tells us about a market’s supply and demand. For example, with multifamily properties, cities average a 6.8% vacancy rate whereas suburbs average 5.9%. If the market you’re researching is above the averages, it may be a sign that there isn’t enough demand in the area, driving rent down and increasing turnover. When turnover is high, it leads to lost rental revenue from additional leasing costs, mandatory maintenance costs, and a host of other issues. 

Keep in mind, there are separate vacancy rates for each separate asset class. So, if you’re interested in a specific real estate market but know you’ll be investing in single-family properties, look up the rates for that asset class. 

Additionally, a market with high occupancy suggests overall economic strength in the local area and that the potential tenant pool has the means to pay the rent instead of defaulting. Speaking of which…

Low default rate

Not only are you looking for a market with high occupancy, but it should also have a low default rate. What percentage of renters are defaulting on their rental agreements? 

It’s easy to find default rates for states, but city and local markets can be more difficult. Reach out to local real estate agents and professionals while doing your research. 

If you have not yet delegated landlord duties to a hired property manager, here’s another thing to keep in mind: Default rates are often linked to an individual’s credit score. It may not surprise you to learn that people with higher credit scores tend to default less. What does that tell us? If a local market has a low default rate, it’s another sign that the economic situation in that market is robust and should provide steady tenants for the foreseeable future. 

Market growth

Within the last five years, national real estate prices have changed dramatically. First, there was the skyrocketing demand for homes during the COVID-19 pandemic. Then, after a period of substantial inflation, Fed rate hikes increased the costs of lending, bringing some home values down. These factors and more impact the appreciation of property value—an amount that traditionally increases at a steady pace. 

Local markets are still in an adjustment period. Some are going up and some down. As you research, look for recent trends in median home price. As the dust starts to settle, we are seeing that some markets are correcting from being overpriced while others are still growing and thriving. 

For real estate investing, it’s ideal to tap into a growing market. 

Market growth is tracked on monthly and quarterly increments by many accredited and respected institutions, such as the National Realator’s Association. Access figures to see which markets are growing the most and the fastest. 

Affordability

Finally, how much do properties cost in a given market? And what can you afford? By checking a market’s median home price—its affordability—you can assess whether or not a market is appropriate for your investment situation. 
As mentioned, though, not all real estate investments require you to foot the entire bill for a property. If the price of a median home anywhere scares you off, consider smaller investments through syndications, funds, or REITs.