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How to Pick the Right Real Estate Market

Today’s PhREI network post is from Daniel Shin of The Darwinian Doctor. His post is going to give you three specific ways to evaluate and pick a real estate investment market: RV ratios, economy, and landlord/tenant laws.

I’ll follow with my commentary at the end…

Take it away Daniel!

real estate market

One of the most common questions I get is how to pick a real estate investment market.  To fully do this topic justice, I’ve started an educational series to walk you through the basics of the entire process of active real estate investing. 

In the first post in the series, I presented three questions to help you decide between local or long distance real estate investing. 

Here are the first few questions you should answer:

  • What are your overall financial goals (and your Why?)
  • Do you want cash flow, appreciation, or both?
  • Will you self-manage or use property management?

If you’ve answered these questions, you’ve already decided on your overall financial goals, and you’re beginning to understand the differences between a cash flow and appreciation investment strategy. You’ve also got a sense of how you might manage your properties. 

Now you’re ready to move on. Let’s figure out exactly where you’re going to invest!

How to pick a real estate investment market

For me, the viability of an investment market comes down to a mixture of the following characteristics:

  • RV ratio (rent to value ratio)
  • Economy and demographic trends
  • Landlord/tenant laws

RV ratio (Rent to value ratio)

RV ratio is the most basic characteristic that will determine if a given real estate market is a good fit for you.  This commonly used formula can quickly analyze a real estate market (or deal).  

  • R = Rent = one month’s rent
  • V = Value = purchase price of property
  • RV ratio = (Rent / Value)

Your ideal cash flow markets should have an RV ratio of 1%, give or take a couple tenths of a point.

Example of a cash flow market: Indianapolis

If you’ve followed the growth of my real estate empire, you’ll know that most of my portfolio is in Indianapolis. I’m a cash flow investor because I’m interested in early financial independence, and cash flow is really helpful in getting to FI faster.

As a cash flow investor, Indy is ideal. Let’s see why, below, with a three bedroom, one bath home I randomly pulled off of Redfin and Zumper. It’s just over 1100 square feet. 

Indianapolis three bedroom house

Three bedroom single family home in Indianapolis:  

  • Rent:  $1200
  • Purchase price:  $111,500
  • RV ratio:  $1200 / $111,500 = 1.1%

Example of an appreciation market:  Los Angeles

Los Angeles is an expensive coastal real estate market. It’s not a place to seek cash flow, but can yield incredible gains from appreciation. Just take a look at the appreciation we’ve had on our two Los Angeles homes over the last 10 years (through lucky timing). 

Here’s an example of a three bedroom, one bathroom home in Los Angeles to show you a typical LA RV ratio. It’s slightly bigger than the Indianapolis example at 1260 square feet. Here are the Redfin and Zumper links.

real estate market

Three bedroom single family home in Los Angeles:  

  • Rent: $4000
  • Purchase price:  $1.65 million
  • RV ratio:  $4000 / $1.65 million = 0.2%

How to use the RV ratio

Of course there are exceptions, but you want the RV ratio to be about 0.8-1% to ensure the property will be cash flow positive after accounting for costs.

In general, expensive coastal markets like New York City, Los Angeles, Seattle, and Boston will be appreciation markets.  Even with regularly paying tenants, appreciation markets may still require you to infuse cash into the property each month. This extra cash infusion will help to pay for the mortgage, taxes, and maintenance.

If you’re looking for cash flow, you can look to the Midwest and Southeast.  

Here are a few cash flow markets to get you started (by no means a comprehensive list):

  • Birmingham, AL
  • Cleveland, OH
  • Detroit, MI
  • Indianapolis, IN
  • Kansas City, MO

Economy and demographic trends

After RV ratio, economy and demographics are very important in picking your real estate investment market. 

You don’t want to buy a rental property in a city where the local economy is in a downwards spiral. No jobs = no tenants.  Less industry also means less tax revenue for the city, which means they’re more likely to look for imaginative ways of raising revenue.  Often times, this means they’ll come after landlords and business owners for more taxes and fees. 

When I want to learn about a real estate market’s local economy, I turn to the HUD reports.

“HUD” stands for the US Housing and Urban Development department.  They do many things, but for our purposes, we’re interested in their “Comprehensive Housing Market Analyses.”

If you can get over the dry, technical sounding name, these reports are pure gold.  

The economists rotate their analyses through all the major housing markets in the country, and update them every few years.  These reports are packed with information and easy-to-read charts.  Pretty much everything a real estate investor wants to know about an area is in these reports.

Here’s a partial list of the information you can find in these reports:

  • Overall description of the market
  • Economic trends
  • Housing sales and rental trends
  • Predicted demand for housing
  • Employer and industry breakdown
  • Unemployment trends
  • Vacancy trends
  • Population growth and migration patterns

Did I mention that the reports are all free?  

If you’ve identified an interesting market, just go to the website and download the most recent report.  Spend some time looking over the trends, and then make a truly informed decision about investing your money. 

Ideally, a rental market will have relatively low unemployment, a stable and varied employer mix, and growing population.  

Here are a few screenshots to show how amazing these reports are (I don’t own this material):

real estate market

Landlord / tenant laws

Finally, let’s talk about landlord / tenant laws. If you’re going to be a real estate investor, this is one area of your life where you’re going to have to lean a bit conservative.  

Landlords are often vilified in the media as an enemy of the common man, but don’t worry. You’re not going to be a slumlord.  You’re going to:

  • Provide quality housing at a fair price
  • Keep your properties well maintained
  • Support industries like banks, carpenters, electricians, plumbers, and roofers

With this in mind, if you have a tenant who is abusing your property or not paying rent (pandemic aside), you should have the right to evict that tenant. It’s also nice not to get taxed into oblivion by the local government.

This scenario above is more common in some states than others.  These laws are ever-changing, but again, there are some generalities.

You’ll typically find these laws and policies skewed more favorably towards the landlord in parts of the Midwest, the South, and the Southeast.

This doesn’t mean that you can’t be a successful real estate investor in other parts of the country.  Clearly many people do great being a landlord in California, despite tenant friendly laws.  But, you may have to be more careful about tenant selection and screening, or budget for an occasional long eviction process.

(Obviously the pandemic has made the entire country tenant friendly with the CDC eviction moratorium.)

Conclusion

I hope you feel more empowered now to confidently pick a real estate investment market.  To summarize, I first recommend you decide if you want to invest locally or long distance.  You can do this by answering these three questions:

  • What are your overall financial goals (and your Why?)
  • Do you want cash flow, appreciation, or both?
  • Will you self-manage or use property management?

Next, zoom in on a specific real estate market and evaluate that market using the three criteria we discussed above:

  • RV ratio (rent to value ratio)
  • Economy and demographic trends
  • Landlord/tenant laws

Once you’ve picked your market, then the real fun starts.  You can build your team, do a city tour, and start looking at properties!

Commentary from The Prudent Plastic Surgeon:

I think that all of these points and analysis brought up by Daniel are really important and should be considered. But, with that being said, remember that I am a simplifier.

When choosing our real estate market, Selenid and I honestly did not look at any of these variables. We chose Buffalo, NY because that’s where we would be living. And it’s where I grew up, so I knew the area fairly well.

We then got an investor real estate agent and started analyzing properties like nobody’s business. We quickly saw that there were many properties that met our criteria for investing. Namely, they achieved a cash-on-cash return of 10% or greater after forced appreciation. Currently, we one two such properties and are closing on a third.

Related Posts:
Insider Look: Deal Analysis of My First Investment Property
How to Screen & Analyze Investment Properties the Right Way

I think this may be a simpler way to go about it. But that’s just me.

Sometimes I worry that such complicated analyses may leave folks the victim of analysis paralysis…

Related Post:
How to Win the Fight Against Analysis Paralysis

Regardless, as always, Daniel makes some excellent points and very thoroughly defines how he went about selecting his real estate markets. And he has had a lot of success!

So, pick a strategy that you like and stick with it!

What do you think? How did you pick your real estate market? Or, if you are still thinking about getting into real estate, which markets have you considered? Why?

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    The Prudent Plastic Surgeon

    Jordan Frey MD, a plastic surgeon in Buffalo, NY, is one of the fastest-growing physician finance bloggers in the world. See how he went from financially clueless to increasing his net worth by $1M in 1 year and how you can do the same! Feel free to send Jordan a message at [email protected]

    3 thoughts on “How to Pick the Right Real Estate Market”

    1. I have always said that if a Doctor becomes wealthy via his practice, he is either cheating his patients or insurance companies. Plastic surgeons are excluded from my dictum. As a retired family doctor and founder and chairman of 2 community banks I can share with certainty what has worked for me.
      1. Find the edge of a city or growing community and buy undeveloped land across the line.
      2. Look for opportunity zones (invented by Trump)designed to attract private investment to blighted areas …. e.g. New Hilton in downtown Fort Lauderdale…. with major tax advantages.
      3. Stay away from residential properties where people
      “sleep at night”… no one calls the landlord or management from commercial properties about problems until morning.
      4. Look for good seller terms offered to you; Soneyimes the terms make the buy attractive even if the price is higher than surrounding properties.

      I could go on and on about mortgage investments etc. But this is just an example of thinking out of the box as opposed to standard “research “ and studies of statistics, none of which I employ.
      Money has to work while you sleep… it doesn’t while in the bank unless you are the banker.

      Reply

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