A well-known and widely accepted dictum in real estate investing is “it’s all about location, location, location.” That’s because the exact same property in two different cities can have drastically different rents, quality of residents, and values. And the same is applicable for two submarkets in the same city, or two neighborhoods in the same submarket, or two streets in the same neighborhood.
With this being the case, how do you determine which city, submarket, neighborhood, or street to target?
That’s where a market evaluation is performed in order to select a target market for real estate deals. A target market is the primary geographic location in which you search for potential investments.
How to Select a Target Market
Specifying a target market is important for more reasons than location. If your target market is undefined or is the entirety of the United States or a certain state, the number of opportunities will be so large that your deal pipeline will be unmanageable. If it is too large, it will be extremely difficult to gain the level of understanding required to make educated investment decisions. If it is too small, you’ll have problems finding enough deals that meet your investment criteria. Like the porridge in the story of Goldilocks and the three bears, your target market must be just right.
When attempting to select a target market for real estate, for both my clients and for my business, I advocate a three-step process. First, identify 7 potential target markets. Then, evaluate those markets using 7 variables. Finally, analyze the results and narrow down to 1 or 2 target markets.
Step #1 – Identify 7 Potential Target Markets
First, identify at least seven potential markets to evaluate. There are a few strategies for selecting these initial markets. One method is simply choosing the city in which you live, especially if you’re just starting out or are uncomfortable with the prospect of investing out-of-state. But even if you’re fearful of out-of-state investing, it is still important to select additional markets to evaluate so you can compare your city’s data to that of other cities to ensure that your city has a strong real estate market.
A second strategy is to Google “top real estate markets in the US.” If you’re an apartment investor, search “top apartment markets in the US.” Or substitute “apartment” with whichever investment niche you’re pursuing.
A third option is to review detailed real estate reports and surveys, created by different companies, about the condition of the markets. Even if you are selecting a target market for real estate at random or are using the Google approach, I would still recommend reading these reports for a deeper understanding of the overall real estate economy.
If you’re an apartment or multifamily investor, the reports I recommend are:
- Marcus & Millichap Annual US Multifamily Investment Forecast
- CBRE Biannual Cap Rate Survey
- Integra Realty Resources (IRR) Annual Viewpoint Commercial Real Estate Trends Report
- Zillow Annual Consumer House Trends Reports
Step #2 – Evaluate 7 Markets
Next, once you’ve selected seven, you will perform a detailed demographic and economic evaluation of each. What follows is each of the seven market variables I analyze, including what to look for, where to find the data, and how to log the data.
1 – Unemployment
Specifically, you want to calculate the unemployment change over a five-year period. This will require the unemployment percentage for the city for the last five years. This data can be found on the Census.gov website under the “Selected Economic Characteristics” data table. A decreasing unemployment rate within your target market for real estate is ideal. A low, stagnant rate is acceptable. A high and/or increasing rate is unfavorable.
2 – Population
Calculate the population growth for both the target market city and metropolitan statistical area (MSA). This will require the population data for the last five years. An increasing population is ideal. A stagnant or decreasing trend is unfavorable, especially if supply and/or vacancy is on the rise. Both the city and MSA population data can also be found on the Census.gov website. The city data is located in the “Annual Population Estimates” data table. The MSA data is located in the “Annual Estimate of the Resident Population” data table.
3 – Age
Similarly, calculate the population change for the different age ranges, which can be found under the “Demographic and Housing Estimates” table on Census.gov. This will require the population age data for the most current year and the previous five years. The increasing or decreasing of specific age ranges within your target market for real estate will dictate the property types that will be in the most demand. For example, an increasing population of 25-to-34-year olds will put luxury apartments with nicer amenities in demand, while an increasing retirement age population will put assisted living facilities in demand.
4 – Jobs
Determine how diversified the job market is. This will require the employment data for the different industries for the most current year. A market with outstanding job diversity will have no one industry employing more than 25% of the employed population. Twenty percent is even better. That is because, if a certain industry is to dominate, the market will struggle or even collapse if that industry were to be negatively affected. This data can be found on the Census.gov website under the “Selected Economic Characteristics” table.
5 – Employers
Additionally, figure out who the top 10 employers are in the target market for real estate. Similar to job diversity, a market with one company that employees the majority of the city is unfavorable. Also, understanding who the top employers are will allow you to track developments with that company (i.e. are they creating a new facility, cutting jobs, etc.). This data can be found by Googling “(city name) + top employers.”
6 – Supply and Demand
Discover the change in rental vacancy rates over a five-year period and the number of buildings permits created for 5 or more unit buildings. A low, decreasing vacancy rate is ideal. A high vacancy rate that is decreasing is also a positive sign. A stagnant rate is okay too, but an increasing one is unfavorable. If the vacancy rate is decreasing, you will likely see an increase in new building permits, and vice versa. A high volume of building permits and an increasing vacancy rate is a huge red flag. The vacancy data can be found on the Census.gov website under the “Selected Housing Characteristics.” The building permit data can also be found on the Census.gov website. Locate the MSA annual construction page and select the data table for the most current year.
Based on the “what to look for” standards outlined above, you will analyze the data and create “market insights” for each of the six market factors based on the following questions:
- Unemployment: Has the unemployment rate increased or decreased over the last five years? Is it currently trending upwards or downwards?
- Population: Has the city population increased or decreased over the last five years? What about the MSA population?
- Age: What age range has the largest population increase? Largest decrease? Based on the largest increasing and decreasing age range populations, is your target investment type in demand? For example, if the largest population increase is the 45-to-54-year old range, assisted living facilities would be an attractive investment type.
- Jobs: Which industry employees the largest portion of the population? Does that percentage exceed 20%? 25%? 30%?
- Employers: Does one company employ a large percentage of the population? Are the top employers in similar or different industries?
- Supply and demand: Are there a large or small number of new buildings permits? Is the trend going up or down? Is the vacancy rate increasing or decreasing? Is it higher or lower than five years ago?
Step #3 – Narrow Down to 1 or 2 Target Markets
Finally, after logging the data for all seven potential target market for real estate, analyze and compare the results and determine the top one or two best/ideal markets. Keep in mind that the markets you select will depend on your investment criteria as well.
A simple analytical approach is to rank each of the seven markets 1-6 for each of the variables. Then, add up the scores, and the market with the lowest total ranking is the “best.” For markets with similar rankings, use the market insights to determine which is superior, again, based on your investment criteria.
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.