Picking a Market for Remote Real Estate Investing
Investing in real estate is a great way to build your long-term wealth while at the same time unlocking income streams that can improve your financial standing in the short term. A “good deal” for me is a property that offers a mix of appreciation (-> long-term wealth) and cash flow.
In real estate investing, cash flow is the net income you take home after all expenses and the principal on your mortgage have been paid for. Here’s super simple formula:
(I’ll write a separate blog post about what all these are)
I live in coastal California and I own my family’s primary residence. As an investor, though, I’m totally priced out of the market. I’m a coder and not a craftsman, so I consider only turn-key properties that don’t need a rehab. I mostly invest in single family rentals and small multi-family properties.
So for me, and many other Californians, the only viable way to get started with real estate investing is to invest remotely in markets that are much more affordable than California.
How to pick a market?
That’s the million dollar question. In the past, I’ve invested in markets I knew well. I lived in Berlin, Germany and invested there. I was doing a lot of business in the Washington, DC area, so I invested there. So my investment decisions were driven by having a connection to the area and knowing its real estate market. That’s always a good starting point.
However, being a coder and data guy, I want to see if I can rank markets quantitatively. As a starting point, I’m considering the rent-to-price ratio (RPR, in percent).
The higher the rent and the lower the price of the property, the higher the RPR. Higher RPR is good — I’ll get more rent for my investment.
The RPR is also known from the “one percent rule”. This rule of thumb states that if the RPR of a property is near or above one percent, then the property is likely to cash flow.
While it’s very useful to compute the RPR for an individual property, it’s also useful to compare markets by their market RPRs, basically taking the median/average rent that is being paid and dividing it by the median/average property price in the market. (Aside: I generally prefer medians over averages, since averages can be skewed by outliers.)
The RPR is clearly not the only thing one needs to consider when picking a market, but it’s not a bad starting point.
The Data and my Methodology
For this analysis, I’m using data provided by Zillow at https://www.zillow.com/research/data/ . Specifically, I’m using their Zillow Home Value Index (ZHVI) and their Zillow Observed Rent Index (ZORI).
I downloaded their data on May 20, 2023 and here I’m focused not on trends, but on the current RPR, so I picked their most recent data set, which is of April 30, 2023 and contains about 530 metro areas (ranked by relative size) in all 50 states.
I joined the ZHVI and ZORI datasets based on the provided RegionID and took the top 200 regions in size (I guess, that’s population). Then I made the biased choice to throw out all regions with home values (ZHVI) above $300k. That’s my personal preference — you may want to consider a different threshold based on the capital you have for down payments etc.
Results
Here are the top 20 markets with Zillow home values below $300k, ranked by RPR:
It’s interesting that there is not a single market that has a market RPR above 1%. So no more one percent rule? Well, cash flow must always be evaluated on a per-property basis. The market RPR is just an indicator for the likelihood of being able to find a cash flowing property.
So based on this analysis, are investors streaming to Shreveport, a metro area in northern Louisiana? Well… no. And that’s because RPR is just one factor to consider. Take a close look at houses on Zillow in Shreveport, LA, and you’ll quickly understand what’s going on. Outside the inner regions of Shreveport, you can find many nice home at substantial prices. The inner City, however, has rough neighborhoods with many run down properties in the $50k (and lower!) price range. These may still fetch $800 in rent, but due to where they are and due to their building substance, there’s not much hope for any appreciation and rent growth.
So the example of Shreveport tells us that there’s more to consider than just the RPR. But it can be a starting point. There are quite a few Texan markets in the top 20, and these are truly interesting markets, since Texas is growing and some markets in Texas have been exploding over the past few years (hello, Austin!). I’d probably take a really close look at them.
There are also metro areas in Illinois on the list — I would stay away, since property taxes in Illinois are insane (the second highest in the nation, out-taxed only by New Jersey). Texas, actually, also has quite high property taxation (ranking 7/51 among all states + DC). Similarly, NY markets are tricky because of high taxation (9/51).
So in a follow-up analysis, we could exclude certain metros (after vetting them individually) and entire states based on their property tax rates. Enough for now, I’ll be back with a follow-up post on how I vet metro areas. You can go ahead and run your own analyses using the code and data that I provide here: https://github.com/ottcsconsult/real-estate-rpr-2023-05-20
