The advantages of real estate investment are widely known, and they range from a tax efficiency and portfolio diversification to building up physical assets that not only provide cash flow but also increase in value over time. The foundation of any real estate investment plan should include income-producing properties, particularly commercial and multifamily assets. However, where you purchase is the most important consideration; not all marketplaces are created equal.
So, where are the ideal locations for commercial real estate investments?
Due to the constant change in the commercial and multifamily real estate markets, we continuously assesses the best locations for real estate investments. Nevertheless, when our acquisition team obtains a thorough understanding of a market and its underlying principles, we must be careful to avoid making decisions based solely on intuition rather than hard evidence. Numerous potent economic indicators determine whether properties are likely to produce high risk-adjusted returns like how the discounted cash flow model has demonstrated accuracy and reliability in evaluating investment possibilities.
Fundamentals Must Be Given Weight in Analysis
Each city and metropolitan statistical region (MSA) has its unique set of economic drivers and growth metrics. Numerous organizations and government departments in the United States, including the Census Bureau and the Bureau of Labor Statistics, as well as real estate-focused think tanks like the Urban Land Institute and market research companies that charge for data subscriptions, keep tabs on and document these basics. Starting with information from several of these reputable industry reports, our prediction model is developed.
Data by itself, however, is insufficient. The key to our methodology, or secret sauce, is how we weigh the essentials. Weighing the basics of commercial real estate in an equation to decide where to invest eliminates prejudice from our research, just as we objectively assess risk concerns in a possible investment. As a consequence, we now have a model that is thorough and rigorous, providing us with a neutral basis on which to base our market selection approach.
Creating Our Objective Model
The senior acquisitions team at our company as well as the investment committee have all contributed to the gathering, analyzing, and assessing of the raw data that forms the basis of our model. After determining the weightings, we assessed our eight current investment markets as well as any possible growth areas we were evaluating and compared them. As all of our current target markets ranked in the top 10-15 out of the 26 markets we assessed, we realized that our initial market selection had been excellent. We now have a structured framework in place to direct our internal debates about how to allocate our resources, so the exercise was definitely worthwhile. The technique will need us to modify the weightings at least once a year because market fundamentals are dynamic and subject to change. Although our model uses data on the economics of privately held real estate, various public sources also offer some important suggestions on where to put your real estate assets.
Our Top 9 Foundational Ideas
Our weighted approach is driven by the data on each of these fundamentals, which we consider to be nine tested markers of a possible investment market’s performance. Listed below are the main drivers of the model along with their locations:
1. Rising Population. Annual population fluctuations are estimated by the U.S. Census Bureau. Real estate demand is driven by a city’s population increase. An increasing percentage of millennials (aged 18 to 34) is a reliable predictor of future demand for commercial and multifamily buildings. In Colorado Springs, the largest 5-year millennial growth was discovered, according to a recent Brookings Institution analysis.
2. Employment opportunities. According to the U.S. Bureau of Labor Statistics, Houston, Texas, Seattle, Washington, and Orlando, Florida saw the most year-over-year employment increases. Orlando also receives the greatest rating for growth momentum over the next five years.
3. Business expenses Numerous well-known rankings, such as the Inc. 5000 list of rapidly expanding firms, rate how simple it is to launch a business. Expenses like taxes, electricity, and credit are included in the World Bank’s Doing Business index, which is extensively mimicked. These costs are also heavily weighted in our real estate methodology. Forbes included a salary component in its list of rapidly expanding cities, with Seattle’s 7.52% wage increase in 2017 serving as the benchmark. (Boise, Idaho, ranked first in Forbes’ population growth rankings.)
4. Concentration of Industry. A city’s healthcare job pool may be taken into account by investors analyzing the potential for medical clinics. In Brooklyn, New York, there are significantly more occupations in the fields of education and health, according to an annual assessment by the Urban Land Institute and the consulting company PwC. Boston and Philadelphia rank best in terms of occupations in sciences, tech, engineering, and mathematics. However, less pricey cities like Orlando also perform substantially above average in many categories.
5. Cost of housing. Because of their high housing prices, gateway cities like New York, Los Angeles, and San Francisco provide a significant investment challenge. Home prices are compared to the regional median income by realtors and other trade associations. Only 5.5% of the house sales in San Francisco were financed with a loan requiring a minimum salary of $119,000, according to the National Association of Home Builders/Wells Fargo rankings. Real estate investors are drawn to Chicago mostly because of its affordability when compared to other major cities worldwide.
6. Public and Investor Attitudes. The 2019 leaders in the ULI study, which measures investor and developer interest, are Dallas/Fort Worth, Brooklyn, Orlando, Raleigh/Durham, and Nashville. But we also take into account indications for the infrastructure related to lifestyle, travel, and other factors. Resonance Consulting awards Chicago a perfect score on a “product” assessment that takes into account airport accessibility, higher education, museums, and athletics. Additionally, Chicago is ranked first for corporate relocation by Site Selection magazine. Civic assets are included in the top-10 rankings of the personal finance website SmartAsset as well. For example, Madison, Wisconsin, received the highest score for the work-life balance due in part to the city’s abundance of cultural, recreational, and artistic venues.
7. Capitalization Rates Investors who are looking for commercial properties may become focused on cap rates, which are calculated as the first-year net income (net of capital expenditures and debt servicing) divided by the acquisition price. However, it’s crucial to be aware that pricing changes from year to year might be unpredictable, as shown by subscriptions such as Real Capital Analytics. To better understand the level of risk associated with holding assets in a certain market over an extended period, we examine not only cap rates but also the local history of volatility—you could think of it as a VIX for real estate.
8. Rent Increase. Multifamily homes in Indianapolis are currently averaging a 6.0 percent cap rate on a market-wide basis. 4.5% are in Los Angeles. If yearly rent hikes in LA don’t climb significantly over time, as they have in the past, LA becomes an expensive area to invest in compared to Indy. While rentals in Los Angeles are anticipated to increase by more than 3.0% over the following five years, those in Indianapolis are expected to increase by 2.25 percent annually. It might have been wiser to purchase in Indianapolis if LA rent increases don’t proceed at the anticipated rate. For the time being, we are concentrating on cities like Phoenix and our other priority investment locations since they are all seeing strong expected growth (more than 3.25% annually) and modest cap rates (5.25% in the case of Phoenix). Right now, it seems like they have superior investment chances for real estate.
9. Liquidity and supply The quantity of new supply being created in a certain market (measured through various data sources and municipal permits offices) and how liquid the market is are two other crucial criteria that are assessed and taken into account in our model (the number of transactions per year versus total inventory). To ascertain the effects that this additional supply will have on the current stock and the feasibility of achieving the anticipated rent rise, the supply side of the formula is compared to the consumer end, which is frequently measured in terms of employment and population density. A market’s liquidity, which is measured by the volume of buying and selling in a given year, is crucial to monitor for 2 reasons: first, it assures investors that future transactions will allow them to develop scale in the market, and second, a market with robust transaction activity typically provides additional alternatives when trying to sell an asset.
Putting the Model to Use
Because chances for consistent revenue and price growth aren’t available everywhere, the profitability of a commercial or multifamily real estate venture depends primarily on regional factors. Every business we contemplate is put to the test using our methodology, and it also serves as a roadmap for our expansion and scaling into new areas.
The top asset managers in the real estate industry use tactics for investing in real estate that anticipate trends and have a thorough grasp of how markets operate. With the use of our methodology, we can ensure that our research is impartial and will provide favorable outcomes for our investors.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.