The 6 Pillars Of A Great Cashflow MarketMay 11, 2020
50% of the new investors I talk to live somewhere that's not affordable as a rental market.
They want to invest but feel handcuffed by the high prices and competition around them.
I say "dude, you need to pick a new market and invest virtually!"
They are usually both surprised and excited...
To learn that they could have been investing all along.
For many people I talk to...
Picking the market is their very next step.
If this is true for you, this post is going to spell out exactly how to go about doing that.
I got started by investing in Nashville around 2014.
I knew nothing about picking markets.
I just happened to live there.
The properties I bought appreciated an INSANE amount over the next 5 years.
Now, Nashville is too expensive to invest in for cashflow.
But I got really curious "What made Nashville such a great market?"
"Are there any other markets out there that are in a similar spot to what Nashville ONCE was?"
That led me down the path of researching the ingredients that make up an affordable, safe, and EXPLOSIVE rental market.
Picking the right market will:
- Ensure that you get positive cashflow on your deals
- Have a high likelihood of great appreciation over the long run
- Protect your investments during a downturn due to less recession in the immediate area
- Give you a thriving community to plug into to help you learn the ropes and meet the right people
- And much more
Don't be blinded by a house that's only 20K but it's in a small, rural town.
Price isn't everything.
That house will be hard to renovate, keep rented, and manage in a town like that.
It will also never appreciate.
Start with MARKETS, not deals.
This is the hallmark of a savvy investor.
So, let’s dive into the six pillars of what makes a great rental market:
Pillar #1 - Rent/Price Ratio
I put this one first because if your market doesn’t have it, it’s an immediate deal killer. It’s also a quick way to eliminate potential markets from your research.
This pillar will also take you the most time to figure out, because it’s not super cut and dry. Don’t worry, the others are much faster.
Have you ever heard of the 1% rule? It states that one month’s rent divided by the all-in purchase price should be 1% (.01) or better.
For example: $700/month in rent, $70,000 all-in price (purchase + repairs + closing costs)…
700/70,000 = .01 (or 1%)
Some people think that’s good enough. But, in my experience, “1%’ers” don’t really cashflow. They’re more “break even” properties that do better as some time passes. They’re way better than doing nothing, but you can do better than this.
My minimum is actually 1.5%.
So if the rent is $700, I need to get that property for about $45,000 all in.
700/45,000 = .015 (or 1.5%)
And if the property needs 10K in repairs, and there’s 2K in closing costs, the purchase price needs to be no more than 33K.
$33,000 purchase price
$2,000 closing costs
= $45,000 all-in price
Now THAT is how you buy a rental that cashflows.
So how do you know if the houses in a market will meet that 1.5% mark?
What I do is start by looking at the houses that are listed for sale. I might just hop on Zillow and look at the cheapest houses in, say, Greenville, South Carolina.
I sort them by “cheapest” and I see that there are houses in the 50-60K range. That’s a good sign.
Generally, I always look for markets where you can buy a segment of the houses for under 100K. It just means there’s a higher chance that the houses will cashflow (meet that 1.5% mark) and it’s also easier to get financing for smaller amounts.
Once I see that I can get a 3 bedroom in Greenville for around 60K, I’ll then check all the available “for rent” listings in the city. How much are 3 bedrooms renting for?
If I see that they are listed around $850 or more, I’m happy. No, it doesn’t quite meet the 1.5% requirement, but that’s OK. This is because you are NOT typically going to be finding your deals from the MLS, nor are you going to be paying full price.
In this first test, you are just confirming that the houses for sale in that market are near the 1.5% mark.
You might look at another market, like Portland, Oregon, and see that most of the houses are above 100K. Now, will a $150,000 house rent for more than $1,500/month? Probably not, meaning you probably can’t easily get cashflow in Portland.
Once the deals in a market pass this initial test, I go ahead and join a few Facebook Groups for real estate investors in that market. I do this because I want to see the “off market/wholesale” deals that are floating around at the moment.
They are usually cheaper than the stuff on the MLS. They may still be overpriced, especially if the market is up overall, but they will give you a much better indication of the types of deals you will be seeing if you were to choose that market to invest in.
Once you join the Facebook Group, make a post saying “Cash buyer looking to buy rental properties, email or DM me what you’ve got” and then put your email address in the comments. You will get a handful of deals within a small amount of time.
They probably won’t be great deals, but they’ll give you that indication of what the deals will be like. Then find out what those houses would rent for.
The wholesalers and realtors should have included this information when they sent you the deal. These deals will probably be much closer to the 1.5% mark.
Again, they don’t have to be all the way there. This is because you’re going to create close-knit relationships with a few of the best wholesalers and you’re also going to be negotiating on price.
Once you’ve done this amount of due diligence and you’re confident that you will be able to find 1.5% deals (or better), this market can stay on your list of potentials, and you can move onto the next piece of criteria.
Pillar #2 - Economic Strength/Diversity
This pillar is super important, because you want to make sure your properties are in an area that thrives. The economic strength of an area directly affects your properties. If things are booming, then rents will go up, value will increase, and so will demand.
On the flipside, if the economy is suffering in an area, you’ll see “For Sale” and “For Lease” signs every where, businesses and homes will be boarded up, and people will be packing up to go find a place with better jobs and a higher quality of life.
There’s a town in Tennessee called Spring Hill. Spring Hill boomed when GM built a Saturn plant there and started making cars. Thousands of jobs were created, developers started building new homes, and the city thrived.
Then one day, someone at GM decided to shut down the Saturn plant in Spring Hill. What happened next? Well, everyone that lived there for that reason no longer had a reason to be there. They sold their house, or moved out of their rental house. They left Spring Hill to find another job.
When this happened, property owners in Spring Hill took a big loss. Investors looked to sell their rental properties.
The story of Spring Hill does have a happy ending, however. Years later GM decided to reinstate the Saturn plant, and the jobs and workers came back. Since then it has grown to be more than just a town with an automobile plant.
But, the old version of Spring Hill, where the towns economy relied on the decisions made at the GM executive roundtable, are the exact types of towns I want you to avoid as a real estate investor.
Economic diversity means that the different industries that make up the economy itself are diverse. A city with a diverse economy might have:
1) A big college/university
2) Mining/Oil/Natural Resources
3) Tech companies moving there
4) Big businesses like Fedex, Nike, UPS, Amazon, Samsung, or LG opening up shop there
3) An automobile plant
THAT is the difference between a one horse down and an economically strong and diverse market.
Make sure that the market you choose is NOT supported by just 1-2 economic sectors.
Pillar #3 - Population Size/Growth
When I first started investing, I bought a few houses in Birmingham, Alabama. The prices were really cheap in relation to the rent so I thought I was a genius.
Fast forward 5 years, and those houses have NEVER appreciated. Maybe 5K or so, but peanuts compared to the appreciation I see in other markets.
One day I had done some research on Birmingham and found that the city has been in a population decline for something like 20 years.
People are moving away from the city. No wonder the houses weren't appreciating!
Population growth is a huge thing you want your rental market to have. It's a strong indicator that prices and rents will go up over time in that city.
Pick a market that's growing in population by at least 1%/year on average.
Now let's talk about population size.
A common mistake I see people make is choosing really small cities to invest in. “The houses are so cheap and there’s no competition!” they tell me with excitement.
To humor them, I look it up online to find out that the town has a population of 3,000 people, and there’s currently only 5 houses listed for rent on Zillow.
Now, you might think that a lack of houses would be a good thing, less competition right? What it probably means is that there’s not enough demand for rental properties, hence the low number of listings.
What if the 5 people who are looking for a rental property all find one, and your property is the sixth? Can you see how playing with such small numbers is risky?
Pick a city with a minimum population size of 100K.
Pillar #4 - Job Growth/Income Growth
This pillar is very much linked to Pillar #2 - Economic Strength/Diversity.
In a nutshell, analyzing job and income growth is another angle at analyzing overall economic strength. You want to make sure your market has all of these things, it’s that important.
Economic growth/strength is the largest predictor of long-term appreciation.
Out of all the reasons someone might pick up their life and move somewhere else, which one do you hear the most?
“I got a job offer there” or “my company made me move”
Jobs are the one thing that really motivate people to live in a certain city. I’m sure you know people who actually hate the city they are in, but they stay. Why?
“I can’t lose my job”
Because jobs have such a strong influence it’s worth your time to take a look at how the jobs are doing in your potential market of choice.
Another thing you can look at is the unemployment rate. You want a low number, 5% or less.
At the time of this writing, Nashville, TN has an unemployment rate of 2.2%, while Bakersfield, CA is sitting at 8.2%.
That means that the percentage of residents hanging out in Bakersfield with no job is four times the percentage of those same people in Nashville.
Now, don’t you think you’d want to know something like that before you invest your hard earned money into a property?
Quite simply, all you need to do here is make sure that both the amount of available jobs, and the average income, are both growing.
Pillar #5 - Vacancy Rate
Another thing you want to take a look at is vacancy rates. If you’re going to buy properties with the intent for other people to occupy them, wouldn’t it make sense to see how often properties are sitting empty?
With vacancy rates, you want to avoid markets where the vacancy rates are high (10-15%). This typically is found in seasonal or coastal towns, like Las Vegas or Ocean City, NJ.
These towns can lose 25% of their economies or more during “down” seasons. There’s no point investing somewhere like this when you can simply choose a city that doesn’t even have a down season.
To find vacancy rates, just consult Google. For example, I just looked up the vacancy rate of Lexington, Kentucky by Googling “Lexington Kentucky Vacancy Rate” (By the way, it’s 3.9%, which is good!)
Find a city with a vacancy rate of 6% or lower to ensure your properties are occupied almost all of the time.
Pillar #6 - REI Activity
This is a big one that a lot of people overlook. The city you are going to invest in should already have other investors. You don’t want to “be first” in this sort of thing.
Being first usually means that there’s something wrong with the market, or some reason why you shouldn’t invest.
But, there’s a much bigger reason to want REI activity in your potential market.
You will leverage that community to find out a ton of information to get started, such as:
- finding out the best zip codes/neighborhoods
- discovering the top property managers
- finding the best contractors
- learning which local banks are most investor friendly
- finding the local private money lenders
Tapping the local REI community will dramatically shorten your learning curve, which is why you need to make sure it exists in the first place.
Now you have the information you need to go out and pick a great cashflow market.
Don't delay this decision by more than a couple of weeks.
It may feel daunting but as long as you follow the criteria laid out here you will make a solid decision and you'll be massively successful over the long haul.
To your success,