If you want to be successful in flipping or holding a property, it is important to do a thorough real estate market analysis. This means more than just comparing similar properties. You need to have a complete understanding of the local real estate market so you can tell if a property is a good investment.
When conducting a market analysis you will want to consider factors such as the economic, employment and educational health of the area as well as any social, technology or political issues that may be of concern. It is important to align your personal and financial goals with any potential risks that may bepresent in the market.
Don’t worry if the process of conducting a market analysis sounds daunting. This guide will show you how to do it, so that you can determine if a particular property is a good match for your investment goals. By the end of it, you’ll have a scorecard that you can use to compare the strengths and weaknesses, as well as the opportunities and risks, of different real estate markets. Doing a market assessment is key to making a smart investment, whether you’re considering investing in Tampa or Seattle, or trying to choose between two different areas.
Real estate market analysis vs. comparative market analysis
The purpose of a comparative market analysis is to price a home by using similar, recently sold properties. However, sale price, square footage, lot size, number of bedrooms and bathrooms, and proximity to amenities are all just parts of the overall picture.
Are there more or fewer homes than what is demanded? Who will be interested in buying homes in this area? Does this area have the infrastructure to support the current residents?Is this area at a high risk for flooding or wildfires?
Remember that a CMA and real estate market analysis are both based on personal opinion, but a market analysis takes into account more information and variables. They are both different from a property’s appraised value, which is determined by a certified professional appraiser.
Where to find real estate market information
But, at the end of the day, data is data, and the interpretation should be as free from personal biases as possible. It is important to consult with professionals when doing market analysis, but it is also important to be objective and unbiased when interpreting the data. Your research should include:
- Local newspapers
- The National Association of Realtors and local real estate organizations and agents
- Government sources, like:
- Online listing services like Zillow, Trulia, and Redfin
- Services like NeighborhoodScout
Essential real estate numbers and terms
The first step to doing a market analysis is to understand the essentials concepts. You can’t just jump into the assessment without knowing what you’re doing.
Days on market
How long is the average property on the market before it sells? This number is called “days on market” (DOM), and it can be used in two different ways:
- To assess the status of an individual property
- To determine the average DOM—which provides perspective on an area’s overall market
You should charge rent that is based on the market value for your property and the rental costs of similar homes.
A good guideline for setting monthly rent prices is to charge a percentage of the property value that falls between 0.8% and 1.1%. If the home you are renting is valued at $100,000 or less, you can charge rent at the higher end of this range. In local markets where the average home value is more than $350,000, you may need to adjust the percentage you charge to a lower amount in order to attract tenants. This may not be as important in markets where home values are very high, such as in San Francisco or Miami.
When determining rent, be sure to:
- Include your costs for expenses like repairs and maintenance, taxes, insurance, and other fees as you calculate cash flow and profit margins
- Account for washers and dryers, recreation areas, or other add-on amenities that justify higher rent
- Take local economic conditions and seasonality into account, since they affect demand and tenants’ spending power
Be sure to research local laws regulating rent before signing a lease. In some communities, like California, Maryland, New Jersey, New York, and Washington D.C., these laws are very strict, dictating how much rent can be raised each year.
The Rent Estimator by BPInsights can help you understand what prices are like in your local market.
The cash-on-cash return lets you compare the annual cash income to the cash you’ve invested. It’s different from the standard return on investment because it only looks at the cash, not the total return.
To calculate cash-on-cash return, divide annual pre-tax cash flow by cash invested. So, if you paid $100,000 with a $90,000 mortgage and sell after 1 year for $110,000:
First-year cash expenses
- Down payment: $10,000
- Closing costs, insurance, and maintenance: $1,000
- Loan payments: $2,500, including $500 to principal
Total expenses: $13,500
First year cash inflow
- Sale price minus mortgage payment: $20,500
Total inflow: $20,500
The cash flow for this investment is $7,000 and the cash-on-cash return is 51.9%.
The price-to-rent ratio is a comparison of median home prices and median rents. It is used to estimate the potential profitability of an investment.
The ratio to determine if it is a good time to buy a home is 15 or less. This is found by taking the purchase price and dividing it by the total annual rent.
Gross rental yield
To find the percentage of return on investment for an individual property, divide the annual rent by the total property cost, including purchase price, closing, and renovation costs, then multiply by 100. This can be used to compare comparable homes.
Capitalization rate (cap rate)
Your return on investment when using the cap rate method is determined by the net income of the property.
To calculate your return on investment for a rental property, divide your expected annual net operating income by the property asset value to get a percentage.
The cap rate is the percentage at which the property is expected to be valued. A proper market analysis is needed to determine the expected cap rate, as it typically varies depending on the market. It’s also worth noting that a lower cap rate often corresponds with a higher potential return and lower risk.
The results can also help determine how long it will take to get your money back.
Although it is commonly believed that high property taxes are negative, you shouldn’t eliminate locations with high taxes from your market analysis. Often, neighborhoods with high taxes that are in demand and attractive to long-term tenants have high taxes. You need to consider the risks and rewards when making your decision.
If you’re looking at a property to rent and don’t see any information about estimated or recent property taxes, you should ask your agent. The local tax assessment office will also have all tax data on file. Make sure to research whether future increases are likely and to assess recent trends. This will help you ensure that competitive rental prices can accommodate anticipated tax loads and your personal cash flow.
Essential market numbers
When analyzing the real estate market, you must determine whether you are working with a buyer’s market or a seller’s market. This is indicated by factors such as the DOM (days on market), prices increases or decreases, and the overall inventory of homes for sale.
- A buyer’s market has more supply and less demand—think of the 2008 recession. Home prices dropped, construction nearly stopped, and foreclosures increased. This gave buyers tremendous leverage in negotiations.
- A seller’s market is created when there’s more demand than supply. This happened just before the crash in 2008, when home prices rose dramatically.
What Is Real Estate Investing?
Real estate investing refers to the process of buying and/or owning property in order to make money.
Real estate investing can be done through different methods then just buying a property outright or obtaining a long-term mortgage.
On the contrary, there are many different ways that you can gain access to this investment arena. Nevertheless, the primary objective when investing in real estate is to grow your capital in two streams:
- Appreciation: This is when the value of your investment property increases. For example, if you bought the property when it was worth $200,000 and five years later its value has grown to $250,000, this amounts to capital gains of $50,000.
- Rental Income: Unless you are yourself living in the property, you will also be able to make money through rental income. This is usually a fixed amount that is paid each month, albeit, commercial properties might settle on a quarterly or annual basis.
The way that the two revenue streams are similar to dividend stocks is that you can earn money when the shares increase in value, as well as when the company releases a dividend payment.
Beginners in the realm of real estate investment should take into account a variety of property types – not just houses. This includes commercial buildings, warehouses, shopping malls, healthcare facilities, and so on.
However, instead of investing in stocks or bonds, a REIT invests in – you guessed it – real estate A REIT (Real Estate Investment Trust) is an easy way to access real estate products. REITs operate similarly to an ETF, but instead of investing in stocks or bonds, a REIT invests in real estate.
This is because the provider will purchaseproperties on behalf of its investors. Plus, minimum investment requirements are often super-low, as most REITs are listed on public stock exchanges.
Ways to Invest in Real Estate
Now that we have covered the basics of what real estate investing is, we can move on to the specifics. In the sections below, we will explore the many ways to invest in real estate, with options ranging from low-budget to high-risk.
Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts, or REITs, are a lot like ETFs. We covered this briefly a minute ago. They’re a good way to invest in real estate.
This is because:
- REITs are listed on public stock exchanges, meaning that you can buy and sell any time that the respective market is open.
- Your investment in the REIT is determined by the number of shares you buy.
- The value of the REIT is largely dictated by the NAV of the fund.
A REIT typically invest in a large number of properties in a specific sector of the real estate industry.
For example, a REIT might own a collection of multi-family complexes, a group of shopping malls, healthcare facilities, or commercial buildings.
The REIT will choose which properties to invest in, so you can get exposure to the real estate industry without doing any work.
The value of your REIT investment will fluctuate depending on the NAV of the assets held by the fund, just as it would with an ETF.
An overly simplistic example of this is as follows:
- Let’s say that you invest in a REIT that owns $1 billion worth of commercial properties;
- Five years later, the total value of all properties held by the REIT has increased to $1.8 billion;
- This amounts to an increase of 80% in the NAV; and
- In theory, this means that the value of your investment has also risen by 80%.
There are many other factors that can influence the value of your REIT investment, such as wider industry conditions, rental occupancy rates, and the specific housing market that the properties are based in.
: Not all REITs are created equal. Some REITs invest directly in properties, earning rental income and management fees. Others REITs invest in real estate debt (i.e. mortgages and mortgage-backed securities).
You need to consider the costs involved, because the REIT will manage the properties on behalf of its investors.
All in all, there are a significant number of REITs based in the US and even more located overseas. But, to give you an idea of some of the most traded, check out the list below:
- Simon Property Group (NYSE: SPG): This REIT specializes in high-end shopping malls and outlet centers located in the US. Simon Property Group trades on the NYSE and is now an S&P 500 company. The REIT has since expanded its overseas properties and has locations in Europe and Asia.
- Welltower (NYSE: WELL): Launched way back in 1970, this REIT also trades on the NYSE, albeit, it specializes in healthcare facilities. This covers hospitals, medical centers, and senior housing.
- Equity Residential (NYSE: EQR): If you’re more interested in investing in residential properties, Equity Residential might be the right REIT for you. In total, the REIT is behind over 300 properties, which amounts to almost 78,000 individual units. This makes Equity Residential one of the largest REITs in the residential property sector.
It’s worth mentioning that in the United States, REITs are legally required to distribute at least 90% of their taxable income to shareholders every year. This will be especially appealing to investors who are looking for a reliable source of income from their investments.
The REIT’s NAV should increase along with the value of the underlying properties, meaning that you would make a profit if you sold your shares.
Understand what amenities sell
Before you invest in a property, make sure to do your research on what type of property is in demand in that area. This is true whether you’re planning on reselling the property or renting it out. There are some features that usually make a property more appealing, such as hardwood floors, a washer and dryer, a modern kitchen, a balcony, and covered or garage parking. Most renters will be looking for these amenities.
These elements won’t differ much between markets, but there will be some regional differences buyers and renters should be aware of. In Arizona, for example, having a backyard pool is more common.
Choose amenities that will appeal to the type of tenant you want to attract. For example, installing carpeting would be more appealing to families with small children than to older individuals. Upgrades like tile backsplashes might be too expensive for a particular home, depending on the neighborhood or your desired price point.
Be sure to find a balance between what is best for the house, what your prospective tenants or buyers want, and your investment goals.
Interpreting sales activity on comparable properties
If a listing seems fresh, it is probably a better deal than an older one. This is because older listings have been on the market for longer and have not sold, which means there may be something wrong with them.
There are a few different types of information you can use to check up on trends in a certain real estate market, or to compare properties you might be interested in. You can also find more detailed information about local market trends in BPInsights’ articles.
New and existing home sales reports
- Your real estate agent for recent local activity on comparable homes
- U.S. Census Bureau for data on new residential construction
- National Association of Homebuilders for annual, quarterly, and monthly data on new and existing home sales
The text is discussing how the information can be used to predict future trends.
There are two categories to investigate during your market analysis:
- Pending sales provide the most current values for comparable homes.
- Closed sales give historical perspective on how prices have trended over time.
To find out how much homes are selling for in a certain area, you can look up information on websites like Zillow, Realtor.com, Redfin, Trulia, and RealtyTrac. Find the average sale price for the area you’re interested in to get an idea of what homes there are selling for.
Days on market
DOM can be a powerful indicator for individual properties and regional trends.
A home that sells quickly (within five days) is more likely to sell for its listed price than a home that takes longer to sell, according to research done by Zillow. A home that takes a few weeks to sell is less likely to sell for its listed price than a home that sells quickly, and the chance of selling for list price decreases the longer a home is on the market. Homes that are on the market for longer than average may be overpriced, or they may need repairs or upgrades.
The average DOM—or days on market—is a measure of how long it takes for homes listed in a given area to be sold. This metric can be used to gauge the health of the overall market, as it is affected by factors such as oversupply, negative economic indicators, or a major business or industry downturn.
Remember that these numbers are not set in stone. If an area has a high DOM, look at patterns over the last year or two to see if the time it takes to sell has always been higher than in other areas.
The DOM is usually found on the multiple listing service (MLS). You can also find it on commercial listing sites like Zillow and Redfin, or you can ask your agent.