Nobody would stupid enough to suggest that real estate investing is an exact science. There is always a risk. As I mentioned last week, I’m nowhere near being ready to invest in real estate - mainly because I don’t have the down payment and emergency fund necessary to protect myself from foreclosing on the loan, if something bad were to happen. Even though it may not be an exact science (or perhaps because of this), it is important to do your homework as extensively as possible.
The first part about selecting and buying a rental property begins with selecting a profitable market. One of the keys to a positive cash flow is finding a market that will produce it. While theoretically one could argue that any market could generate a property with a positive cash flow, some markets are better than others. It’s as simple as that.
Understanding the Difference between Real Estate Markets
Finding the best market begins with understanding the pros and cons of each market. What areas will be more expensive than other markets and what aspects will be cheaper. Most likely, certain markets have huge advantages over others only to fail in other aspects.
Let me share an example of two markets I am currently comparing. The first is New Jersey and the second Michigan. Both are areas that I am somewhat familiar with (because I believe you should only invest in markets with which you are familiar). I want to share with you the advantages of each, as I see them. I think this will benefit me in two areas – 1) perhaps you will have suggestions as to the better market and 2) it will help me illustrate the form of analysis you should be prepared to perform.
Michigan Real Estate Market
The advantage to Michigan is the low cost of real estate properties. I can easily find a duplex in Michigan that was built in the last 20-30 years for under $100k. Overall, it is going to have significantly lower expenses. This includes repairs, taxes, insurance. The downside of that is that rent or the potential income will also be lower along with a higher vacancy rate. Let me itemize it for easy clarification:
- Inexpensive Property Values
- Lower Taxes
- Lower Maintenance Fees
- Lower Rent
- High Vacancy Rent
New Jersey Real Estate Market:
The major advantage that NJ has over Michigan is that it has a significantly lower vacancy rate and higher rent. Knowing from personal experience, the right property can go years without any vacancies – even with changes in tenants. The downside is that New Jersey has one of the highest property tax rates in the country and due to its proximity to New York City, the property values are significantly higher. In sum, it is the exact opposite from Michigan:
- Higher Rent
- Low Vacancy Rate
- Higher Property Values
- Significantly Higher Property Tax
- Higher Maintenance Fees (Properties are older and cost of living is higher)
When performing this analysis one may thing that it is impossible to determine which market is better. It may be a certain degree of comparing apples and oranges, but the easiest way to make a choice between the two is to compare two properties and estimate the cash flow. In the future, I will go into what should be included in cash flow and how to properly calculate it.