Real estate can be an extremely lucrative investment vehicle. After all, ninety percent of all millionaires have utilized real estate investing in building their wealth. Housing is an essential commodity of life, which causes real estate to retain its value and appreciate over time much better than other asset classes.
However, savvy investors know that they cannot simply go out and buy every house on the market and instantly become wealthy. They are calculated in where they purchase and the strategies they use to acquire and utilize properties.
You may be looking at your market and thinking the best place to invest in real estate is the nicest neighborhood in town. That might be the case if you’re looking to do high-end flips. But renting a luxury home likely won’t give you the same returns as a starter home.
Every market presents different investment opportunities. Wise investors use data from the market to decide which areas to target based on which strategies they are focused on.
In this article, we’ve discussed the data points that every real estate investor should look at to properly segment their market to make wise investments and maximize their returns.
The Data You Will Need.
Market segmentation begins with data, and you will need a significant amount of it to get a complete picture. It is best to team up with an agent in your market who can pull most of this data for you. Let them know that you are planning to buy, rent, and sell real estate in your market and intend to use them as your agent then, since that’s when agents get paid.
In most markets, you will want to begin segmenting by zip code. Here is a list of metrics you should ask your agent for per zip zip code each month:
- Number of homes sold in last 12 months
- Number of homes sold last month
- Median sales price
- Median sales price of city
- Average Days on Market (DOM)
- Current number of listings on market
- Financed buyers vs. cash buyers
- Average rent prices
Although you will likely need an agent to pull most of this data, you can gather some from sites like Zillow and Redfin.
It will be helpful to track these data points on a month-by-month basis. This way, you will be able to see any outliers and track trends in specific zip codes.
How To Use the Data From Your Market
So you got in touch with your agent, and they dumped all of the data you asked for on you.
Great! But now what do you do?
Simply getting the data is only half the battle or less. Now you need to analyze it in a way that will make it useful for you.
The most practical way to crunch through all of the data is to make a table. This will allow you to visualize it all and perform calculations. The image below is an example from Madison County, Alabama, a couple of years ago. We’d recommend that you build something similar from your market.
As you can see, the table contains all of the data from the list above, as well as some other values.
Inventory is a metric that real estate professionals use to determine how competitive a market is for buyers and sellers. It is calculated by dividing the number of houses currently on the market by the number sold per month. This value tells you how many months it would take to sell off all of the homes currently listed on the market at the current selling rate.
Choosing Zip Codes to Invest in
Now that you have tabulated the data in your market, you can begin to interpret it and pull out meaningful information for your investing journey. Some areas will be better suited for fixing and flipping, while rental properties will perform better in others. Only a deep dive into your market’s data will give you those answers.
What Inventory Tells You About Your Market
The level of inventory in a certain zip code or your market as a whole will tell you whether you are in a buyer’s or seller’s market. In general, real estate professionals say that six months of inventory indicates a balanced market.
Anything less than six months of inventory is considered a seller’s market. Prices generally climb in this type of market due to having more demand for houses than the available supply. If inventory rises over six months, it is considered a buyer’s market, and buyers can typically buy homes for cheaper and demand more concessions.
Even though it is tough to find good deals in a seller’s market, the appreciation during times of low inventory makes every other part of investing work well. It isn’t unheard of in a hot market for a home to appreciate tens of thousands of dollars while an investor is flipping it.
If you plan to buy rental properties and hold them for a long time, you can typically find the best deals in a buyer’s market. That is a strategy of many buy-and-hold investors – buying while the market is down, renting out the house, riding the appreciation curve, and selling at the top of the market.
Focus at or Below the Median Price Point
For nearly every investing strategy, most investors focus on buying properties with After Repair Values (ARVs) at or below the median price point of their city. When looking at zip codes, you can filter out the ones that are well above the median sales price of their city.
The reasoning behind buying houses below the median price point is that this is where your largest pool of buyers will be. First-time homebuyers often make up a large percentage of the prospective buyers in a market, and this price range is where they typically look to buy. Even if you are not flipping, the rent-to-value ratio generally increases as you look at lower-priced homes.
Days On Market (DOM)
Average days on market tells you how long the average house is listed before it receives an offer and goes under contract. If zip codes in your area have a higher DOM than the rest, there is likely lower activity there, and it could be more challenging to sell a flip. When getting started, it is typically better to start in areas with low DOM so you will have less time waiting for your houses to sell.
Percentage of Cash Buyers
It is important to evaluate the percentage of cash buyers in each zip code you are looking at. Since most of these buyers are other investors, a higher percentage means that you will have more competition. If you are getting started flipping or buying rental properties, you will likely want to stay away from these areas.
However, if you plan to wholesale properties, these areas are likely where you want to focus since you will be looking to flip your deals over to these cash buyers.
Final Thoughts on Choosing Zip Codes
How you use the information you gather on your market’s zip codes will depend on what you are looking to do. You may use it to determine which areas you want to focus on based on your preferred investing strategies. Alternatively, you may rely on the insights you gain to know how to approach each potential deal that comes your way.
Either way, going through this exercise will give you a much better understanding of your market so that you can invest with confidence.
Finding the Right Neighborhoods to Invest in
You may be thinking, “So I’ve found the right zip codes, but each zip code has a ton of variety.”
You’re correct!
The process of evaluating a market involves drilling down a little at a time until you have a laser focus on the areas that you want to invest in.
Investment Strategies Based on Neighborhood
Real estate investors often group neighborhoods into categories based on their price point and quality of homes. They range from “A” to “D,” with A being the nicest and most expensive neighborhoods. Here are tips and recommended investing strategies for each type of neighborhood:
- “A” Neighborhood – Mostly flips
- “B” Neighborhood – Mostly flips
- “C” Neighborhood – Flips & Rentals
- “D” Neighborhood – Mostly rentals
Owning rental properties generally doesn’t make sense in “A” and “B” neighborhoods because rent value does not increase at the same rate as home value. The cash flow and rate of return on expensive houses are typically much lower than these values when renting more affordable homes. For example, a $200,000 house might rent for $1,500 per month, while a $400,000 house in the same area will only rent for $2,300 per month. Even though the house is worth twice as much, the market rent isn’t near double.
Although “D” neighborhoods can provide excellent cash flow from rental properties, these areas are not the best to flip houses in. This is because renters instead of homeowners occupy most homes in these neighborhoods, so you will have a smaller buyer pool when you list your house on the market. “B” and “C” neighborhoods are usually the sweet spot for flippers.
How to Find the Hottest Neighborhoods
If you plan to flip houses, you’ll likely want to focus on the areas with the most buyer activity. But how do you find out where the buyers are looking?
By finding the cluster zones in your market.
Once you find zip codes within your market well suited for flipping, you can drill down in these areas and find pockets of houses with elevated activity.
To find these pockets, go to Zillow and search for recently sold homes in your zip codes. You can set a price filter to exclude anything extremely low and anything above the median sales price. You’ll also want to filter your search to only show homes that have sold in the last 30 or 90 days.
With your filters set, you can zoom out and visually pick out pockets of yellow dots representing sold homes that meet your criteria. You’ll likely find neighborhoods with much higher activity than others. These are the neighborhoods that you want to target the most when searching for deals.
The only caveat to this approach is that you likely want to avoid neighborhoods with many active listings since these will be your competition. If you can find areas with high recently sold activity but a shortage of active listings, your flip will sell in a heartbeat!
It’s Time to Start Finding Deals!
If you implement the strategies discussed in this article, you will be well on your way to making the best investments your real estate market has to offer. So many investors dive in just looking for the infamous “deal” but are so misguided they end up wasting time. Having your finger on the pulse of your market will not only guide you to the best areas to invest in, but will also allow you to negotiate better deals when talking with sellers. This is because you know exactly what their house is worth as well as your preferred exit strategy.
There are two things to avoid when evaluating your market.
The first is a flat-out rejection of deals that don’t perfectly fit your criteria. Just because you choose to focus on certain zip codes doesn’t mean there are no profitable deals anywhere else. The analysis tools discussed here are intended to serve as guidelines, but you also have to use common sense when investing in real estate. Be sure to remain flexible enough to consider a deal if the numbers make sense.
The second thing to avoid is getting into analysis paralysis. It is very comfortable to stay behind a computer screen looking at numbers and never take action. However, success in real estate investing comes from gaining specialized knowledge and then applying that knowledge to structure profitable deals. You’ll learn even more as you get out in the field and start putting deals together.
So get out there and start making offers!