What if I told you that diversification is the key, especially when mitigating yourself against risks? You never want to have all of your eggs in one basket. And in todays uncertain market, a smart investor will diversify their portfolio.
As longtime readers know, I believe one of the best ways to achieve our financial goals—including diversification—is through real estate passive income. As you build your real estate asset portfolio, that might mean investing in different types of properties, such as condos, single-family homes, multifamily properties, or commercial property.
But what is often lost in the conversation of diversity is location, location, location. Why is this the case? When we first start investing in real estate, it’s natural to look in our own backyard. For me, it was important that I could drive to my first investment properties to keep tabs on things. If there were any maintenance issues, I could be there personally for my tenants. But I live in Southern California, and things are expensive here. To continue to tap into real estate opportunities, I had to look out of state and find the best places to invest.
And there are many good reasons to invest in property out of state. First, like me, maybe it’s difficult to afford the astronomical prices of the local market. Better yet, there are many out-of-state markets that generate a better return on investment. And finally, investment diversity helps us mitigate downside.
That all sounds great, but out-of-state property investment can be incredibly intimidating. It’s already difficult to get a handle on our local market, so how are we supposed to familiarize ourselves with other markets?
The good news is that there are easy-to-learn and basic real estate investment principles to use as tools when evaluating out-of-state markets.
Attributes of a Strong Real Estate Market
Although I consider real estate income to be passive, there can be some upfront work before the time you put in is no longer proportional to the scaling income you earn. Much of that upfront work is detailed research—sometimes called due diligence—on a particular market or property.
As you consider a particular market with your team of professionals and investment community, here are some fundamental things to look for.
This ratio compares the cost of a property’s monthly mortgage against its expected rental income. Ideally, the rent should be paying off the entire mortgage and providing additional profits in the form of passive income. The higher this ratio trends toward profits, the more favorable the market is.
In some circles, this ratio is called the price-to-rent ratio, and it calculates annual prices rather than monthly prices. Either way, both indicate a specific market’s potential return on investment.
Another determining factor is the market’s occupancy rate, sometimes tracked as a vacancy rate. This rate tells us about a market’s supply and demand. For example, with multifamily properties, cities average a 6.8% vacancy rate whereas suburbs average 5.9%. If the market you’re researching is above the averages, it may be a sign that there isn’t enough demand in the area, driving rent down and increasing turnover. When turnover is high, it leads to lost rental revenue from additional leasing costs, mandatory maintenance costs, and a host of other issues.
Keep in mind, there are separate vacancy rates for each separate asset class. So, if you’re interested in a specific real estate market but know you’ll be investing in single-family properties, look up the rates for that asset class.
Additionally, a market with high occupancy suggests overall economic strength in the local area and that the potential tenant pool has the means to pay the rent instead of defaulting. Speaking of which…
Low default rate
Not only are you looking for a market with high occupancy, but it should also have a low default rate. What percentage of renters are defaulting on their rental agreements?
It’s easy to find default rates for states, but city and local markets can be more difficult. Reach out to local real estate agents and professionals while doing your research.
If you have not yet delegated landlord duties to a hired property manager, here’s another thing to keep in mind: Default rates are often linked to an individual’s credit score. It may not surprise you to learn that people with higher credit scores tend to default less. What does that tell us? If a local market has a low default rate, it’s another sign that the economic situation in that market is robust and should provide steady tenants for the foreseeable future.
Within the last five years, national real estate prices have changed dramatically. First, there was the skyrocketing demand for homes during the COVID-19 pandemic. Then, after a period of substantial inflation, Fed rate hikes increased the costs of lending, bringing some home values down. These factors and more impact the appreciation of property value—an amount that traditionally increases at a steady pace.
Local markets are still in an adjustment period. Some are going up and some down. As you research, look for recent trends in median home price. As the dust starts to settle, we are seeing that some markets are correcting from being overpriced while others are still growing and thriving.
For real estate investing, it’s ideal to tap into a growing market.
Market growth is tracked on monthly and quarterly increments by many accredited and respected institutions, such as the National Realator’s Association. Access figures to see which markets are growing the most and the fastest.
Finally, how much do properties cost in a given market? And what can you afford? By checking a market’s median home price—its affordability—you can assess whether or not a market is appropriate for your investment situation. As mentioned, though, not all real estate investments require you to foot the entire bill for a property. If the price of a median home anywhere scares you off, consider smaller investments through syndications, funds, or REITs.
Using market growth to identify appreciation home valuesand investment affordability as the primary factors, let’s identify seven real estate markets that may be worth researching further. (Data used indicates the price and growth in Q2 of 2023.)
Tallahassee, Florida Median Home Price: $332,000 %Change: 7.1
Oklahoma City, Oklahoma Median Home Price: $247,600 %Change: 6.8
Worcester, Massachusetts Median Home Price: $452,000 %Change: 6.3
Cincinnati, Ohio Median Home Price: $294,200 %Change: 5.9
Albuquerque, New Mexico Median Home Price: $361,400 %Change: 4.6
Portland, Maine Median Home Price: $538,700 %Change: 9.1
Milwaukee, Wisconsin Median Home Price: $387,400 %Change: 6.3
Diversify Your Passive Income Education
Different parts of the country have different economic and external issues that they deal with. Certain places are tied to certain industries—industries that could be boom or bust. Some places have to regularly deal with natural disasters. As you diversify your rental properties, it’s best to spread them out—don’t keep them in one location. If disaster strikes, geographic diversification will help you mitigate the risks of investment. Even better, it can scale the passive income you earn through real estate.
On top of that, consider the benefits of your continued education in real estate. Your ability to make sound investments only improves with the more you know. Tap into the many investment networks we have created here at Passive Income MD. Consider joining the Passive Real Estate Academy (PREA). Its courses, which only open twice a year, allow you to confidently invest in passive real estate, not to mention the network of thousands of other investors working together to leverage the right investment opportunities.
Or, for you conference-goers, I hope to see you at the next Physician Real Estate & Entrepreneurship Conference (PIMDCON) as part of your investment journey.