Individual Market Focus During Evolving Market Conditions and the Top 10 Metros Least Susceptible to a Housing Downturn
It is easy to let the noise and headlines invoke fear or distract investors from reaching their portfolio goals in an evolving national real estate market. I challenge investors to remember the basic fundamentals of their investment strategy and their overall goals:
1. What is the planned holding period?
2. Regardless of interest rates, do the projections show net positive cash flows after debt service and expenses?
3. What market is the focus of your research? (Redfin Research Study);
a) What sub-markets in these cities are you focusing on
b) What is the market's susceptibility to a housing down turn
1. What is the planned holding period?
Firstly, market cycles are less substantial for investors planning on holding an investment property for a longer period. If the holding period is over 10 years, then you have plenty of time to see market fluctuations that will “sweeten up” after the market cycles. If the property is cash flowing through higher interest rates, it’s still a solid investment and shouldn’t prevent investors from acquiring property. When the interest rates lower back down, there is always the option to refinance at a lower rate.
When markets evolve, investors tend to let emotions dictate their thoughts on investing. Instead of letting emotion take hold, keep building your portfolio to not lose out on years of building equity in your portfolio. Days and years of holding property are precious and the longer the holding period the more equity and creativity will be available in the portfolio.
Investors have owned rental properties through every economic cycle regardless of interest rates. The underwriting and due diligence process becomes more important during higher interest rate cycles, but property that cash flows is a good investment, period.
2. Regardless of interest rates, do the projections show net positive cash flows after debt service and expenses?
There are buzzwords that are used for “rule of thumb” purposes that are an important baseline for a lot of investors to know and use, but it shouldn’t be the primary focus. One of these buzzwords is the RTV, or rent to value ratio. While I agree that this is an important factor during the underwriting process, contrary to popular belief, it doesn’t need to be all the way up to 1% to be a good investment. I think if it drops below .85%, there should be more time spent looking at other projections like appreciation potential and rent growth to determine the investment’s viability.
The primary focus should be simple. Does the property cash flow after debt service and expenses? If the projections are conservative and still show a net positive return, then it is still a good investment. Also, even adjustable-rate mortgages may be shielded from extremes in volatility by adjustment caps.
3. What market is the focus of your research? (Redfin Research Study)
National averages from news headlines and articles are important, but the weight it holds does not apply equally to all of the markets in the nation. Redfin recently published an article written by Dana Anderson and Sheharyar Bokhari ranking the country’s metropolitan areas from the most to the least susceptible to a housing market downturn.
The methodology is based on the following factors: home price volatility, average debt-to-income ratio, average home-loan-to-value ratio, labor market shock, percent of homes flipped, how much market is “cooling, year-over-year change in domestic migration, share of second homes, year-over-year price growth, and supply elasticity.
The most resilient markets shared common characteristics with the main being affordability. Additionally, they show prices rising more slowly than the national median, which makes it more likely for people to buy homes and it attracts people from bigger cities looking for lower prices.
Out of state investors need to choose areas that have smaller fluctuations during market volatility. This should lead to the same level of confidence as long as the projections are in the positive. For example, the fluctuations in San Francisco, Phoenix, and Riverside are more erratic than Midwest markets like Akron, Kansas City, Cincinnati and Philadelphia.
Picking a metro with a strong turnkey investment real estate presence is a good indicator of a market’s viability during market fluctuations because the business model wouldn’t be possible without affordability and modest home appreciation. This is a solid hedge against high volatility. Stay tuned for my next post touching on the strategy of using real estate to combat taxes and inflation.
Todd Crippen is the founder and CEO of Turnkey Property Group based out of Kansas City, Missouri. He graduated from Kansas State University with a degree in Advertising before earning his JD and Certificate of Real Estate Law Practice at Oklahoma City University School of Law.
Dana Anderson, Sheharyar Bokhari, Pandemic Homebuying Hotspots With Steep Price Increases Most Susceptible to Housing Downturn in a Recession, (2022), http://redfin.com/news/metros-recession-risk-housing-downturn-2022/