Month: March 2016

Local Economic Analysis

Objective

Now that we have isolated a specific zip code, we can begin researching the specific location in order to begin formulating an investment thesis for the specific zip code. We are looking for key value drivers, such as:

  • Local government budget (the area we can focus on is Marietta, GA)
  • Job growth
  • Household income
  • Types of occupations
  • Tax rates

Economics

To find some additional information, I went to Bestplaces.net to acquire additional job and demographic information. While some of the earlier sources we utilized also have similar information, I wanted to present another website with some additional job growth forecast information as well. On the website, we can type in the zip code circled here:

Bestplaces.net splash.png

Typing in the zip code “30067” takes us to the following website, with a summary of Marietta, GA. We can select the “Economics” link on the left to take us to the local economics summary.

Bestplaces.net second page.png

Using the data, I first note the future job growth of 36.0% versus 36.1% for the US economy. In general, Marietta seems to be reflective of the median (or slightly less) of the general economy. In order to drill down on an investment thesis, we need to look at some of the information pertaining to the individuals that currently live there. First, we compared the general income ranges for the Marietta population versus the US population:

Comparison of Income.png

As we can see, Marietta’s population is more allocated to income earners below $50,000 per year. This is seen as a positive since we are looking for potential renters rather than buyers. We will research how to find attractive properties for these specific populations in the relevant zip codes at a later date. Now, lets focus on getting a more complete picture. I reviewed the types of occupations in the zip code and highlighted the top 3:

Occupation.png

About half of the population focuses in these three areas. Later on, I will look for information related to where these individuals work, travel time to work, and whether there are more jobs opening in these areas.

Now, in order to look for more information about potential home price appreciation, I like to review Zillow home prices & values information to get an idea of how the market is looking at the zip code. Thankfully, it looks like our screening has come through based on Zillow’s predictions. While I would not consider research done at this point, the following from Zillow validates a lot of our work so far:

Zillow.png

One thing that immediately concerns me, however, is that prices have increased about 8.3% over the last year. I may have missed the opportunity to invest or find a good deal. However, the market seems to have an upward trajectory for the time being.

Summary

We have found some additional facts to consider for our due diligence, and our nearing the process of actually focusing on finding specific deals. For the next lesson or two, we will focus on the local government and finding any indicators we can to hang our hat on. A lot of the websites out there report general information, we are looking to validate market trends. These next steps will require a bit more rigor as the processes cannot be automated like before.

Selecting Investment Zip Code

Objective

Now that we have acquired numerous data points pointing to a few potential zip codes, we will work on filtering through the information and summarizing the data to make a decision.

This section involves subjective decision making when it comes to weighting of certain factors over others. I have selected a basic strategy of assigning equal weight to each of the factors. In reality, some of the factors may more or less heavily weighted based on an investor’s investment strategy, risk profile, and geography of the property.

Putting it all together

Using the analysis from my posts about IRS zip code data and risk management, we can build a model that focuses on two drivers of value: (1) demographic information contained in the IRS data and (2)  market data  related to pricing. Based on the previous color schemes, I assigned a value of 2 for green rows, 1 for yellow rows, and 0 for red rows. Surprisingly, none of the zip codes achieved a “perfect” 4, and only 2 zip codes scored a 3. The general trend indicated that the areas with favorable demographic information may be getting overheated.

Summary of Results

With the data, I focused on the two zip codes that scored a 3. While it may be generally to broaden the search to those two zip codes, I want to select just 1 zip code to focus the analysis. I reviewed the data, and see that the 30067 zip code scored a yellow on the IRS data and a green on the deal data. The 30328 zip code scored in reverse. I dive a bit deeper in the IRS data to get the story.

I see that, for the zip code 30067, state income and sales tax increased faster than GA. Furthermore, salary & wages and business income grew strong as well. Interestingly, real estate taxes fell faster than the state of GA. I note to research later for the zip code to understand why real estate taxes are falling almost double that than the entire state. Overall, some of the factors that ‘underperformed’ are something I can live with, but the favorable pricing for this zip code outweigh the demographic negatives. So, I will focus the rest of the analysis on locating a property in 30067.

30067 zip code.png

As I look on the map, I can note several cities that have done well over the past couple of years and understand the potential story for that area to potentially grow and enhance my return. In addition, I note that additional construction for the new Atlanta Braves stadium will go up near the area. Over the next couple of years, many potential catalysts could exist for rising prices. In the next couple of posts, I’ll explore some of the more local-based research to find the right properties quickly.

Summary

Using the previous analyses, we have now selected a zip code we will focus on. There has been a lot of subjective input I have put in to decide the location, but always remember to test the strategy and assumptions during due diligence.

Risk Management: Key Ratios

Objective

In the last post about general demographic information on a zip code level, we discussed different ways to screen for potential zip codes based on a breadth of factors. Another critical component of screening is to locate properties in locations where you avoid getting burned on the actual deal. Focusing on individual deals is time consuming; therefore, in order to drill down the total number of properties you need to look at, we need to examine where we are more likely to find better deals.

Risk Management 101 – Ratio Analysis

There are many ratios out there for evaluating potential investment opportunities. One of the more common ones you may hear in the news is the Price-to-Earnings (P/E) ratio for stocks, which represents the current market value of the company relative to that company’s the net income. The benefit of these sorts of  ratios is that they allow us to understand an investment is expensive or cheap.

For example, lets say the long-run price-to-earnings ratio for the whole stock market is around 15.0x (meaning the price is about 15 times the net income of the company). If stock A has a P/E ratio of 16.0x and stock B has a P/E ratio of 14.0x, assuming all other factors are the same, an investor would more likely select stock B because it is “underpriced” relative to the stock market’s long-run P/E ratio of 15.0x. While there certainly many other factors you would need to analyze, the ratio helps give you a starting point so that you are not researching positions that are possibly overpriced to begin with.

In the same way we look at P/E ratios for stocks, we can adapt the same logic for residential real estate. Two of the key multiples we can look at include:

  • Price-to-Income (P/I) ratio:  the ratio of the average home prices to the average personal income.
  • Price-to-Rent (P/R) ratio: the ratio of the average home prices to the average rent.

Note: the averages may be replaced with the median as certain investors believe it is a better representation of centrality for a specific zip code. For the purpose of this analysis, I have utilized average numbers. 

In order to acquire the data, we can acquire the average home price and household income data from the moving.com analysis per my previous post. The average rent figure is a bit more difficult to look at given the ever changing nature of local rent and aligning housing characteristics (such as the number of bedrooms or bathrooms). In order to acquire the information, I went to the MyApartmentMap website. Below, we can type in the zip code of the areas we are looking at:

Website - 1.png

After selecting the zip code, select the “rental data” link at the top of the page:

Website - 2.png

Finally, we can see the average rental rates for studio, 1 bedroom, 2 bedroom and 3 bedroom apartments.

Website - 3.png

Once this has been applied to all of the zip codes, we can compare the average P/I and P/R ratios. For the purpose of this analysis, I looked at both sales price relative to 3 br and 2 br rental prices. Using the same color scale as before, we can separate the good from the bad. Remember, we are looking for ratios below the median of all the ratios, which is an indicator for “underpriced” homes.

analysis

As you can see, this analysis will provide a conflicting analysis with the previous two posts. The reason for this is that growing jurisdictions (such as 30342) may be overpriced (an indication that the market has peaked and prices will soon start to fall). If, as an investor, you believe that the specific jurisdiction will keep growing, then the ratio analysis means less and less to you. However, to take a more conservative approach, picking from underpriced homes helps you find areas where prices still have room to move north.

However, be warned when selecting properties only based on the multiples, because they may also indicate that prices will keep falling in that respective zip code. From lessons learned in 2008, catching a falling knife can burn your investment portfolio. After the screening part of your investment due diligence, always remember to do a more detailed dive into the specific property (we will review this in later posts). The aim is to layer the initial analyses on top of the multiples research and find the best risk-to-reward ratio based on your investment profile.

Now, how else can we use this data? As the Great Recession has taught us, the economy moves in cycles. If we compare these multiples to historical data points, we can see when the market starts to become more overheated. Review this Investopedia article for more information on the P/I and P/R ratios.

Conclusion

Being able to analyze the macro trends in the housing market allows individuals to smartly filter through different zip codes to find the best potential deals. Risk management is an essential component of any investment portfolio, real estate is certainly no exception. In the next lesson, we work on combining the research from the past couple of days and reducing the number of zip codes we are looking at from 27 to 3.

Screening for Residential Real Estate Investment Opportunities – Part 2

Objective

In my last post about Screening for Investment Opportunities, I discussed a zip-code approach utilizing IRS data trends for the past few years. Looking at the same geography, I wanted to post another method to quickly compare different zip codes by using current, demographic information.

Zip Code Level Data via Moving.Com

Many websites focused on various aspects of people moving will offer information services so people rely on them as a one stop shop. One particular website – Moving.com – provides easy-to-access demographic information for zip codes across the US. Clicking the link above will take you to a screen shown below:

Moving.Com image - 1

As shown above, you can type in the zip code and click “Get Report” to access the information below:

Moving.Com image - 2

While this is just a snapshot of the detailed information, the different sections presented include:

  • Demographics
  • Income and Jobs
  • Ethnicity
  • Education
  • Climate
  • Crime
  • Residential

I used various data points from these pages across the same zip codes used in my previous post. I compared the data to National figures and the median of the selected zip codes as the benchmark and came up with the following screen below. The “Value” column aggregates the number of times each zip code ‘outperformed’ the national benchmark and the median of the zip codes (a total of 2 points for each factor). While this method is very generic, potential investors may feel the need to experiment with their weighting schedule if they feel certain factors are more important than others. Weight based on your gut instinct, if you don’t know how important something is… research it.

I utilized the same tranches as before: (1) Green – High Growth, (2) Yellow – Potential Growth, and (3) Red – Low Growth.

First set of factors:

Analysis - 1

The second set of factors and the value for each zip code are below. Keep in mind, the specific zip code will of course not “outperform” the national index when it comes to factors such as Homes Owned and the number of Graduate degrees (above). Using my formula, the same logic would be applied to all of the zip codes, so we can ignore the impact of this hole in the analysis.

Analysis 2

For comparability, we can look at the map to see where the zip codes lay:

Map of GA

Now that we have two data sets of analysis for the zip codes I am interested in, I can begin to dive deeper by focusing on what type of risk do I want to take, what is my investment horizon, what are the trade-offs between these zip codes, what sort of return am I looking for (note that the return question comes after your risk management questions), etc. We can also compare the analysis from the IRS data we analyzed earlier to see the overlap between the two data sets.

Conclusion

Now that we have looked at the overall trends, we see there are certainly some zip codes that have historically outperformed others. As always in finance, you have to remember that the past is no indication of the future. The next step in the analysis that we will explore over the next couple of posts focuses on risk management techniques.

Screening for Residential Real Estate Investment Opportunities

Objective

The first step in any search for investing is to screen the prospective properties to invest in. An immediate impulse is to jump to Trulia or Craigslist in order to find potential opportunities, ignoring the trends for the specific property. The first objective in locating a suitable investment involves actively screening for areas by finding key trends, including:

  • Increasing home values
  • Stability in value
  • Low crime
  • Good schools
  • The right tenants

While this list is certainly not exhaustive, the purpose of screening is to find general areas that make sense, before you jump in to locate the best deals.

Zip Code Level Data via the IRS

One potential way to search for certain trends is to utilize IRS data on a zip code level. The IRS collects and distributes certain data points collected from everyone’s tax returns. Click here to access the website.

Once you click the link above, you will be directed to the following page, you can locate the tax year(s) you wish to use in your analysis:

IRS Website.png

As you can see, the data is only available through 2013, so the analysis will not be as up-to-date as we would like it to be. However, the data allows us to gain a sneak peak into such factors as:

  • Tax revenue growth
  • Unemployment trends
  • Salary/Wage growth
  • Business income
  • Dependents

Each of these factors can be compared to general rates in the state of Georgia (per my example below). For example, a recent search I performed was focused on finding potential zip codes to focus on in north Atlanta. Here is the map I focused on (created with ZipMap.Net):

Map of GA.png

I decided to look back for a period of 5 years to see the growth of each of the zip codes since the bottom of the Great Recession in 2008-2009. I downloaded the information, created a small model for myself to look at the 4-year change through 2013 for a number of different factors listed below (I have used a couple of acronyms, feel free to ask if you cannot decipher any of the data points). The zip code “00000” corresponds to all of GA:

Data Set 1Data Set 2

While there is certainly additional information I could have included, this is a quick way to see potential opportunities before diving in deeper. With the data, I looked at each of the respective zip codes versus the state of GA and calculated the number of times each zip code outperformed the state as a whole (using a simple binary system illustrated below). After, I separated the zip codes into three tranches: (1) Green – High Growth, (2) Yellow – Potential Growth, and (3) Red – Low Growth.

Summary of Findings.png

From here, I have a list of potential zip codes I can focus on, instead of blindly looking for deals. Of course, we want to drill down a bit further once we have refined our focus. Follow me on this blog and I will explore different points of analysis that we can incorporate.

Summary

The IRS data can be a powerful source of data to locate trends within zip codes. It helps to find investments by locating increasing tax revenues in certain jurisdictions, information about the jobs and businesses in certain areas, and the type of people moving in versus moving out (i.e., increasing SSI benefits may indicate more retirees moving in and more stable sources of potential investment income). The trick is finding the data and revealing the story that is screaming out at you.

 

First Post

My Mission Statement

I found it interesting when I hear individuals seek out real estate investment income, but have yet to taken the first step. Given the amount of fake gurus and real estate experts out there, the entire process seems futile and out of reach. Some of the marketers out there also set you up for failure, charging thousands of fees with little to negative returns. Furthermore, the focus on short-term income (via “flipping” or option investing) has detracted our focus on retaining a conservative approach.

The purpose of this blog is to provide an ordinary person’s perspective on how to research and find potential real estate investments that work in the long-term. I do not claim to be an expert, because I’m not. I do not claim to have the inside scoop, because I surely don’t. I’m not trying to sell some nebulous formula to success, because I am working on making it as well.

So why read what I have to say? There is not a lot of educational websites that give information on how individuals can use public information to research potential real estate rental property investments. The problem I have found is navigating through government websites, real estate websites, and various other sources of information.

I want you to join me on my journey of navigating through the weeds and reveal different ways to research the market. I don’t plan on using any special or proprietary software, just a good old spreadsheet and the internet. I am happy to learn where I may be going wrong, because I only hope to improve as I blog.