Investing in anything is all about timing. Real estate is no different. Yet, many real estate investors operate more on a gut feeling than on economic indicators. That doesn’t need to be the case. Like other investments, there are key indicators you can use to make reliable decisions. And when these indicators align, you can be confident you are making an excellent investment. When all these indicators align at the same time, we call it a perfect storm, and we become buyers. If even one of these indicators is off, we act with caution.
You will note that we ignore the one thing that most investors focus on the most, the direction of prices. If the below indicators are all positive, we don’t have to worry about the price. We know with near certainty that a property bought under these conditions will be a good buy. It will generate wealth beyond expectation over the long term. We like the long game.
1. Rents are rising
The first indicator to look at when purchasing rental properties is the rental rates. If rental rates are falling, it is a sign that there is either to much supply or not enough demand. If either of those two things is true, you need to make sure you are buying exceptional properties. You also need to make sure that you have some room built into your projections for lower rents. If a 10–15% reduction in rents would cause the property to lose money, don’t buy it. If rents are rising, it indicates demand is high, or supply is low, both good things for investing in real estate. Increasing rental rates show an active or strengthening real estate market. That’s a good thing.
2. Employment is steady or growing
Employment growth is a positive sign for the economy. It creates demand in the housing market, it encourages net migration, and it leads to rising rents. All good things for real estate investment. Negative employment numbers can be a sign that things are going wrong. And when employment is struggling, so does the housing market. Rental rates will likely fall due to lack of demand, and bad things can happen. In markets where employment is not steady or growing, you want to avoid investment. At least until things turn around.
3. Net migration is positive
Positive net migration is a sign that things are going well in an economy. It means that people from elsewhere see a future in your marketplace. If that is the case, there is going to be a higher demand for rentals. Most people choose to rent when they move to a new city before they buy. They want to get the lay of the land. If you own property in desirable areas, this can be great for your portfolio.
4. The housing market is affordable (<45% )
This one is often overlooked but is essential. Before you invest in any real estate market, it is critical to determine if it is affordable. Affordable markets have less than 45% of household income going towards housing expenses. Anything more than that and the market is headed for a correction. When you invest in a housing market that isn’t affordable, you are speculating. When you speculate there is a good chance you will see your net worth shoot past zero on the way down. Unless of course, your timing is perfect. But how many people do you know that have ideal timing? Few, so only buy in affordable housing markets.
5. Properties break even with 20–25% down payment
Last, but not least only buy in markets where you can put 20–25% down and break even. If a property breaks even at this loan to value, then you ought to buy it. If it doesn’t, don’t. Buying properties that lose money is speculation. See point four about what happens to speculators.
If you are in a market where all five of these indicators are true, we recommend you invest in real estate. If you aren’t we recommend, you either wait or look for a market where they are true. Either way, if you buy a property in a market with rising rents, positive employment growth, positive net migration, affordable housing costs, and where properties break even with a 20–25% down payment, you will likely do very well.
