You know the saying can’t see the forest for the trees?
I always thought it was kind of dumb. The trees literally are the forest, so if you see the trees you see the forest!
But now that I’m old and wise, I get the point. It’s about stepping back and seeing the bigger picture. Don’t take it so literally.
The most common question I’m asked is what is the best city for a rental property? I worry that everyone who asks might be missing the forest for the trees.
The Best City
Of course you want the best. You saved up twenty thousand dollars for the down payment and want the best possible returns. What’s so wrong with asking for the best?
There is an assumption built into the question that there is one city that is the answer.
The best city for you depends upon your goals. What is more important, cash flow or long term wealth? How active or passive do you want to be? At what price point are you looking to invest?
I would much rather you ask, what are the top cities I should consider given my goals? Not just one, but several to compare.
Learn How to Fish
You should be able to evaluate the cities yourself because things change over time. If you wanted to know the “best” in late 2009 and I said Dallas, does that still hold in 2016? Nope.
No matter what answer you get, you need to be able to verify whether it is correct. And when you save up your next chunk for a down payment, you need to evaluate whether the last city is still the best option.
It’s the whole “Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”
The Most Important Factor for a City
Work, work, work, work, work, work!
It’s all about jobs. They feed population growth, which increases the demand for housing.
When you dig into the jobs in a specific city, you want to see many different industries and think about how they respond in times of turmoil. Tourism isn’t exactly recession proof, but big medical centers are.
Specifically, how easy is it for those jobs to move elsewhere? Transportation hubs likely aren’t going anywhere. I also look for a big corporate presence, including headquarters, of established Fortune 500 companies in low cost cities.
You want to see some job diversity as well. That is the issue with more remote towns, if the one industry declines for some reason, you don’t want to have all your eggs in one basket. There was a real estate boom in North Dakota based on excellent job growth in the oil and gas industry, but those aren’t looking like sound investments now.
To sum it up – we want a growing number of jobs during the good times and stable industries for the bad times.
Where Are We in the Cycle?
It generally takes 7 to 10 years to get from the bottom to the top of the cycle. And the same back down.
Some places are affected by this cycle more than others though. A ‘boring’ city like Indianapolis will be able to return a steady cash flow even at the top of the cycle when things are their most expensive. However, for states like Texas, Florida, and Arizona the numbers only work when we are at the bottom of the cycle.
If we are within 1 or 2 years from the bottom of the cycle (either before or after), it might be a good idea to look at places like Dallas or Phoenix – they will cash flow and have greater potential for appreciation.
Otherwise we can eliminate a lot of those cities from our search. During the vast majority of the cycle, we should look at the more boring cities.
Does it Make Sense to Buy at the Top of the Cycle?
If the numbers work for the property to still cash flow, yes. But we should also consider that there is potential for the rent to drop a little.
In the boring cities, I believe we shouldn’t just purchase at the very bottom of the cycle, but during most times. I don’t pretend to be able to predict when the up slope will end. I don’t think you should either by keeping your money on the sidelines (or in the stock market, which has it’s own cycles as well).
When it does hit the top, it might be a good idea to wait a year or two for prices to go down before purchasing. This means still purchasing 90% of the time throughout the cycle.
I am more concerned about the gains over 15 to 20 years rather than the appreciation potential over the next 2 years. If you are trying to precisely time the market, you might be missing the forest for the trees.
Do you feel there is one best market? How important is timing to you?