Why Some Places are Great to Live but Bad to Buy
What makes a city the perfect place to live?
Affordability, a healthy job market, low crime, nearby schools and universities, and quality of life are typically a few characteristics one would use to describe an ideal place to call home. For years, New York City, Los Angeles, San Francisco and Chicago were a few of the most popular cities that fell under this category; and for a period of time, these were prime locations for certain commercial real estate investments, as well.
However, as these large metro areas have grown, they’ve struggled to keep their infrastructure that once attracted residents and have become overpriced and overcrowded.
Because of this, there’s been a steady shift in popularity towards secondary and tertiary markets. Many people are no longer focused on the sole attraction of living in a large city, and are instead looking towards suburbs that offer more space and a better lifestyle for a more affordable price. Factoring in the pandemic, the migration pattern has only accelerated, sparking newfound investor interest in more suburban commercial assets. Many investors have found that by shifting from primary markets towards lower cost locations, they can purchase similar assets for a significant discount. Plus, as more residents flood to these markets, rising rental rates will result in higher returns, making them more attractive than ever.
Is there correlation between great places to live and buy?
Though population growth is something to consider with each commercial real estate investment, it doesn’t entirely predict where your next investment should be, and it really depends on which type of asset you’re looking to acquire. It’s also important to note that the market is ever-changing, so it’s important to thoroughly evaluate each location before jumping into an investment solely because of a city’s rise in popularity.
Chances are, if it’s already become a great place to live, you’ve missed the window to invest. Instead, try focusing on cities in surrounding areas that show the potential for popularity and increase in demand.
At Excelsior, we follow these 7 data points when looking for markets to invest in:
- Population growth
- Job growth
- Wage growth
- Access to quality education
- Affordable housing
- Rising rental rates
- Discount to replacement costs
These data points have led us to find our niche within certain areas in the Southeast and Midwest; a few examples being Kansas City, KS; Richmond, VA; Nashville, TN; Cincinnati, OH; and Southfield, MI.
Where to Avoid Investing in Commercial Real Estate
Areas with little to no job growth combined with negative migration trends might seem like obvious places to avoid, but investors are often distracted by the high rate of return in these locations.
Let’s take New York City for example–
Prior to the pandemic, the opportunities and jobs available were endless. People were continually drawn to the city and were willing to pay the steep costs associated with living there. So you may wonder, if the city had been growing at a significantly fast rate for years, why not invest there?
Commercial real estate assets in New York City (and many well-known cities) can provide a higher return, but aren’t always worth the risks that come with these investments. There is an important concept that goes along with this called a risk adjusted return, which simply put, is adjusting returns based on the risk before making a decision to buy. From a taxable investor’s standpoint, if you are looking to have a return profile expectation of 8-12%, a large metro is probably not the right fit.
Cities that are growing at an exponential rate don’t have the stability that smaller cities have to offer…nor the safety, quality of life, affordability, and other factors you should consider when looking at properties to acquire. Stability is one factor that investors have valued more than ever with the COVID-19 pandemic. Now, they are turning away from seeking these higher, short-term returns and gravitating towards longer, reliable investments, which are hard to find in cities like New York.
Then where should I look to invest?
Similar to looking for a place to live, it’s just as important to have a list of qualifications that must be met when looking to buy commercial properties.
At our firm, we look for markets that provide residents access to both affordable housing and quality public education- while also having a high quality of life attached to them. We look at diversified economies that maintain government, university, healthcare and professional services presence and do not rely on one type of industry to support the metro — More specifically, sub-markets in these areas with price appreciation, millennial populations, population growth and a strong job market.
The Bottom Line
While the criteria for a great place to live varies among each individual, most commercial real estate investors would agree that places with growing economies, that have the potential to generate returns, are considered ideal investment locations.
It all comes down to being able to identify cities that encompass characteristics crucial to the success of your type of investment.
If you are interested in learning more or have any questions, please do not hesitate to contact us.
Among the myriad of data points available, there’s two that stand out as key indicators of profitability: Internal Rate of Return (IRR) and Cash-on-Cash Return.
In the world of alternative investments, few sectors have garnered as much respect for their stability and long-term appreciation potential as commercial real estate.
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