Picking a Market
This playbook was the sole reason why I was able to accelerate to 5k/month in cash flow income. It neutralized my fear and gave me immense confidence to jump in.
As a result, I had no hesitations in moving fast because I knew the blindsides were covered.
PS: Don't have time to read the whole playbook? Just get the framework to your email!
What’s the goal here?
This playbook explains how to pick a rental market per your strategy.
Picking a strategy is a prerequisite to using this playbook.
For the purposes of this playbook, I am going to assume your strategy is to buy and rent with the motive of building passive or cash flow income.
If you do not know what your strategy needs to be, I wrote a post about it here
Playbook teaches a framework I built using my experience at my W2 job, creating frameworks for fortune 500 companies and compressing the knowledge gained from tons of research,
This playbook is also distinct in that I have years of experience analyzing data and breaking down many variables into digestible and actionable output.
I also ran experiments with other W2 earners doing REI for months to understand the gaps. Finally, I did days of due diligence to verify the data sources were credible.
Unlike other posts on my blog related to quick hacks, this playbook is an outcome of a rigorous methodology consisting of experimentation, data collection, iteration, pivots, and other qualitative factors in quest of continually de-risking my investments while looking for high potential markets.
In short, I have spent weeks and months so you don't have to.
If you're skeptical of advice like I am, then use it with a grain of salt. I am sharing the framework that works for me. Ultimately, it’s up to you how you pick your markets.
I will try to make it as simple as possible to understand but please tweet at me if you have any questions or suggestions so I can keep improving it.
Who is the audience?
Anyone looking to build passive income through rental properties in markets providing high yield a.k.a cash flow.
What you'll learn
Right now you might have anecdotal evidence to work with - this playbook will remove layers of abstraction and present you with logical reasoning in picking a market.
The playbook is divided into 4 parts
Part 1 - What indicators to look for in a market and why?
Part 2 - How to find the data for those indicators for a specific market?
Part 3 - Qualitative factors to add to your quantitative analysis
Part 4 - Finding micro-markets in the MSA to be able to start analyzing properties
I’ll add a cheatsheet at some point in the future, but I propose taking notes.
Doing so will help you make meaning of the information. A lot of content out there will provide information but not explains what it means.
Taking notes will help you think and understand better.
But we won't get into neuroscience here 🙂
Part 1 -What factors to look for in a market and why?
What is a market?
Market is a very subjective term and is used to denote a variety of dimensions for business like target audience, geography, etc so it is important to align on what we mean by it here to avoid confusion. When I say market I am targeting
A metropolitan area like a city, town or a county.
Real estate is very sensitive in some regard and can change from block to block so your analysis purview needs to be as small as possible on those sensitive factors. This means we cannot start analyzing a whole state like South Caroline or Florida etc.
We need to go narrow and deep at the county level at least. A larger area than that is too big and going narrower than that like at the zip code level becomes challenging because the data is not easily available for anything smaller than the county or city level.
What is market analysis?
It's important to learn about a market before choosing any rental investments. Before starting, assess whether your market is suited for three things:
✅ Your qualitative goals
eg - Do you want a lot of money or more time through real estate? Do you want a low-headache tenant pool?
✅ Your quantitative goals
eg - How much money will be enough for you?
✅ Your risk tolerance
eg- You can make more money in lower-class hoods but can you handle the risks associated with crimes, non-paying tenants, etc?
I'll blow it out with my own example later.
A Common Confusion
What’s the difference between a housing market and a rental market?
Housing market = People who buy/sell real estate. Usually, people buy either to live in it or to rent it out as a landlord
When you read articles and reports online about the housing market, I caution to let it affect your long-term strategy or even emotions. It says little about the rental market.
As an investor, it only affects what price you can buy or sell a property at.
But if you are thinking of flipping or doing BRRRR type stuff, then it would definitely affect your strategy because you would need to sell it after the work, and the housing market factors would play a part.
If the market is a seller's market, then you can command higher prices for a property and if it is a buyers market, then you can buy new ones for cheaper prices.
No one can time it!
On the other hand,
Rental market = People who rent. If the market is growing, there is more demand for renters and vice versa. You can command higher rents especially if the supply of rentals is low in an area.
In short, analysis of:
Housing market = buy or sell price potential
Rental market = Rent potential
This playbook mostly talks about how to pick a rental market but overarching factors could still be used to gauge the potential energy of a housing market.
My example - What indicators do I look for?
My quantitative goal for financial freedom is to get to $20k/month after-tax income.
My qualitative goal is to be completely passive and I also like working on my own
My risk tolerance is somewhat high so I use a lot of data and try to dilute risks at every step of the way.
So at an aerial level, I personally look for 5 conditions to be met when analyzing a market.
Cash Return is high =
- A market where I am seeing current rent > total expenses
Risk is low =
- Rent will be > expenses in the future also
Side note on risk:
No one can mitigate risks completely. You can only plan for "oh s**t” scenarios.
You have to build risk mitigation into every layer of your investing strategy and not just at the market level.
At least a few diverse industries
- if you went into Detroit during the auto industry collapse, you would have been hit hard. It is imperative to have multiple industries and companies sharing the jobs.
Get long term loans
- If you are buying in an LLC, you want to add long-term loans as another criterion as commercial loans might have a balloon at the end. Pick lenders who don't!
- I get 20 yrs in term
Have Cash reserves
- I keep at least 6 months of expenses(Mortgage + Interest + Insurance + Capex + Repairs + PM + any utilities) in the bank
The above 5 rules are fundamental to me to ensure income potential stays high and it also builds a solid defense against external forces of economy and market.
I also look to add tenant quality as core criteria because I want to be totally passive and as a W2 earner I do not have time to deal with noisy tenants
Bonus is good tenant districts tend to appreciate more as the data shows
In short, my framework boils down to 6 factors
✓ Buy in areas with forecasted rent demand growth
✓ Buy for cash flow
✓ At least a few diverse industries
✓ Areas with good tenant quality
✓ Have the cash reserves
✓ Get long term loans
Keep in mind, its very hard to find good tenant districts with very high cash flow potential and you need to analyze many markets till you find one.
Risk mitigation strategy in a slide
When I said earlier, risk mitigation needs to be built into every layer, this is what I meant ↓
P.S - Point is not to take a risk at all here. It is to take calculated risks!
Without risks, we can’t progress fast - I guarantee that!
Time to jump in the framework and make our understanding 3D!
Part 2 - How to find the data using the framework?
Here is a snapshot of the framework!
Action: Take a minute and orient to it.
A couple of important factors before we jump in
- It’s a relative analysis framework
- If I only looked at one market I wouldn't know if it is a good market or not but as I add more markets I see the comparison forming a picture of the best markets. So more markets you analyze the better the scoring.
- Catch 22 between strategy and market Analysis
- The markets you choose to analyze again would depend on your strategy, goals, and values. Alternatively, you can choose to select some markets and analyze them to see if you need to tweak your strategy a bit.
- eg - If you only started with an analysis of an area within driving distance and you are not finding it to be a strong market, then you can choose some remote markets to analyze and if they are strong, then you can maybe add remote investing to your strategy
Here are my criteria again for a refresher,
✓ Buy in areas with forecasted rent demand growth
✓ Buy for cash flow
✓ At least a few diverse industries
✓ Areas with good tenant quality
✓ Have the cash reserves
✓ Get long term loans
1️⃣ Buy in areas with long term rentability
Applying the basic supply and demand law of economics, we want to ensure the demand is greater than the supply of rentals in the market now and long term so rents stay high and vacancies stay low.
3 factors that play a part in determining demand:
- Population Growth - If people are moving there, they will need housing. Look for:
- Historic Growth - It tells me if more people have been moving there.
- Forecasted growth - There is no easy way of knowing this but this is where I highly urge you to google keywords like "Forecasted Population growth in [area]" etc. The more you read the lesser your fear will be.
- Job Growth - If there is job growth, more people will move there and hence need housing.
- Look for:
- Historic - Has employment been growing in the area?
- Forecasted - Like population growth, there is no easy way of knowing this also and I highly urge you to google keywords like "Forecasted job growth in [area]" etc.
- Rental Change - We can also look at the rents. If they have been increasing that’s a good sign demand is outlasting supply.
- Historic - 3-year trend of rents should be sufficient here.
- Forecasted - If there is population and job growth forecasted, then we can with some certainty say, the rents will continue to grow
2️⃣ Buy for cash flow
Find an area that gives enough in rent that you can cover ALL your expenses
Some people are lucky to be in a market, where the property prices are low and rents are relatively high to be able to achieve a decent cash flow.
A lot of us are not so we have to look outside of home areas.
There are a bunch of books written on this topic of remote investing. I have personally tried looking to invest remotely but ultimately I decided to find areas within drivable distance for two reasons:
My decision was anchored in fear and in lack of time since I personally want to be able to know the market in and out and without being there, fear always came into the picture slowing me down
I personally think if I had a trustworthy property manager, then I would have pulled the trigger to invest remotely
It is a catch 22 though because to build a relationship and vet a PM, you need properties for them to be managing.
My recommendation here would be if the market you live in is not cash flowing, then find an area within driving distance and start there first even if it means lower returns for the first couple of properties till you learn and systematize.
Rule of thumb: It’s a well-known rule that if the rent per month is around 1% of the purchase price, then the property is most likely to cash flow.
I reckon it all depends on how you are able to decrease your variable costs and if you are able to compress them then even, .7% works like in my case.
The framework takes into account the data on monthly gross rents in the area you are analyzing and the average house value.
Both are taken from the census.
A caveat: If you find that an area is not around .7%, then don't just completely reject it. Go into Zillow and search through different properties for sale in different neighborhoods of the main area.
Check the Zillow estimate for sale and for rent.
You might be able to find pockets where the condition is met.
3️⃣ At least 5 diverse industries
This is self-explanatory but I am surprised how many people miss this filter.
We want to avoid areas with a couple of major industries and companies.
There is a cool resource you might want to check out - https://datausa.io/
Once you search your city, you will be able to see the industries under the economy filter.
4️⃣ Pockets in your main market with good tenant quality
As a rule of thumb, the better the tenant area, the lesser the return, and vice versa. Better tenants want to live in nicer properties in nicer areas, which means higher purchase prices and higher taxes so the returns get lower.
This criterion is very individual and I chose it because I was able to find a market where I can find good tenants without compromising on the return. But more so, I don't mind lower returns for lower headaches so I can focus on buying more and make up the lost return in the volume.
Good Tenants = tenants who pay rent on time and are financially stable
Many factors play a part in defining what kind of tenants desire a specific area. Here are some factors to consider
- If there is a university nearby, rentals will attract students. Parents pay the bills here :) but might come with headaches/liabilities of party students
- Downtown areas attract young professionals because of the restaurants and bars
- Good school districts attract responsible families. They stay for long and pay rents on time.
You can completely choose to skip this section and play around with the framework. It is just a deeper dive for the audience who is not familiar with Excel or Google Sheets.
- Since there are many factors to consider in a market I have divided them into two groups
- Must-haves(in purple) - I reject a market if one of these factors is not good. Eg - If population growth has been negative, I do not even go ahead.
- Nice to haves(in Blue) - I look at them as garnish and not something that is part of the main recipe. They are good to know factors that help decide better when two markets are close in their score.
- I have also put some sample markets in the columns to better clarify
- As I mentioned above, one market on its own won’t give a good picture. The output gets better with more data.
- I have left comments in the cells on where to find the data for a specific factor with specific links
- Rows 21 and 33 and All the "Rank rows" are formulas. So as you add more markets you would have to use the hold and drag function to insert the value.
Instructions if you are starting from scratch
- Do a search on Google for "top cash flowing rental property markets 2021"
- If you search for just 'top rental markets' you will get subjective answers. We are looking for cash-flowing markets.
- Read at least 10 articles from credible sources that are based on data
- Extract markets that are commonly mentioned in those articles
- Eg - I am finding Memphis, Atlanta, Cleveland, Baltimore on these lists time and again
- Open the framework
- Go to an empty column and type in the name of the market in row 3
- Start with the purple factors first as they are the most important
- Before you start, please note that you can either find the data at the MSA level or the county level, or at the city level. The more you are zoomed in on the geography the better the analysis but sometimes data is not available like that so you have to use one of the other two as a proxy
- Eg - If I am trying to find population growth for Conyers, GA, data might not be available so I can look up the data for covering the county, Rockdale, instead.
- In population growth and job growth,
- Google search for forecasts and ensure the number of articles is saying there will be population and job growth growth
- If you want to take it to another level, Google CAFR [Area] and read the report on population and job growth.
- eg - https://www.northamptoncounty.org/FISAFF/FINPLANCTRL/Documents/Quarterly%20Statements%20-%20Unaudited/2020%204th%20Quarter.pdf
- If more articles are saying there will be population and job depletion, reject the market for now and move on.
- I have dropped the links to find the data for the last 10 years
- Just change the city in the link and enter the values
- In rent demand,
- Again go to the link in the comments and change the city name. There will be a table showing a 3-year trend for rent.
- Just simply enter the number here.
- Cash Flow Potential
- Go to links and change to your market and enter the values for Median Gross Rent and Median Home Value.
- Then drag the formula to see the rent to price ratio
- Ideally, this needs to be more than .7 but note that it doesn't have to be. There might be pockets of areas in the area you are analyzing where house prices might be lower. Real Estate prices are very sensitive and can even differ from block to block in some cities. It is just a matter of digging in more and finding those smaller pockets- Zillow is your friend.
- Go to the link and find the market you are analyzing.
- Scroll down till you see industries in the market.
- If there are more than 5 industries and none of them have more than 20% share, enter 1. If there are more than 5 industries and one of them has more than 20% share, enter 2 and so on and so forth.
- Drag the rank row out for every factor so you can see the rank
- Drag must have and nice to have score row, till you see a score.
Repeat to de-risk
Do this for more than 8 markets. Yes, you read it right. 😀
I recommend doing it for
- Two markets in the south
- Two markets in the mid-west
- Two markets in the northeast
- Two markets within 4 hours of driving distance
- Markets where you have some close family or friends
Once you have scores calculated.
The market with the least "must-have" score is the strongest
Numbers only tell part of the story,
You want to combine this quantitative analysis with some qualitative analysis and build a gut feeling.
Part 3 - Qualitative Analysis
Main MSA(Metropolitan Statistical Area)
✅ Research Google " [Area] rental market" Read as many articles as you can especially from local agencies
✅ Go to Google and type in "biggerpockets [area]", this is a simple trick to search within a specific site. Discussions if any for the market should show up"
✅ Look at Zillow home values and forecast
✅ Look at realtor trends
✅ Look at Redfin
✅ Landlord Friendly State - This would be easily available on Google.
Part 4 - Finding sub-markets
Real estate markets are hyperlocal. Tenant pool and prices can change from block to block so it is essential to gain intricate knowledge for risk mitigation.
Assuming you have identified a strategy and an MSA market from following Playbook 1 and Parts 1 - 3, this is where we start zooming in.
MSA stands for Metropolitan Statistical Area. Think of it as a one large area spanning across handful of counties and sometimes even cities
There are around 400 MSAs in USA.
Our goal is find areas of the MSA that attract good tenants and still give us a good cash flow.
If you are doing this full time and do not mind tenant head aches, you could just for only cash flowing areas.
Otherwise, you will find that in areas of quality tenants, your cash flow is lower and vice versa.
We have to find the hoods with the sweet spot where there is good cash flow with decent tenants.
The white whales so to speak!
What is good tenant quality
Definition of a good tenant is subjective. It depends on multiple factors like relationship status, kids or not, median income, type of employment(blue collar or white collar)
After experiencing dealings with 40 odd tenants over sometime now, I found that tenants with kids are the most stable and responsible.
There would be other types of tenants that could also make for a good tenant pools but it would be beyond the scope of this playbook for now.
As a starter, lets keep it simple and safe and go for hoods withs school ratings of average 5 at least across all divisions.
Finding cash flowing hoods
So how do we find sub markets at an aerial level where we might get decent cash flow.
Eventually these are the only areas for which you will set your filters on.
Schools are easy - data is available on major platforms but how do you find the areas where cash flow might work so you are not analyzing non relevant properties all day long.
There are two two options.
Option 1 - Free - Use Zillow since it gives a projected rent for a property.
I like this option
- Its free. Paid tools charge a monthly fee and you will not try to find markets every month.
- Credible because Zillow is one of the platforms used by landlords to list their properties so they have direct access to rental data.
Caveat is that it is a bit more work but to me it is a net positive because of the credibility of the data itself
Finding good school districts first
- Easiest way I have found is using realtor.com or redfin.com since they have a good school filter.
- After you identify districts with good schools, you would have to flip to Zillow because they provide rent estimates.
Lets says we find that Conyers, GA has schools >~ 5
- Now Change the 'For sale' Filter. Only select
- By Agent
- By Owner
- Change the home type. Only select
- (If the numbers work for these, then they will work for other home types)
- I usually only go for 3 bedrooms
This will narrow down properties for sale in Conyers
- Click on a few of them and pick a property in the middle pricing range
- See the rent/asking ratio. It needs to be ~.8%
- If its < .8%, then find cheaper properties in the area, where the ratio ~ .8% or more.
- Run numbers on a couple of properties using your analysis framework(See playbook 3 if you do not know how to analyze a rental)
- If you are finding cash flowing properties then congrats you have one hood selected
- Repeat the process for other hoods around Atlanta where schools have average rating of at least 5
Before you settle on a market. There are a few more angles to de-risk for long term.
✅ Check the Crime rate and schools
- Realtor provides school and crime overlays on the maps.
✅ If a remote market, go to Google street view and browse the streets and landscaping around the properties.
✅ Check niche.com and read through the neighborhood forums
✅ Check Google Maps for where departmental stores, hotels, office parks and transportation is. People like to live near those amenities.
✅ If an area has more owner-occupied homes, it means the neighborhood will be well taken care of and fewer rentals will mean more demand.
🎊 Two amazing hacks
- Look for rentals in the area on Zillow and scroll down on a rental listing till you see # of views and contacts. More the contacts and applications, more the demand for rentals in the area
- Check out this cool resource. Above resources will give you data but the below resource will tell you meta information about a hood in a cool way.
And that is it!
If you read through the whole playbook, I believe you are doing to do great in REI - It shows commitment and nothing can replace the hustle as the main factor in achieving success. 🙌🏼