The Real Estate God

Pick Markets Where You Can Actually Find Deals

I get asked all the time “how do you choose a market” & to be honest it’s pretty simple Instead of approaching it from the statistical perspective, I approach it from the “can I actually find a deal in this market” perspective Here’s how I choose a market to invest in: First let’s talk about how institutions look at deals & why it doesn’t make sense to look at deals that way as a smaller investor Way I see it, there’re 2 strategies when choosing a market 1. “rising tide lifts all boats” 2. search for dislocations/discounts Strategy 1 is used by institutions who need to deploy a lot of capital This involves them playing “economist”. They need to find markets with high population growth, rent growth & appreciation They operate in a competitive segment of the mkt ($20MM+) & it’s difficult to pick up assets for a “discount” in that range So instead, they have to find mkts where competitors are underpricing future growth This is dangerous since if you guess wrong, it could be a disaster. But institutions are built for this as they have analysts & data they can use to correctly pick the next high-growth mkt As a smaller investor, you don’t. You have no edge over large firms. It’s not a smart place to compete But as a smaller investor you don’t need to deploy a lot of capital So you can use strategy #2 Instead of playing economist, you search for the least competitive mkts, where there’re the most pricing dislocations &, therefore the most discounts Basically I look for the market with the least competition that’s stable // Choosing a Market // Ignore the data & focus on making money (finding markets where you can stabilize over the market cap rate) A 4 step process: Step 1: Look for cities/towns under 250k pop Step 2: Vet supply Step 3: Vet demand Step 4: Make sure there’re mispricings (Assuming shorter term holds) Step 1: This is really just to narrow down to an area that has less competition 250k isn’t a hard & fast rule & this is by far the least important step If you find a mkt that satisfies steps 2-4, you can ignore step 1 Steps 2 & 3: There are 2 drivers of a mkt - supply & demand Want to make sure supply doesn’t increase & demand doesn’t decrease - that’s where you get into trouble If anything else happens (ex “demand increases”) that’s actually positive So what causes supply to increase? There’s only 1 answer - development And when do developers develop? When it’s profitable So if you can find a mkt where it’s not profitable, you know supply won’t go up Easy way to do this is to find mkts where the avg sale price per unit (market basis) is below replacement cost Intuitively, this means it’s not profitable to build For ex, let’s say the mkt basis is $200k & replacement cost is $100k. In this mkt developers would obviously build like crazy Why would you buy existing product for $200k/unit when you could build brand new for $100k/unit? You wouldn’t So we’re looking for the opposite We’re looking for mkts where the mkt basis is $75k & replacement cost is $250k (not profitable to build) Finding this “neutralizes” supply Now you need to make sure the 2nd variable will stay stable Demand is trickier I look at: - UE rate (just need “decent”) - pop growth (just want “stable”) - crime rate (just want “not bad”) - employer concentration (don’t want a “Detroit”) You get the idea. Don’t go crazy, just need to make sure the mkt won’t crap out over your hold Step 4: Last criteria is making sure there’re mispricings (discounts) You want to find deals where your stabilized yield is greater than the mkt cap rate So track a mkt for a bit If you don’t see a few deals where the stab yield is 200bps+ above the MCR, the mkt is too competitive & you need to try again If you do find a few deals, you’ve found your mkt That’s really it You’re looking for the market with the least competition that’s stable. Way you make money in RE is stabilizing over the MCR, so that’s what you’re looking for