Regardless of your preferred real estate investment strategy, a thorough real estate market analysis is essential to your success. This analysis entails much more than looking at comparable sales and determining whether or not the neighborhood is nice. To ensure that your investment dollars go the furthest, you need a complete picture and a thorough understanding of the local market and properties.
Researching a local real estate market to see if it’s a good fit for investing is known as real estate market analysis. Investors use this process to determine which properties are in demand, what prices they will sell for, and whether a profit can be made. It’s one of the most crucial steps in determining where an investor wants to buy property.
When constructing your real estate market analysis, you should concentrate on four key areas: economic analysis, calculated ROI, property value estimation, and risks. It’s important to note that a real estate market analysis differs from a comparative marketing analysis. You’ll look at things like cost of living, job growth, neighborhood amenities, and more beyond just the comps of recently sold properties in your market.
While this can sound like a significant undertaking, the work you put into a thorough real estate market analysis will help you determine where you can get the best returns on your investments. This guide will help you create your real estate market analysis for each market you’re considering.
Key components of a real estate analysis
You’ll need more information than just who lives in the neighborhood and what properties are hot. An economic analysis should be included in your overall real estate market analysis to gain a deeper knowledge of the local area and anticipate future changes.
Economic analysis
You’ll need more information than just who lives in the neighborhood and what properties are hot. An economic analysis should be included in your overall real estate market analysis so that you can gain a deeper knowledge of the local area and anticipate future changes.
Cost of living
The amount of money needed to maintain a particular lifestyle in a given market is the cost of living.
Because the cost of goods and services varies from city to city, calculating the cost of living tells you how affordable it is to live in a specific area. It, therefore, helps you gain better insight into the local population and their real estate trends and preferences.
The cost of living is impacted by housing affordability and the cost of food, entertainment, and transportation. Salary ranges and hourly wages are also measured in relation to these expenses, so the cost of living is also related to income. A cost of living calculator can be an easy way to add this data point to your real estate marketing analysis.
Employment and demographic trends
Employment opportunities impact local housing demand and home values. The U.S. Bureau of Labor Statistics collects and provides data on unemployment rates, job growth, and wages across regions. You can search their resources by state or region to see which areas have the most potential for employment growth.
Census data is also a great source of information about overall population trends and demographic shifts in the area you’re considering investing in. For example, if your target market is young professionals, you can use Census data to pinpoint areas that are seeing an influx of millennials moving into the community.
Don’t forget to do your own research in addition to looking at these larger sources for real estate market analysis. Keep an eye on the local news and any new businesses that enter your market. Will they bring new job opportunities to the area? What types of jobs are there, and how many are there? Also, keep an eye out for businesses that are moving out of the neighborhood. You should evaluate the impact of these types of company openings and closures on people moving into and out of your market.
Neighborhood and environmental factors
How are the schools? Is there a hospital nearby? Are there plenty of shopping opportunities? What about access to public transportation? All of these things can affect how quickly a property will sell. If you’re planning to rent out the property, it’s also important to consider what kind of tenant you want to attract. Is the area good for families, or would it be better for single people or couples? Does it have a lot of retirees, or do recent college grads mostly populate it?
Climate can affect the resale value of a property and how difficult it is to maintain. A home in Florida, for example, needs a different type of roof than one in Vermont. Also, if you live in an area with extreme weather conditions such as heavy snowfall or flooding, you need to take that into account when calculating maintenance costs. Even if you don’t live in the house yourself, you’ll still need to hire someone to look after the property during your absence.
Another important concern is whether any environmental problems could affect the property. For example, is there a risk of flooding or landslide? Has any work been done on adjoining properties that could?
Real estate investment ROI
When you’re looking at an investment property to purchase, it’s essential to know the numbers. And not just the property’s price and how much money you can make. It’s important to understand your return on investment (ROI) if you buy that property.
In real estate investing, the return on investment (ROI) is a metric used to evaluate how much revenue an investment property generates compared to the original investment cost. The ROI figure is expressed as a percentage and helps investors determine if a particular property will yield high returns or if it’s better to pass on the deal.
When deciding whether to invest in a property, you should also consider other factors besides just ROI, such as cash flow, expenses, and rental rates. However, ROI is an important factor to consider because it gives you an idea of your return. It can also help you compare properties side by side.
Because it provides a concrete, factual picture of how profitable a potential investment could be, ROI is a valuable tool for any investor, regardless of experience level.
Although it may sound complicated, calculating your investment ROI can be done using a simple formula:
(Investment Gain – Investment Cost) ÷ Investment Cost = ROI
There are additional ROI calculations and assessments you can perform based on your investment type, but if you want to keep things simple and get a solid data point into your analysis, this formula provides a good baseline to evaluate your options.
Assessing value
There are many different ways to assess whether or not a property is worth its asking price. One of the most common methods is reviewing comps. This involves looking at properties that are similar to the one being valued and determining what they have sold for recently. Pending sales provide the most up-to-date values for comparable properties. In addition, closed sales offer historical context for how prices have trended over time. A real estate agent can help you with this process and may provide information on comps through their multiple listing service (MLS).
Vacant lots or undeveloped land without existing structures or infrastructure, such as roads and utility lines, are generally viewed as having less value than developed property. But there are exceptions to that rule, especially when the vacant lot or land is in a highly sought-after neighborhood.
When evaluating the price of a vacant lot or undeveloped land, it’s best to make an onsite inspection of the property and do some research about the market in which it’s located.
In terms of determining the market value of a vacant lot or undeveloped land, here are some things to consider:
- Location.
- Zoning (so you know what uses are permitted).
- Size (in acres and square feet).
- Elevation and topography (how much of the property is usable).
- Any utility hookups (water, sewer, gas, electric).
- Environmental issues (flooding potential, wetlands).
Assessing risk
When you buy real estate, you’re betting that the value of the property will rise over time and that your costs will be less than the amount you’ll eventually sell it for. If you buy low and sell high, you’ve just made yourself a nice profit.
But as an investor, you’re taking a financial risk. For example, if interest rates rise or fall, if the economy slows down or speeds up, if the value of your property increases or decreases, all of these things can significantly impact how much money you make from real estate.
To help manage risk, here are some of the most common risks investors face:
- Economic risk. A recession can be just as bad as a market correction because it can cause unemployment to spike, which may force borrowers to default on their debt. Property values drop too, making properties more difficult to sell and increasing losses from foreclosure.
- Market risk. A market correction can wipe out a lot of your investment. The stock market doesn’t go up every single day, so your portfolio can go down for a few years and still come out ahead.
- Cash flow risk. If you’re in the middle of a strong bull market—if prices are rising rapidly—and you make loan payments or prepayments, there’s a chance you’ll fall behind on those payments or even lose out on interest income as prices drop back down.
- Property management risk. Property management can be a significant expense, and finding good property managers isn’t always easy. As a result, property management companies could also go out of business.
- Leasing risk. Finding good tenants can be difficult, and dealing with bad tenants can be even more difficult. Bad tenants can cause damage, pay rent late or not at all, and create unacceptable conditions for other tenants.
- Tenant risk. If an investor relies on rental income to pay the mortgage, losing a tenant—or having a tenant who pays late or not at all—could cause financial hardship. Some experts recommend having three to six months of mortgage payments in reserve for this reason.
- Legal risk. You’re putting a lot of money into an asset that could turn into something you legally cannot do anything with (like sell). If your loan gets turned into a foreclosure or short sale, you could lose everything.
- Entitlement risk. Entitlement risk refers to the possibility that a project may not get city approval for development or may not get approval within the expected time frame. For example, estimates for how long it might take to get approval for a new construction project may not be accurate and could lead to delays in completing the project and getting a return on your investment.
- Construction risk. Potential issues that may arise during the construction and renovation of your investment property, such as cost overruns and delays.
- Geographic risk. Refers to political, economic, or natural events that have the potential to have a negative impact on an entire geographic region.
Preparing a comparative market analysis
The real estate market is always changing, so being able to analyze it is an important skill for any investor. A comparative market analysis (CMA) is a good place to start, but figuring out which factors are the most important and how to use them to your advantage can be challenging. A CMA is a comparison of similar properties in your area that have recently sold. You can estimate how much your property is worth by looking at how much similar properties are selling for.
Gather all necessary information about recent sales in your area as the first step in preparing a CMA. You’ll need:
- Address and date of sale.
- Price per square foot or price per square footage range.
- Location.
- Square footage.
- Number of bedrooms, bathrooms, and parking spaces.
Put everything you’ve learned into a well-organized spreadsheet or database. This will make it easier for you to analyze your data later on. Make a column for each of the variables listed above, and a row for each home sale listing or sale date that meets your comparison criteria. Calculate ratios between each variable for each home sale listing or sale date you’re looking at to compare the data. For example, if one property has more bedrooms than another but is sold for less money per square foot, it may be more valuable because it has more living space.
You should prepare a CMA on multiple properties and neighborhoods before deciding where you want to invest.
Final thoughts
Ultimately, there’s no universal answer to the question: “What should I invest?” Each market and property requires its own in-depth analysis. One of the biggest benefits of creating a real estate market analysis, however, is that you’ll be forced to consider a wide range of factors, which is helpful no matter what kind of real estate purchase you’re considering.
A market analysis is only as useful as the tool you use to implement it. The information you gather from a real estate market analysis drives your investment decisions and informs your long-term business strategy. It’s important to remember that the real estate market consists of many moving parts, and each part may favor buying or renting depending on the dynamics of the local economy.
