Choosing the right market to invest in is your most important investment decision. Location determines all long-term income characteristics essential for achieving and maintaining financial freedom.
The characteristics defined by location include:
- Total capital required: If you can grow your portfolio using accumulated equity by cash-out refinancing, which is only possible in areas with high appreciation, you’ll need considerably less capital from your savings.
- Inflation protection: Rents outpacing inflation, enabling you to sustain your lifestyle indefinitely, only occurs in cities with significant, sustained population growth.
- Income persistence: This is how long your income will last and depends on the city’s long-term economic growth.
- Natural disaster risk: Certain locations are more prone to natural disasters, such as hurricanes, tornadoes, earthquakes, fires, and floods. Although insurance may cover rebuilding your property, it could be vacant for months or years until the community recovers and people return.
- Operating costs: Every dollar lost to property taxes and insurance is a dollar less for you to live on.
- Rent control: Government control of your rental property can transform a promising investment into a nightmare.
Fortunately, good location data is available, and the location selection process is straightforward.
Location Selection Process and Tools
There are two primary methods for choosing a good investment city. The first is to analyze all possible cities in the U.S. and select the best one. However, this approach could lead to evaluating thousands of cities, which is impractical due to the time commitment required and insufficient data for smaller cities.
The second method is to eliminate all cities that are unlikely to be good investment locations, and the remaining few are worthy of further investigation. This method is straightforward and practical.
The process starts with an initial list of candidate cities. Start with those with a metro population of greater than 1 million if you want long-term, reliable income. Smaller cities may rely too much on a single business or market segment. You can use information from the U.S. Census Bureau to easily find this data.
From this initial list, eliminate cities that do not meet the following additional requirements. You can use BiggerPockets Market Finder to find this information in most cases. In others, I’ve indicated another tool I find useful.
Total capital required (to achieve financial freedom)
To replace your current income, you need to buy multiple properties. The capital needed from your savings will depend on the location’s appreciation rate.
In low-appreciation areas, you’ll need to cover the cost of purchasing multiple properties entirely from your savings. However, in cities with higher appreciation rates, you can leverage the accumulated equity to buy additional properties via cash-out refinancing. Therefore, you’ll need less capital in rapidly appreciating cities than in lower-cost locations. Never buy in slow-appreciating cities.
Inflation protection
The only way to maintain your purchasing power and living standard is if your rents increase faster than inflation.
Prices drive rents. Where prices are higher, fewer people can buy, so they are forced to rent. This increases demand for rental properties, which drives up rent. Where prices are low, more people can afford to buy, so fewer people rent, and rents increase slowly, so you will not have the money to pay inflated prices.
Only buy in cities with significant, sustained population growth. Never invest in any location with a static or declining population.
Income persistence
Financial freedom requires an income you will not outlive. Your income depends on your tenants staying employed throughout your lifetime at similar wages.
However, all nongovernment jobs are short-lived. The average company lasts 10 years, and even an S&P 500 company has an average lifespan of 18 years (and falling). So, every nongovernment job your tenants have will vanish in the foreseeable future.
The only way your tenants can continue to pay the rent is if new jobs are created that pay similar wages and require similar skills. For replacement jobs to be created, companies must choose to set up new operations in the city. Companies have a lot of flexibility as to where they set up shop and are unlikely to create new operations in any city with high crime levels.
Low natural disaster risk
A natural disaster can be a financial disaster for you. The issue isn’t your property. Insurance will cover the cost of rebuilding. The problem is the community.
Jobs, stores, roads, healthcare services, and gas stations can all be destroyed in a disaster, as is often shown in the news. With the community destroyed, your tenant has no choice but to move somewhere they can live and work today. It could take years to rebuild the community, and it may never recover in many instances. Meanwhile, debt service, taxes, insurance, maintenance, and other expenses continue without pause.
The relative cost of homeowners insurance is the best indication of a high-risk location.
My favorite tool to check out these markets is ValuePenguin.
No rent control
Some states and metro areas have implemented various kinds of rent control, which may prevent you from increasing the rent fast enough to keep pace with inflation, limit your ability to select a reliable tenant, and make evictions of nonperforming tenants difficult or impossible. Never invest in any city with rent control.
My favorite tool here is Google search.
Low operating costs
It’s not about how much you gross; it’s about how much you net. Every dollar lost to operating costs means one less dollar for you to live on.
The two most significant operating costs for investors are property taxes and insurance. Operating costs vary significantly by state; only invest in states with low operating costs.
My favorite tool to use here is ValuePenguin.
Final Thoughts
In summary, you began with cities with a metro population greater than 1 million and remove any that did not meet the additional criteria. The outcome is a short list of cities that are potentially good investment locations.
Select a city with an experienced investment team to narrow the list of cities further. Everything you learn from podcasts, books, seminars, and websites is general knowledge. But you will buy a specific property in a specific city, subject to local rules and regulations. The only source for the local knowledge you need is an investment team.
Choosing the right market is your most critical decision, not the property. You can only generate the income required for lifelong financial freedom by selecting a location that meets all these requirements. If you invest in the wrong location(s), no matter how many properties you purchase, you won’t have lifelong financial freedom.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
