Case Study: What Makes a Good Investment? (Part 1)
Putting a value on an investment property is not the same as being able to evaluate an investment opportunity. So, how do you, as an investor, determine if an investment opportunity is good or not? As an investor, you need to be able to objectively measure the potential return on an investment in order to compare that particular opportunity with any other opportunity. To do that, you’ll need to be able to calculate different measures of returns and compare them across multiple potential investment opportunities.
To help illustrate this, we’ll look at a hypothetical case study but use real market data.
Joe is a relatively young working professional from Las Vegas, Nevada, who’s been saving up for his first investment in real estate. He’s looking to acquire a property and rent it out for cash flow.
He was originally planning on putting $25K down and financing the rest, but with his recent windfall from his lucky foray into Bitcoin, he is now sitting on a tidy $75K that he can put toward an investment. From asking around, he knows that he’ll need to cover at least 30% of the purchase price as a downpayment, meaning he can look at investment properties that cost $250K at most.
Joe would like to invest relatively local—in Nevada or a neighboring state—so he could get to it easily.
Which Market Should Joe Choose?
Joe wants to invest in a market that is relatively easy for him to get to from Las Vegas, so his options are Las Vegas, Phoenix, Reno, and Los Angeles.
Let’s look at information Joe obtained for these markets:
|Los Angeles||Phoenix||Reno||Las Vegas|
|Median Home Price, June 2018||$749K||$265K||$409K||$285K|
|Median Rent, June 2018||$2,929||$1,295||$1,695||$1,342|
|Pros||Mature market, rental stability, solid housing, and rental growth; Los Angeles||Solid housing and rental growth; 25% below 2006 peak levels||Double-digit job growth, high tech (Tesla factory), no state income tax||Growing tech scene, more details, familiar and convenient, 30% below 2006 peak levels, no state income tax|
|Cons||Can’t afford. California state tax, already back to 2006 peak levels||Arizona state tax, falling household income, uncertain long term demographic and job outlook||40% more expensive than Las Vegas, longest travel from Vegas, 94% back to 2006 peak levels||Still tourism heavy, more volatile housing market|
|2018 Annual Rent/Cost Ratio (post state tax)||4.2%||5.5%||5.0%||5.7%|
Source: Zillow.com using 2006-2018 data
Alright, so after getting really excited about investing and looking at several cities, Joe decides to be conservative and do his first investment in his hometown of Las Vegas.
He’s lived there, been through the housing crash, and has really seen how it has been changing and evolving in recent years, with many very promising developments. Plus, it’s affordable for his budget, and it provides the best bang for his buck in terms of the rent achievable per dollar invested, especially factoring in state income taxes for California and Arizona. Lastly, he’s wary of buying in markets that have already gone back up to their 2006 peak levels so quickly.
So, he decides to explore different potential neighborhoods. Specifically, he has seen tremendous growth in the downtown region of Las Vegas, having seen housing values go from the lows of $30K to getting over $100K-plus and with solid, consistent rises in rents. With more tech companies following Zappos and relocating near downtown, rents are expected to keep going up as demand for space goes up in the area. But the properties there tend to be very old and require significant rehab.
He decides that he’ll explore that for a second or third deal, but not for his first one. He wants to keep it simple and get experience under his belt before working on something more complicated.
After digging around and working with a local agent, he received four listings as potential buys.
Let’s see how Joe decides between these four choices in tomorrow’s lesson.