3 Key Metrics to Identify a Strong Submarket
Once an MSA or market has been selected for investment, we turn our attention to evaluating submarkets. Cities are heterogenous. There are a wide variety of environments within an MSA and we want to invest in the submarkets that will give us the best opportunity to achieve our goals. How do we manage risk at the submarket/neighborhood level?
THE FIRST ELEMENT OF SUBMARKET ANALYSIS IS AN EVALUATION OF CRIME IN THE AREA.
Since our goal is to provide a clean, safe place for our tenants to live we want to avoid an area with significant violent crime. It is important to look for violent crime ratings that are well below average for the MSA. This will insure that high quality tenants will be attracted to location and ultimately to the property. Property crime is also part of the submarket crime data picture that in investor will want to evaluate. The way we treat this information can sometimes be counterintuitive. It is not uncommon to see a discordance between property crime and violent crime. A submarket may have low violent crime rates and higher levels of property crime. This is not necessarily a deal breaker. Closer analysis may reveal that incomes in the submarket are above average or that there is a large retail center near the property under consideration. Retail locations are a natural target for theft and other types of property crime. Likewise, more affluent submarkets can have higher than expected property crime for similar reasons. In short, violent crime can take a submarket out of consideration where property crime statistics require further investigation to understand.
THE SECOND ELEMENT OF SUBMARKET ANALYSIS IS TO ASSESS SCHOOL QUALITY.
B-grade apartments serving the workforce demographic will necessarily appeal to families with school age children or couples planning to start a family in the future. School quality is a prime consideration for prospective tenants of this type. School rankings and quality data are readily available and give an indication of the overall character and quality of the submarket. It is best to identify submarkets with individual school and school district ratings that are above average for the state in which the MSA is located. This analysis not only provides insight into the submarket but also provides and indication of the quality and type of tenant a particular property is likely to attract.
THE THIRD METRIC TO CONSIDER FOR ANY SUBMARKET IS THE MEDIAN AREA INCOME AND ITS RELATIONSHIP TO NATIONAL AND MSA SPECIFIC INCOME DATA.
It is ideal to find submarkets with median incomes at or above the national average and at least average for the MSA. Incomes within the submarket will set the upper limit for what can be achieved in terms of rents for a property. A general rule of thumb is that individuals can afford to spend approximately 30% of gross income on rent. Area incomes need to support property level business plan assumptions regarding rent growth over the lifecycle of the investment. It is, therefore, ideal to see a gap between what tenants are currently paying in rent as a percentage of income and what they can afford. This tells us that there is room for rents to grow without creating an affordability problem for one’s tenants.
Crime stats, school quality and area median incomes are not the only data points to consider when evaluating a submarket, but they are some of the most important. By selecting submarkets that score well in these areas we are laying a solid foundation for positive returns on an apartment investment in that neighborhood.