When commercial mortgage lenders and real estate investors are pursuing fix-and-flip properties, location may be the most important factor in closing the deal. From a macro-level perspective of choosing a location, two key things to consider are the area’s population and migration trends.
When it comes to fix-and-flip projects, investors and the mortgage brokers they work with should be mindful of market trends created or intensified by the COVID-19 pandemic, especially with regards to increased worker mobility, a change that means more opportunities to work from home or enjoy hybrid work schedules.
This freedom in the working world means that more people can live where they want, including in the countryside where prices are lower. As a result, there is a growing demand for renovated homes in emerging markets, including second- and third-tier cities where populations are growing. Of course, the opposite is also true. A key part of this investment analysis is to avoid areas where job growth is negative and residents are leaving.
Many homes in newer areas have lower purchase prices because they haven't yet experienced the pricing pressures that have occurred in larger metropolitan areas in recent years. These markets are generally located 30-90 minutes from metropolitan centers. They have newer subdivisions and may have better repair and resale conditions. For example, the Phoenix suburbs of Queen Creek and San Tan Valley are popular areas where subdivisions were built in the last 10-15 years and are easier to resell than older homes that require more investment and extensive repairs.
Rural American moment
The results indicate, at least anecdotally, that homebuying activity is on the rise in small to mid-sized cities across the country. Coming in second on a list dominated by these smaller cities was Coeur d'Alene, Idaho. The rest of the top five cities were Fort Wayne, Indiana; Rapid City, South Dakota; and Raleigh.
According to a survey of real estate agents, people are drawn to Billings because of low unemployment, affordable housing costs, low crime rates, and beautiful natural surroundings. Other cities in Montana are also growing, and as a result, the state's population has increased by about 100,000 since 2010, and Montana gained its 2nd congressional district.
Dr. Bryce Ward, economic consultant and professor at the University of Montana, reported that oil, coal, agriculture and outdoor attractions have contributed to recent job growth in Billings and other parts of eastern Montana. This job growth has resulted in increased demand for housing across all income levels. And this trend is expected to continue, with Billings projected to see a 24.4% job growth rate over the next decade.
The current housing market in Billings lends itself well to both traditional fix-and-flip projects and homes in need of more extensive renovation (often referred to as “demolition and renovation”). Mortgage brokers should advise investors to be wary of the latter activity. When reselling these demolish-and-flip homes, there is a high probability that the physical foundation and structure of the home will need to be modified. In other words, the design of the home will need to be altered by adding bedrooms, doorways, windows, etc. Naturally, this type of work will make the renovation more expensive.
Another reason customers should avoid tearing down and redoing is that they'll be dealing with outdated amenities like old electrical wiring, cast iron plumbing, rusty sewer pipes, damaged drainage systems, and more. By comparison, with a new home that's a perfect fit for a fix-it-and-flip home, the owner literally fixes the small issues before reselling the home. That's not to say new homes don't have issues, but in most cases, they're much more cost-effective and investor-friendly.
A search on Zillow.com will reveal a wide variety of homes in markets like Billings. Investors should carefully consider older homes, as they can be expensive to renovate. Many homes built after 2000 have modern architectural styles and typically only require appliance upgrades and cosmetic improvements to make the home appealing. Again, this type of investment saves time and money on renovation and design fees. This is another sign that emerging markets are a good opportunity for investors and new residents due to the growing demand for housing.
Know what to avoid
For lenders and property owners who are still wary of the concept of investing in emerging markets rather than major metropolitan areas, there is one important thing to consider: today's workforce is changing and it's likely to be permanent. Consider the large technology companies with affluent millennial employees who are able to enter the housing market at a young age. Companies like Coinbase, Shopify, Quora, Zillow, Indeed, and Square have announced that they will allow their employees to work remotely permanently.
To ensure a profitable fix-and-flip investment strategy, commercial mortgage brokers and lenders need to help their clients do the proper research and really understand the market they are considering entering. Job growth, investment opportunities, per capita income, quality of education, and crime rates are all important factors to look into. Ultimately, it is important to understand that there is not one best emerging area for real estate investors to focus on. If there was, all investors would flock to the same place, and potential investment returns would rapidly diminish.
Just as important as what to look for in an investment property is what to avoid. One of the most obvious and serious warning signs is an area that is experiencing a significant decline in population and unemployment. This double whammy is common in rural areas, so lenders and investors need to do their homework to find the right place to buy.
The fastest-shrinking city in the U.S. over the past decade is Pine Bluff, Arkansas, whose tax base shrank due to a decline in agricultural and manufacturing jobs. As a result, the city's population fell by more than 12% between 2010 and 2020. The second-fastest-shrinking city is Danville, Illinois, whose population fell by 9.1% over the past decade. Like Pine Bluff, the population loss began after major manufacturers such as General Motors, General Electric, and forklift maker Hyster closed operations in the late 1990s.
The more time we spend looking at cities with declining populations, the more patterns and similarities become apparent. It's fair to say that, in general, cities with stable and growing job markets are safer places for commercial real estate investors.
When considering entering the fix-and-flip market, commercial mortgage lenders, brokers and buyers should keep in mind that as more concentrated metropolitan areas and major markets continue to exponentially increase in value, second and third tier emerging markets will become increasingly lucrative for investors. Emerging markets can offer significant long-term appreciation in real estate values, but they must be in the right place. Researching topics such as regional demographic trends and employment statistics is investors' best bet to find the right place to put their capital.
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