Yesterday I met with an investor from Israel interested in US real estate. A good portion of our discussion focused on the current state of the Philadelphia real estate market. I’ve had similar conversations with a dozen or more people over the past month. Where is the market today and where is it headed?
While I don’t have a crystal ball, I’ve been involved in real estate investing long enough to see some similarities to the pre-crash frenzy of 2005-2007. But I’ll save my prophetic analysis for another post. I want to give my two cents on the best residential real estate investment when it looks like we’re at the top.
Over the past 11 years I’ve been a full-time investor. During that period I’ve wholesaled hundreds of houses, built and sold a +600 unit property management company, flipped a few dozen properties, built a rental portfolio and provided successful turn key style investments to people from around the globe. The most exciting investments I’ve seen are in gentrifying markets.
I live and invest in the metro-Philadelphia area. Philadelphia is an old city. Most of the properties here were built before 1960, and like many Northeaster cities, we’ve been negatively impacted by the loss of manufacturing and the shrinking demand of blue collar jobs. Much of our city was ignored, abandoned and forgotten for decades. Thankfully this trend has shifted.
I’ve seen at least 6 local neighborhoods experience gentrification in the last 10 years. Areas that were once the definition of urban blight have transformed into beautiful, safe, desirable neighborhoods. These areas have made a lot of smart investors rich, and they provide an opportunity for people looking to invest for the long term – even if they buy when the overall market is at the peak.
All real estate is local. Even within zip codes there may be significant fluctuations in property value, especially in an urban environment. The following factors can help identify neighborhoods in the throws of gentrification:
- Local Sales – I was researching a potential investment the other day and searched my local MLS to look over the recent sales. Within a quarter mile from the subject property there were 117 sales in the past 6 months. This example is a little extreme, but a high volume of sales is a great indicator of gentrification.
- Bi-Polar Prices – During the same search I saw single family properties selling as low as $65,000 and as high as $550,000. Sales prices pooled on the low and high end of the sales spectrum tell a story. Investors are buying, rehabbing and selling these properties. The neighborhood is changing.
- New Permits – Check with your local building office. Areas with a large influx of building permits are areas where change is underway.
- New Construction – Renovation is one indicator of a developing market. New construction is another. I bought a house in South Philadelphia earlier this year. When I first looked at the property, a vacant lost sat next door. By the time we settled on the house there was a new, 3-story building under construction and 2 other new builds on the block. It increased my resale by $25,000 before construction even began.
- Follow the Artist – You can identify the up-and-comers by following demographic shifts. It starts with the artists. Next come the students. Young professionals quickly follow. Before long business and families move in. By the time you see restaurants and bars, its already too late.
The ”why” to investing in gentrifying markets is as important as the identification. Why are these areas less impacted by market cycles than the rest of the real estate market? Because the appreciation in property values is based more on the change of the neighborhood and less on the ebb and flow of supply and demand. Additionally, the tenant pool in changing neighborhoods is often better than candidates in more traditional rental areas. Residents tend to be people that will one day own a house of their own. They make a decent living and generally take care of the place they call home. So while neighborhood values increase, your tenants pay rent on time, take care of the property and take less of your time. It’s a win all the way around.
It is important and practical to note that rising interest rates, lending restrictions and the overall health of the real estate market will most certainly have an impact on the rate of change in a transitioning neighborhood. But progress is like a stone rolling down a hill. You can slow it down, but it’s really difficult to stop all together.
No one knows what the future holds. Real estate cycles will carry the market through its ups and downs. That’s a certainty. If you’re concerned about where to invest as we approach the top, look at developing markets as a great place for your investment to grow.