When first assessing a market, pick a market that appeals to you geographically. This assumes of course, that an immediate track record of 20 percent per annum appreciation (a.k.a. hot market) is bona-fide. The 20 percent plus range is defined by many investors as a flip or hyper-appreciation market. Most recent flip markets include Las Vegas, Sacramento, Phoenix, and Riverside, California. It’s worth mentioning that one’s market area of focus should be on markets that are hands down in fact appreciating. Just because it may appear that a market area has peaked does not necessarily mean that it’s not a market that may still possess appreciation that is in the double digits. For example, by first quarter 2005, the Las Vegas market, having just come off a 52 percent appreciation on new tract homes in 2004, had an overall modest year-to-date gain in the high single digits. The operative word here is “overall”-since if one was buying a home priced in the $200,000 to $300,000 range in January of 2005, they would have had an appreciation rate in the high teens by yearend. However, in comparison to homes purchased at the same time in January 2005 in the $350,000 to $500,000 range, the rate of appreciation would have been only in the single digits. There is a huge difference in whether or not you just bought a potential flip or something you just wasted nine to twelve months hoping what you thought would be a flip. This just illustrates the importance of deal size. Smaller properties, based upon cost, tend to appreciate faster in a growth market because a wider scope of the buying consumer public can afford them.
One index to pay close attention to is the “affordability index.” When the affordability index starts to go down, then demand for lower-priced homes increases. It’s an inverse relationship that every investor should know about, especially if the market is on fire. In a hot market, you want to start buying properties that a larger percent of the population can buy. Pricing for new tract housing is primarily predicated on supply and demand. And if the average buyer can’t afford your $400,000 home, then they’re going to look at somebody else’s $300,000 to $350,000 new tract developer home. And guess where the initial pricing started on the homes now being sold in the $300,000 to $350,000 bracket before they exploded in value? Very likely in the $250,000 to $300,000 range. Simply stated, demand is a primary driver that increases prices, all other market conditions being equal. And if a larger portion of the consumer buying public can afford homes in the $300,000 to $350,000 range, then those are the homes that are going to be bought faster and appreciate faster, and also put an escrow “closing check” in your pocket faster. Keep in mind that the entry-level to mid-market homes-both of which have the broadest appeal to the buying public-will range in initial pricing depending upon the geographic region.
What this all means is that you’ll have additional seed money to go out and buy some more home product. As discussed earlier, keep in mind your reserve ratio minimums for future acquisition costs and debt service requirements. Remember, the more you make, the more you can buy, which if done correctly and methodically, will increase your net worth exponentially. This is especially true for the more aggressive flippers who desire to conquer the world by buying every single new tract home he or she sees. These investors can comfortably build a pipeline of twenty to thirty properties and, depending upon the new home market chosen, can earn in excess of $500,000 to a million dollars a year. And this doesn’t mean all of the deals have to be homeruns. I’m talking about a few singles, a few pop flies, and some strikeouts or laggards, as we in the real estate flip business call them. The upside is so potentially substantial that a few bad ones won’t hurt you, as long as they’re handled correctly.
To avoid those laggards, researching a market requires more than just a touchy-feely approach. As mentioned earlier, a 20 percent per annum appreciation rate is undeniably a “hot market.” Anything above that is pure gravy. There are many ways in which to approach research; the best approach, however, is to follow the K.I.S.S. rule: Keep It Simple, Stupid. (And no offense to the reader.) Remember, paralysis by analysis is a sure-fire way of making nothing. And let’s not forget, you can’t win if you don’t play. Like in sports, paralysis by analysis can be a critical stumbling block in achieving success.