How do you know if you have found an under-valued market?
The seasoned investor looking for appreciation, the investor looking for cash flow, and the buy-and-hold investor are all looking for the undervalued market.
Makes great sense, but where or how you find these undervalued markets? Today’s undervalued market may not be there tomorrow. Markets which provide undervalued pricing will always be changing. How do you protect yourself?
It has been my experience that investors overlook or do not understand this piece of diligence. Investors look for the good deal within a market. But is the market overvalued or undervalued?
The best deal in an overvalued market does not have any safety or sustainability to it at all for the buy and hold investment. It may also catch a flipper off guard if the market changes suddenly. This became evident to many investors just before the economy fell apart.
In this case, you have to do the math to find the secret formula:
In short: it is the median income of an area divided by 3
Example. Markets may have a median income of $60,000 a year. Divide this by 3 and you get $20,000. This $20,000 represents the affordable housing expense a person can afford in the calendar year or divided by 12 month you have $1,666 that you can afford to spend each month on housing. You want to determine if you can buy the median price home in the area and with PITI (principal, interest, taxes and insurance) included and pay for this house. If so, you are a balanced market. If the payments based on PITi would be, say $1500 per month you are in an under-valued market. If the payments would be say $2000 per month you are in an over-valued market. It sounds so simple yet many investors totally skip this piece of diligence.
Interest rates change this affordability so too can insurance. Finding markets with lower based insurance premiums may be a starting point to your diligence. Places prone to high winds or hurricanes or mudslides will of course have higher insurance premiums. These high insurance rates and or high taxes can and will cut into the performance of your investment and unfortunately these are expenses we have no control over. Identifying the market for affordability as a whole is so important, as opposed to just making sure the property is priced better than competing homes.
Final point, in doing your diligence for undervalued markets, remember it takes more than just an undervalued market to be a great and sustainable investment but it is a paramount part of the equation.
Remember our other blog post on sustainability. You want:
- Job growth
- Population growth
- A growing city.
Read our sustainability post here.
Do you agree with Larry? Do you disagree? Let him know in the Leave a Reply area below.
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