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Wall Street is Missing Baltimore’s Huge Upside

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The primary lift is being provided by something so staggeringly huge and permanent, it can’t be argued.

My favorite part of being in the business of picking winners in the real estate market is when I find a market hiding in plain sight.

Baltimore is just such a market. But what makes it a great market, and why are so many people missing it?

Whenever we analyze a real estate market for our clients, we start with the big picture. We ask simple questions like, “Are people moving there? Are they staying there? Why? And are those reasons likely to continue?”

We call it “looking for lift.” We want to see circumstances that forecast stronger-than-average population growth. And since people prefer living indoors, population growth translates to housing demand and upward pressure on rents and values.

There are several different kinds of lift a market can experience. Sometimes a market is a destination of the glacial migration moving from cold, expensive places to mild, cheaper ones. Sometimes, there is a macro-business trend that is driving population in that direction, like how the Panama Canal expansion is driving growth in Jacksonville, or the fracking industry in Pittsburgh. Other times, it’s a company expanding and creating lift through specific job growth, like Mazda/Toyota opening in Huntsville, Alabama. Sometimes it’s a combination of more than one type of lift, and when you find one of those, you’ve found a true winner.

Now let’s look at Baltimore. The primary lift is being provided by something so staggeringly huge and permanent, it can’t be argued. Baltimore is Washington D.C. Or more accurately, Baltimore is a planet that revolves around the sun that is Washington D.C., the center of power in our solar system. When the “business” that drives the economic activity in a market is the federal government, the density and permanence of that economic activity is recession-proof on a long-term basis.

For example, even when a new administration takes over the federal government to shrink the government, they never actually shrink it. They might slow down its growth, but they never cut it back. And they vote themselves into permanent prosperity, no matter what is happening in the rest of the country.

The macro trends are locked in for Washington D.C. and all its surrounding sub-markets, including Baltimore. So why is the institutional investment sector largely avoiding the entire region? Two simple reasons:

1. Low Yield in D.C

The prices are high and the rents have not kept up. D.C. and its close surroundings are a sub-8 percent gross yield. Not high enough for institutional money. The market has appreciated at about 6 percent per year on average for the past 20 years, making it among the elite markets in the country, but large investors don’t like to count on price appreciation.  A note to small investors: You can count on price appreciation.

2. Bad Headlines on Baltimore

Unfortunately, the city has had a rough run. People assume the real estate is devalued and the market is risky, and they don’t take a closer look. In fact, prices started out so low 20 years ago and have steadily crept upward that now the 20-year average price appreciation almost matches that of Washington D.C. The rate of growth in real dollars was slow, but compared to how low it was at the start, the percentage is actually above 5 percent per year, and well above the national average of 3.4 percent. All of this appreciation has been taking place at the same time we’ve watched news stories of cars on fire. Headline reading will often lead you to wrong conclusions.

What makes Baltimore so compelling is the combination of the high yield that results from low prices and the higher-than-average appreciation rate. Washington D.C. gives Baltimore lift, but Baltimore’s problems give it yield.

Baltimore is also anchored by an industry that is becoming more relevant and permanent by the day: cyber security. Most of the main players in that sector are based in and around Baltimore, and that illustrates what I mean by being a planet orbiting Washington D.C. Government is the major client category for cyber security companies, so they need to be there.

Baltimore also represents a strategic approach that might appeal to investors who are not satisfied buying rental property at market value and generating market rents and yields. Many investors — too many in my opinion — chase deals as a rule. Sometimes they allow the market they invest in to be dictated by the deal they find. That’s backwards, but the subject of another article. What if, rather than searching for a property that is undervalued, you could find a market that is undervalued. I think Baltimore fits that description.

Happy hunting!