Investing in real estate requires a broad base of information to make informative and profitable decisions. Today, we'll examine Demographics and how an investor can utilize this information to gain better market insight in the due diligence process.
Demographics contain statistical information about a local population and summarize market conditions that drive consumer demand. This can include population trends, income levels, age distribution, housing statistics and affordability indexes. By summarizing relevant information through charts and graphs, aka infographics, an investor can efficiently gain a better understanding of critical market conditions that influence investment performance. The key is finding accurate information, getting the right information to make decisions and understanding how the presented material relates to the type of property you invest in. There are many demographers that provide information to the real estate community. I use ESRI (Environmental Systems Research Institute, Inc.), a top-rated company for accuracy and statistics relevant to real estate investments.
The economics driving the market:
Inflation and appreciating interest rates have priced a large percentage of buyers out of the purchase market. These economic challenges also prevent many owners from selling due to the high interest rates incurred when re-entering the market. The result is less product for sale and rising rents in the remaining supply of rental properties. Demographics help identify what local market tolerances are for income, rent, home prices and more. They show what a local population can or can’t afford on average as well as give insight on demand. Let’s say for example, you want to build an apartment complex. Do you build units with one, two or three bedrooms? By examining the average family size in the surrounding area, you can determine the probability of demand for each size unit. What rent can you charge? Median income and the Affordability Index discussed below give invaluable information to knowing those limits and supporting pro forma valuations.
Jobs:
Industry growth is an essential element to any community’s economic health. Basic employment drives total employment which increases demand for office and industrial real estate. The overall population rises as a result and demand for residential and retail real estate also increases. Analyzing employment can help an investor understand a community’s potential for population growth and income potential. Looking at racial diversity, age and education levels can also provide insight into the type of employment and income one could expect.
Median Income and Median Household Income:
Median Income separates income distribution into two equal groups with half having income above the median and half having income below the median. By examining the Median Income of a local population an investor can determine what prospective tenants earn. ESRI also has a Median Household Income Index which provides a more robust and accurate measure for summarizing income when analyzing diverse neighborhoods.
Housing Affordability Index:
The HAI (Housing Affordability Index) is a powerful tool used to analyze local real estate markets. The index measures the financial ability of a typical household to purchase an existing home in an area. An HAI of 100 represents an area that on average has sufficient household income to qualify for a loan on a home valued at the median price. An index greater than 100 references areas where homes are affordable to median income earners. An HAI of less than 100 indicates where homes are less affordable and the median income is not high enough to purchase a median valued home in the area.
Wealth Index:
The Wealth Index as defined by ESRI is the product of multiple financial indicators including income and net worth that contribute to the financial well-being and sustainability of a household. The Wealth Index is not designed to evaluate worth, but rather to capture the standard of living and financial stability of area households. The index represents a scale of an area’s wealth relative to the national level. An index of 100 represents wealth on par with the national average. An area with a wealth index below 100 has lower than average wealth. An index above 100 identifies an area with above average wealth.
Conclusion:
Utilizing demographics in a market analysis provides investors with critical information to support and enhance any financial analysis. When utilizing demographics, one can draw conclusions as to where customers come from, how much they can afford to spend and what kind of potential for growth an area represents. They provide a deeper understanding of the key indicators used to make real estate investment decisions and should play a role in the investor’s due diligence process.
Jeff Huling
Best Choice Realty
206-550-7177
