Analyzing Trends and Avoiding Traps
Do you have a good understanding of trends and time horizons? Much of what we do as real estate investors is analyze trends, so this skill is critical. What’s been the trend of the last 30 days? The last three months? The last three years? How long your time horizon is depends on the data you’re looking at, and that depends on how fast you can get reliable data. That applies to tenant lead traffic, income, expenses, rent growth, population growth, and much more.
Take population growth, for example. Population growth is measured by surveys of employers and/or households. They are samples and the effort to collect this data is monumental. For this reason it isn’t reported that often, and reporting is usually delayed by a year or more. Yes, it’s more granular than our every-10-year census, but still it’s never that current.
Jobs data is the same way. Monthly surveys are taken, then reported by the Bureau of Labor Statistics. It’s not accurate but it’s the best we have, and gives a good indication of jobs over time.
Look at tenant lead traffic. You’re hopefully getting inquiries from your marketing every day. How many did we get today, this week? How does it compare to last week? That’s an important metric which you should be watching. A change from last week might not be that important but a series of increases or declines tells you a lot about your marketing. You don’t have to wait for months to analyze this data.
What about income and expenses? Most lenders like to see three months of income and 12 months of expenses. This is because for income, what has been happening more recently is the best indication of what will continue to happen. If you had down months prior to three months ago, it’s probably because you had problems. You might have had a fire, done a lot of renovations, or just bought the property with low occupancy. All of these lead to vacancies. Or a pandemic, can’t forget that. But if you got past that and your income is stable, the lender will give you more favorable terms.
Was income steady over the last three months? Are collections 100% of scheduled rent? Or is it trending down? If your last three months are not a good picture, it’s not a good time to sell because the buyer’s lender will not view this favorably. Your income problem is probably easily fixable, so fix it before selling.
Expenses are not as predictable through the year. You might have just one or two property tax payments in the year, or one big insurance payment. You need to report all 12 months so those are included.
How about rent growth? Today, this is one of the most misleading metrics. Rent growth is historically maybe around 2-3% annually in healthy markets but so many markets are reporting rent growth of 5-20%. A major reason to report it is to provide insights into the future, but it would be a mistake to not dig deeper.
I have seen investment opportunities where rent growth in this property’s market was 8-10% over the last 12 months, so the underwriting is projecting “conservatively” 5% growth in the future. That already is a big red flag, but then you do some research and discover that, yes, rent today is 8% higher than it was 12 months ago, but six months ago it was 12% higher than six months prior. So in the last six months it has actually declined 4%. That’s a trend moving in the wrong direction, but the time horizon was chosen because it painted a rosy picture.
Be wary of trends. Find credible data sources and do your own analysis.