Small Markets: Be A Big Fish In A Little Sea
Focusing on smaller real estate markets can allow you to build your portfolio and win deals without having to compete with big players (or even other small players). Just understand the risks.
Tl;dr
You can avoid competing with sophisticated buyers by focusing on smaller markets
Very small markets might be the last places on the planet with value
Market appreciation may be minimal as population and job growth is usually static
You have to know people that know people
Everyone and their brother wants to buy a property in a primary market or the markets that check all the boxes on the "next thing" - big population growth, big job growth, blah, blah, blah. The reality is that, as a relatively small player in real estate, I will not be able to compete with a buyer that has thousands of units under management and a long-term track record of closing deals. So why try to compete with them when you can focus on smaller markets that bigger players will not bother with?
Small Market Risks
I'm writing from a standpoint of having invested in many multi-family units in what would be considered rural markets. I'm talking very small markets with populations of 3,000-5,000. Am I an idiot? Many say yes. And I might be if I didn’t understand these communities well.
The typical risks of very small markets are:
Stagnant/decreasing rental rates driven by lack of population growth driven by lack of economic opportunity
Difficult to find buyers when you want to sell (scared of the risks/no glamour in owning in the middle of nowhere)
Stagnant/expanding cap rates
My Investment Thesis On Small Markets
Everyone needs a place to live. No one is building new rental housing in small markets. The end.
I promise I will never use the term "investment thesis" ever again. I heard someone smart (rich) use it and wanted to try it out.
Why I'm Comfortable Investing In Very Small Markets
Over the last decade, housing in the "primary" market nearest where I'm invested has become very expensive due to some population growth (been ranked on "best place to live" lists) and the lack of affordable housing being built due to high construction costs. This has pushed renters that are in the workforce housing market further and further away from the primary market, while still being a feasible distance to commute.
“If I could do it all over again, I’d have bought class B/C apartments in Podunksville, USA. I could’ve been a trillionaire.”
-Warren Buffet, 91 (the guy with only one “t” in his name, not the Berkshire guy)
In really small markets, it's all about who you know and the connections you have to get things done. I have lived there and have family in the area. I know people that know people that know people to get things done. My property manager is on the town council. Do not underestimate having connections in a small town. Do not expect to walk into small town USA as an out-of-stater (especially a state no one likes) and be welcomed with open arms.
The first property I purchased, I acquired from an extended family member that had owned the property for 40 years and knew the building inside and out. They could speak to the vacancy rate/credit losses over the past few decades. This gave me confidence it was a viable market.
The Downsides
I know that at some point vacancy rates won’t be near zero and collections won’t be near 100% forever (even with COVID - thank you gubmint subsidies). The risk mitigation for a very small market is the same you'd do for a larger market, except you just add more cushion to your worst case scenarios.
Healthy cash flow day 1
Prudent leverage
Adequate capital expense reserves
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-@CavemanREGuy