Top Questions Passive Investors Must Ask About The Surrounding Market | Ep 37

James: Welcome to the Furlo Capital Real Estate Podcast, where we dive into the intricacies of passive real estate investing. And our mission is to equip people to invest wisely in both properties and residents so that together we can build wealth while improving housing. I'm James and this is my wife, Jessi.

Jessi: Hey, I found something that I like to build with Legos.

James: Really?

Jessi: Bugs.

James: Bugs. I

Jessi: love my gift. I love it. So yeah, you guys brought me back some Bugs from Legoland. Yeah. Yeah. What are the three, what are the three bugs? Okay. There's a praying mantis. That's my favorite one. A butterfly. A blue morpho butterfly.

And a Hercules beetle. Ooh. Cool. So that one's kind of cool because you can. Cool. Flap little wings. Ah. Take them off. That's awesome. You can close the shell. That's awesome. Kind of interactive. Cool. I I just moved them to my office today, but I've, I've already, I already find that When I walk in and out of my office, I always want to like reposition the little arms so that it's like moving.

Yeah. Yeah.

James: Kind of like Elf on a Shelf.

Jessi: Yeah, a little bit.

James: That's funny. Well, if you're watching a video of this, somewhere in this frame is another Lego that was mine. It's probably super obvious. Yeah. But that's okay. Yeah, that was my gift. And then I also got some, I got plants, that's the route that I went.

Plants. Plants

Jessi: and bugs.

James: Yeah, yeah. So it was fun. Yeah, that's kind of their, they figured out like that's another, Lego is a very interesting company to follow because you can clearly see where they go, Oh, here's a customer segment and they go in because they start making models. And so it's very, very clear what it is that they're focusing on.

Right. In that sense, it's a very fun company to study. Because, yeah, they just have very obvious niches and marketing verticals or avatars. Avatars. That's the word I wanted.

Jessi: Oh, for their customers. Yeah.

James: Yeah. We're going after these people. So they figured out. Makes sense.

Jessi: I'm a bug person. You're a bug person.

I would

James: buy

Jessi: all

James: the bugs. Well, and the plants are, they're more adult like because you're going to put them in your house and leave them there. Right. And they're like, perfect. Oh, cool. Yeah. Plants. I never have to. Bye. Bye. You don't have to walk around. Bugs, I never have to feed or squat. And yet you still

Jessi: get to like, play with Legos.

Yeah, yeah, exactly.

James: Super fun.

Jessi: As opposed to our son, who bought a vehicle, and it's like He puts it together, smashes it, puts it together, smashes it, half of pieces, get mixed in with all the other Legos. That's alright too. And it's placed differently. It's a different target market. Different target market.

Different avatar.

James: Avatar, yeah. It's

Jessi: the, the smasher boy avatar. The smasher,

James: yeah, what are they? Usually when you have, when you do this in marketing, you come up with creative names for how they represent. And they're usually highly alliterative. Yeah. Yeah. Yeah. Yeah. So it might be like, yeah, exactly.

Crusher Calvin. Yeah. Yeah. I love it. So oh gosh, what's a good so in the way that there are multiple different types of customers, there are also multiple different types of markets that you can invest in. And one of the things that you want to do as you are evaluating deals, whether you are active or passive, is you want to evaluate the market in terms of In which that deal is happening because it's kind of a, a, a tide lifts or lowers all boats situation.

So ideally you want to be investing in quote, healthy, vibrant markets. And not ones that are not great markets, but those are very fuzzy terms. And so part of that due diligence process, and I have an entire download that you can learn about the 196 questions that I asked that span all different areas, all the way from the sponsor to the deal itself, to the surrounding market.

And we've done these kinds of episodes for, yeah, we've done a few of them. So this time this is kind of the fourth one in that series, we're talking about the market itself. So I've given you all the questions that I think someone should ask around the market. And so what I'd love for you to do is kind of read through them, comments, ask questions, and I can I can add a little bit more information.

Before

Jessi: I jump into the, into these questions, I glanced through them. And I, I think it kind of like, is this your point? Like this whole section of questions will help you determine what is a healthy market. Correct. Okay. So like, yeah, as you're, you don't define that ahead of time. I mean, there's general parameters.

James: Yeah. So like,

Jessi: as we ask the questions, people will be like, Oh, okay. I know what,

James: yeah.

Jessi: Okay. That kind of makes sense to me. So some of these questions one surrounding job growth over the last five years, so kind of what sectors of employment are there? In the economy in this particular market and does one section of the job market control more than 25, 25 percent of the employment market.

So like where jobs look like, our people making money.

James: Yeah. And ideally it's not all concentrated on a single industry because let's say, for example, you're doing a whole bunch of timber stuff and you're in a town where they are all working for a lumber mill and then. A state like Oregon comes along and says, Hey, we want to protect our timber, which totally makes sense.

It's great. But all of a sudden the limber, the lumber production drops and everyone's out of a job. And that 25 percent is kind of that magic number of, Hey, do we have like a single industry town? Cause nothing's a hundred percent. Or are we well diversified where it can, it can survive, it could sustain.

I think there was a while where Corvallis was actually, it was, it was on it. on walking ground because HP was the biggest employer by far. I don't know if it was 25%, but like, it was starting to knock up to that number. And then when HP started to, to lay off people and shrink in Corvallis, it had a material impact on Corvallis.

Now, thankfully, Corvallis also has a university and then it had a hospital. It's kind of like those three are now the big ones. And it's more balanced, which I actually think it's a healthier economy than it used to be. But yeah, that's something you want to look at. Because

Jessi: other, other Jobs or industries kind of fill in.

Is that how that works? Overtime. Yeah.

James: But again, depending on the, and especially if you're looking at small cities, you know, a sub 20, 000, you really want to be careful of that because again, if that employer is like, Hey, we're done, like, dude, that could be a problem. Yeah.

Jessi: Hmm. Yeah. So is that I'm kind of thinking of like suburbs of bigger cities.

Are you looking at the bigger city or do you look at.

James: I tend to look at the bigger one, like what's a reasonable distance for someone to drive.

Jessi: Okay.

James: Right? I think someone, it's super reasonable for someone to drive half an hour, probably even 45 minutes to a job. And so as long as, so I would look at that whole surrounding, that 45 minute circle essentially.

Jessi: That makes sense. And then what has been the income growth over the last five years? What's the median, median income and will tenants be able to afford to live there? In other words, is the income to rent ratio greater than three times?

James: Yeah. So this is actually, it's super interesting math that you can do.

So first and foremost, you want incomes going up because that again shows that it's healthy and people are doing well in their jobs. The companies themselves are doing well, so they'll pay their people more like you want. That's just like things are moving in the same direction. By the way, the chances of finding a market where everything is up into the right is not going to happen.

So you kind of got to pick and choose where do I think my risk factors are? How big of a deal is this?

Jessi: Hmm.

James: So. Specifically, there's some math here. So, when we're screening tenants, what is our income rule?

Jessi: They have to make three times the amount of rent, the monthly rent, in income.

James: So, if rent is 1, 000 a month, they need to make at least 3, 000.

Yes. And so, what's interesting is you can look at the medium income for a city.

Jessi: Mm hmm.

James: And you do the math for that.

Jessi: Oh, okay. Yeah.

James: So let's just say to make our lives super easy. If the medium income is 60,

Jessi: 000,

James: do you know what that is on a, if it's 120, 000. It's 1, 000 a month. No, it's 000

Jessi: a month. So

James: if it's 60, 000 a year.

It's 5,

Jessi: 000 a month. There you go.

James: So if rent's 1, 000, are we okay? Yep. Yeah. So that's kind of interesting. Now it's not to say like that's, there's nothing hard and fast about that because in theory everyone who's above, a lot of people who are above it, they're having homes anyways. And what you really care about is more than likely that lower half.

But the closer you get to that, that just means there's even more people who can afford to live in my place. Okay. So, and I would say if your rents are, let's just say, let's keep going with this 5, 000 a month number, right? If you want your rents to be. 2, 000 a month. That's

Jessi: where I was going next.

James: Yeah, if so if you are looking at a deal And they go, yeah, the medium income for this place is 60, 000 a year.

Currently rents are 1, 000 a month, and we are going to target getting them up to 2, 000 a month by doing repairs. That should be a red flag,

Jessi: right? Because now you're like,

James: man, this is a, this is above the medium. Yeah. And that means the people who you're going to attract, you're also competing for homes.

Now, I mean, if, if this is a, like a three bedroom, two bath rental in a neighborhood. Okay. Maybe. But now you gotta start paying attention to, well, what are homes selling for, and what are 30 year mortgages, assuming people do a reasonable amount of payment going forward. Like, that's not what you're competing against.

Yeah. But if you're below the medium, you're like, we're gonna be fine. Like I don't like, like, again, if they're like, rents are at 600, they're going to 1200, you go,

Jessi: yeah, we should be okay. How do you figure out what the median income is?

James: My favorite source is. It's data us. io might be data usa. io or usadata.

io. It's some combination of that. Okay. But essentially if you can type in that city, so Corvallis, Oregon, employment data or income data, population data, and pick one of those first top blue links and you'll get it. But the, the, I should probably look it up. It's the U S it's the. U. S. data, IO, that sounds right.

It just, it looks really pretty. The way they visualize the data is good. It's all comprehensive. And yeah. Is that all pulled from, like,

Jessi: tax information?

James: Census information primarily. Oh, census. Yeah, and other, and, and they pull from other sources, but census is the big one.

Jessi: All right. Hmm. So switching now to a different area of growth.

We talked about job growth, income growth, now population growth is an indicator of a healthy market. So like you're looking at demographics is the under 30 group more than 50%? Like the renters, the primary renters. What's, what does crime rate rate look like? Yeah, you

James: want the let's see there.

What would you call him? The the Rex renter.

Jessi: Rex Renter. Yeah. Rex and reader. Renter. What does crime rate look like? Ryan, the renter. I don't know. How does I, like Rex , what does access to transportation and amenities look like? Yeah. Surrounding neighborhoods. So it's, it's kind of like population growth, but also like how, what?

What's the demographics of this market? What does it look like? Who's there? Yeah. Yeah. Yeah, exactly. Who's there and what's there?

James: Yeah, and this is something where I remember I was looking at a deal once where it was in Like a workforce type of housing place. Yeah, and And the property wasn't in great shape and they're like we're gonna make this thing high class awesome luxury I was like, Hey, that is not the area at all.

Who are you attracting for this? Like they don't, there's zero other amenities why someone would want to live here. And there's not like there was a lot of jobs around either. And so yeah, you just want to make sure that there's a, there's a fit. Ideally population's growing. There's a deal. I would love to buy this deal.

The property itself is awesome. I love the property. All the numbers for the property makes sense. It would be a fantastic investment. I love it. And it's a super cool building. Cool story. There's so much to love about it. As a matter of fact, for my, the way you could structure the deal, it's almost a nothing down deal for this multi million dollar building.

It's super, super cool.

Jessi: But I hear a big, but

James: it is in a town that is around, I think it's like three, four Is it 20, 000? 18, 000? Zero growth to some years slightly declining growth. Yeah. And the next nearest large town is over two hours away.

Jessi: Ooh. Yeah, well.

James: And I just like, I can't, I can't bring myself. You can't sustain a business there.

I love everything about this property except for its location. And it's because I see these numbers. What's the use of the property? Yeah. It's mixed use. It's like, it's my dream property. Is it that

Jessi: it's residential and restaurant? No. So

James: it's, it's got offices. It has a ballroom. It has short term rentals.

It's got such cool stuff. But you don't

Jessi: think the, the market would sustain it. Here's

James: the craziest part. This building is like the building when you see pictures of the city, this is the building that they show. I know, I know what you're talking about now. It's so cool.

Jessi: Hmm.

James: It's such a cool building.

Jessi: Interesting.

James: But I like, but it's in a town that is not growing and isn't very big. The industry it's, it's diverse, which is nice. And my biggest problem is it's so small. I go, I don't know who I would ever sell this to.

Jessi: Right. I

James: would like where it's at right now. It's super affordable. Numbers make sense, but I probably have to hold onto it for the rest of my life.

Cause I don't think I'd find anyone willing to buy it for a fixed up thing because the city itself isn't that compelling, which is hard. There's a lot of cities in Oregon. That where you go, yeah, this property's for a smaller property. Sure. Who cares? You can get away with it because like if you have a single family home, like whatever, because there's, there's 13, 000 people, there's someone who's going to be looking to buy.

So is it

Jessi: like when this is kind of a tangent on this building, but the original, like, Builder of that property was the, was the city booming at one point? And they were like, oh yeah, we're gonna put in this big building. It's gonna be amazing. And it maybe did sustain for a while

James: or I don't know. I mean, building get hosed.

So I think it was like, I think they were anticipating, yeah, this is going to become a place. And it just Interesting. Never did it. Didn't, yeah. It's kind of sad. It fascinating. I, so I care less about the size that's, I mean, there's some investors where, yeah, they're like. Yeah. I just, I just do big cities, which I get it.

There's so much diversity. There's always going to be a buyer or seller. So like, it makes sense.

Jessi: It's a bigger pool.

James: But for me, I'm more in the, like, what's growing. So like when we were doing a place in Astoria, yeah, it's a smaller place, but less than an hour drive. You were in Portland and it was growing.

The growth rate on it was crazy and, and they were like, housing shortages were a problem. And so that same city. I, there was another building, it's an interesting project where they had started a development project, ran out of money and it's just half done. And they're practically giving away this property and, and I'm just like, I, it's such, they're so interesting to me.

It's so cool. I mean, it's like a hundred thousand dollars for something that can have 15 units. Whoa. Right? Yeah. Now there's still a million dollars worth of work that needs to happen on it to get it finished over the line. But the property itself is practically free. And I'm just like, this is like the numbers make sense.

It's such a cool deal, but there's no construction people in the area because it's such a small town. Like there's not really anyone to take off the project. So I have to figure it out, which is another problem that you got to think through. There's like one, maybe two property managers in the city. Cause it's small and

Jessi: yeah, so this is why like,

James: these are really important things.

Again, size is important and you can make a bunch of assumptions if it's big, but you really want to care about. What's the population doing? Is it growing? Is it getting bigger? Which that means, because it's all about supply and demand, right? So if demand is growing, that means there's a good chance that there will be demand for the supply and prices will continue to go up.

If income is going up, that means people have more money, they'll be willing to pay more in rent in the future. It's not necessarily about today, but it's like if I hold onto this thing for 10 years, what's it going to look like 10 years from now when I want to sell it? And so, yeah, that's starting a market's important.

Jessi: Yeah. So this last. Section of the surrounding market is all about like the cap rate. So give us a quick rundown of like the market cap rate, and then I'll kind of read some of these like supporting questions that go with it. Yeah.

James: So the cap rate is short for capitalization rate, and it's simply a ratio of the net operating income divided by the price.

So the net operating income is simply. Income minus operating expenses. So it doesn't include big capital improvements. If someone makes a new roof, that's not part of the number. But essentially, it's saying, it gives you a way to compare the price of properties for the amount of income that this thing is going to produce before you take into account financing.

Jessi: Okay.

James: And so, in theory, things with a lower cap rate, this is counterintuitive, but things with a lower cap rate mean that you're paying more than for the same amount of income. So you don't like that as a buyer. As a seller, you love it. The higher the cap rate, the more you're like, oh, okay. I have to, I get to pay less for the revenue.

In my opinion, they've got the ratio upside down, but whatever. I didn't invent it, so I'm not gonna say. That's how it works. It's inverse of what you would think it would be. A cap rate of about 8 percent is pretty close to your 1 percent rule.

Jessi: Okay.

James: If that helps you.

Jessi: Yeah.

James: All right, right now cap rates in Oregon are in that like Five and a half percent.

Jessi: That's what I was going to say. It was like aren't cap rates closer to like five or six? Yeah, in some

James: places. And so that's why I've talked, there's some deals that we've looked at where it's like a cap rate of three. I was like, ah, man. But it's because they're selling it on future cash flows. Yeah. So the current ones are horrible, but they get it.

There's super easy upside on it. Yeah. But that's what it is. And so what the, so what the cap, the cap rate's important. Because you look at the sales of other properties, that's, again, another problem with a small place, there's just not a lot of cops. But you can say, yeah, here's what the NOI was, here's what it was selling for, you get a bunch of those, you can kind of get what an average cap rate is for the area.

And that's not as important for when you're buying, but it's really important for when you're selling. Because that's how other people value That's how you,

Jessi: yeah. Yeah,

James: that's how you figure out, like, oh, here's what I think it'll be worth. Or at least what I do is I will say, because I am almost like a half care but I will say, here's what I'm buying it at.

And then I'm going to assume, and so given what I just said, I assume that the cap rate slowly ticks up over time. So it means people are willing to pay less and less for the same cash flow. So it means I really need to increase the NOI by increasing income, minimizing expenses, to really see the value in that property.

Because if I can do that, Yes, that's a great deal. But yeah, looking at the market kind of gives you an idea for, all right, what should these things be trading at?

Jessi: Okay, that's super helpful. And then some of these supporting questions then make a ton of sense. You know, to figure out that market cap rate or like surrounding parameters to define like how the market is doing, you comps rental comps, By, by the same type of property.

And then current and historical vacancy rates occupancy, and it changes in it. And it like, is it going up? Is it going down? And

James: as a passive investor, you don't really need to find all of this information. You just wanna make sure that the sponsor. Has found all of that information and can share it with you.

Yeah, because those are harder pieces of data to find and usually require a really expensive subscription to get access to that data. Sure. But if you

Jessi: know what the sponsor is looking for You can kind of say, have you looked at some of these different areas?

James: Yeah. If you go to your sponsor and you're like, Hey, what is the cap rate for this area?

And they're like, yeah, that's a problem. If it's a smaller place than I'd be like, man, there just aren't a lot to go off of. So I think it's in this range. We'll see if, if you ask them, like, what are the average rents for the area? They're like, I don't know. Like, come on, dude, rentometer. com should be easy enough.

And so like, those are the kinds of things you just want to make sure your sponsor knows what they're getting into. And ultimately. What they're projecting is in line with the market that, you know, they're not, because I've seen that too, where people come in and their rent numbers are higher than the market.

Like, well, yeah, because we're making all the units new. Right? If the market doesn't

Jessi: support it.

James: Well, I mean, it's an average, so there are some that are higher. Yes. So, you know, I get it. But like, It's more risky. You really got to make that case for me. Yeah. If that's the case. And for me, if you say, yeah, we're making new units, We're underwriting this, making the assumption that we're only going to get average, but we're pretty sure we're going to get a higher.

I go, cool. You're being conservative in the way that you should be conservative. So you just gotta watch for it.

Jessi: Cool. Well, that is how you define the surrounding market. Yeah.

James: Yeah. So hopefully that makes sense. And it's not too hard. Yeah. It's usually a smaller part of the of whatever deck or whatever presentation someone's showing you.

Cause it's important to touch on it. Yeah. You know, ultimately the property needs to make sense, but I think it's just important, you know, it's the, it's the high tide. We'll raise all boats. It just makes things easier. Yeah. And and why not? I don't know if you explicitly

Jessi: said this. I think you did, but just to reiterate, the market is not like the market for the world or for the U S it's like.

There are different markets.

James: Yes. There are thousands of markets

Jessi: within different cities. And I

James: would say it's like, it's within that 45 minute commute is the market. Yeah. Yeah. Usually it's that specific city that you're looking at. Yeah. So I would find it's more

Jessi: granular.

James: Yeah. Yeah. There you go. There you go.

Cool. Awesome. And hopefully you found that helpful. And if you enjoy this podcast, we would love it if you left either a rating or review, wherever it is that you listen. And if you're interested in investing with us, we would love for you to check us out at furlo.com. And so with that, I want to say, thanks for listening.

Have a great day.