I’ve been talking a lot about markets lately, and oddly enough I was asked on three separate occasions just in the last week my opinion as to whether or not I thought Palmdale, CA would be a good place to invest in a rental property.
So I thought, well, people are obviously wondering — so how about I just make a whole article out of it? I thought it would be a cool idea because it will hit on not only what fundamentals about a market I look at when shopping for places to invest, but it will also tie it into a real-life example so you can see how the concept of knowing the market fundamentals can actually be applied to a real scenario.
What I Look For in a Rental Property Market
Before I can jump into actually assessing a market, I want to make sure you know more fundamentally what things I will be considering.
The basic factors I look at before jumping into any market are:
If I buy a property in that market, how will I be able to make profit? Will it allow for cash flow, or is there appreciation potential? Or will it just cost me money to own a property in that market (which is bad)? You should never go into any investment without understanding the numbers.
I never base my buying decisions on the appreciation potential of a property because I don’t invest for appreciation; I invest for monthly cash flow. But whether or not a market is anticipated to appreciate can sway my opinion on buying when it comes to balancing trade-offs.
For example, if a property or market is lower on the cash flow potential side but it has a tremendous possibility for appreciation, then I may go for it. Or if a market has no appreciation potential but has high monthly cash flow, then I might be OK going for it because the high cash flow keeps me in the game. So, I at least consider appreciation potential in my list of factors.
Population: Growing or Declining?
Is the population increasing or decreasing? Why does it matter? It matters for exit strategy, vacancy, and tenant quality, all of which can dramatically affect your bottom line. Exit strategy can affect it for the ability to sell it later (and for how much); vacancies are extremely expensive, and if the population is declining then there will continue to be fewer and fewer renters, which will increase your vacancy times; and then bad tenants are just expensive all around. You have better options for exit strategy, tenants, and fewer vacancy rates when the population is growing and not declining.
What are jobs tied to? Industry. Every job is part of an industry. The more industry options you have in a particular market, the more jobs there are likely to be, and those jobs bring in more people. But then the additional bit about industry is that, preferably, the market you are looking at supports multiple industries.
If a market has one huge industry and that industry does in fact produce a huge number of jobs, which we’ve already established is a good thing, that is great, but what if that one industry crashes? With one big swoop, all of those jobs we were reliant on are gone, and boom, there go the people.
Remember Michigan with the automobile industry? It was devastating to the whole state, certain cities more than others, when the automobile industry tanked because that was the main big industry there. There is no way to predict the future of any one industry, so if you choose a market with several big industries, you are helping cushion yourself should one industry go out because the others that are there can carry the weight of jobs. If the market you buy in only has one major industry, you are increasing your risk tenfold because you don’t know what may happen to that industry at any time.
What is one of the best ways to support an increasing population in market? Have a lot of jobs available for people there! People go where jobs go. If there are no jobs, there are going to be few people. Jobs and number of people are directly proportional. So the more jobs, the more people, meaning population increase, meaning the benefits stated above.
Specifically for a rental property owner, the laws that are important are the ones regarding tenants’ rights. If a state is considered “tenant-friendly,” it means the laws regarding tenants’ rights are more in support of the tenants and less in support of the owner. This means things like longer times to get an evicted tenant out of the property, legal expenses to the owner to get them out, etc. Basically, it can cost the owner a lot of money.
In states considered to be “landlord-friendly,” the tenant laws are more in support of the landlord/owner in the sense of faster times to get rid of a bad tenant, less or minimal cost to do so, etc. Investing in a landlord-friendly state reduces a lot of risk for expense should you get a bad tenant. It’s not always bad necessarily to invest in a state that is considered to be “tenant-friendly,” but it’s something that should at least be considered.
I say this one to point out the problems associated with, say, investing in a total “troubled” area. If where you are thinking of investing is mostly populated with a rough crowd, just know that bad tenants can be one of the costliest things to a rental property owner. This is especially pertinent in specific neighborhoods of different markets, but it should even be considered for bigger markets.
If a market has a declining population and/or not much for jobs and industry, what kind of people do you think your renter’s pool is going to have? Probably not as many upstanding citizens (who pay their rent) as one would hope. Not saying there won’t be any, but always think in terms of the majority. At the point I’ve assessed population, jobs and industry, I probably have already properly ruled out a market or decided to pursue it, because at that point the tenant quality is often inherent in those other factors so I don’t necessarily need it to make my decision. But it’s worth making a note of.
An Analysis of an Actual Rental Property Market: Palmdale, CA
In order to help you really learn to apply these factors, I’m going to go through here exactly how I went through my initial analysis in my head when I was asked what I thought about Palmdale, CA as a potential place to invest in rental properties.
Now, I want to preface this analysis with my stance on whether I would invest in this market personally is complete personal opinion. If you read this but then decide you want to buy a rental property there (obviously that gives it away that I don’t want to invest there), am I going to think badly of you? Nope. I support anyone doing whatever they want. The only reason I present my analysis of this market is to give you an idea of the things I look for and introduce you into getting more familiar with analyzing markets for yourself.
My second caveat to sharing my analysis with you is that I never made it past the initial analysis phase in order to look at any official statistics or numbers regarding this market. Due to what I came up with just in my initial analysis, I didn’t care to further pursue looking into more details. Had my initial analysis come back more supportive of Palmdale possibly being a good place to buy a rental property, then I would have started looking at more concrete numbers. So, before you start showing me numbers and asking why I didn’t consider them, there it is — I didn’t care. Hopefully once I go through the analysis, you’ll understand why I didn’t care to look them all up.
Are you ready? Following the exact same list I presented up above, I’m going to go through each item and tell you what ran through my head as I thought through each one in regard to Palmdale, with the addition of just a little bit of background information about the city in case you aren’t familiar with it.
Palmdale, CA is a city about 1-1.5 hours Northeast of Los Angeles. It is considered to be in the “high desert” and is technically considered to be part of the Antelope Valley (ironic, since there is nothing “valley” about it — it’s all desert), and it neighbors Lancaster.
The reason people are interested in potentially buying rental properties in Palmdale is because of the numbers. Compared to most of the rest of SoCal, the price to buy properties in Palmdale is much more affordable, and for investors, the properties at least start to hint at being able to provide positive monthly cash flow. I actually lived in Palmdale/Lancaster for about eight months when I first moved to California because that is where my job was based out of, so I have a significant amount of familiarity of the area.
So, what do potential returns there look like? Well, not great in my opinion. Just pulling up Zillow to get an idea of some values, I’m seeing a property listed for $350,000 that would potentially rent for $1,950/month, I see a property listed for $240,000 that would potentially rent for $1,625/month, I see a foreclosure listed for $161,000 that would potentially rent for $1,475/month — and a quick side note about foreclosures, I see a significant number of foreclosures listed.
So let’s look at this — just what I am noticing at first glance. Since people do so love the 1% and 2% rules, let’s just use those. Do any of those properties listed hit those? Not even close. That foreclosure property almost sneaks into the 1% category, but it’s not there. This is a perfect example of a proper way to use those “rules,” by the way — just use them as a first basis of analysis. I will never use those numbers to make any actual decisions, but just seeing whether or not properties in an area come close to hitting those at all will tell me a good bit.
In a lot of markets I don’t necessarily require that a property hit the 1% rule for me to invest, but whether or not a property does hit the 1% at least or not does matter to me in markets that notoriously have higher taxes and insurance costs. All CA cities, to me, fall into that category. Florida, too. Just because I know those costs and other expenses are notoriously higher in those states, I will be a lot more hesitant to scoot away from properties coming up as not meeting the 1% rule. So, without even running actual numbers on any properties in Palmdale, I can see that the general trend of numbers not supportive of positive monthly cash flow in most cases.
Again, no specific stats here, but it is a known fact that high desert cities are the first to decline in value and the last to recover during a recession. They also do not experience the same levels of appreciation as, say, Los Angeles or San Francisco would. So, that should be noted. As I said before in talking about appreciation potential, it’s about the trade-offs. If the cash flow is minimal but there’s a chance of it having Los Angeles-style appreciation, then I might be more inclined to consider it. But in Palmdale’s case, compared to the rest of SoCal, it’s likely to appreciate much less.
Population: Growing or Declining?
This one I have no idea. I actually believe the population is increasing in Palmdale, and especially Lancaster, because of all the building and development that is going on there. SoCal in general of course is always a growing population, but I’m not sure on Palmdale. So for now we’ll consider this one an unknown. (But I essentially skip over this factor once I look at the rest of them. You’re about to find out why.)
This one is a doozy for Palmdale in my opinion — “doozy” in the sense of “not good.” The primary industry supporting Palmdale is the aerospace industry. Literally every aerospace defense contractor company has a building at the Palmdale Airport. Lockheed, Boeing, Northrup, NASA — all the big boys.
Because Palmdale is located in proximity to Edwards Air Force base and other government aerospace test bed hotspots like the Mojave Desert, it makes sense to station all of those companies nearby. I was working at Lockheed, hence why I ended up there. Anywho, the only other “industry,” if you want to call it that, is Edwards Air Force Base. It’s about a 45 minute drive away, but fortunately for Palmdale and Lancaster, they are the only sizable cities even close to Edwards.
So a lot of the military folks who work there may likely end up living there (although more likely Northern Lancaster so they are closest to the base). But for the most part, aerospace is really the only substantial industry supporting that area. As in, one major industry. That in and of itself is a red flag for me when looking at different markets, but more so with aerospace — on one hand, it’s a really sturdy industry because it’s beefy, a lot going on, and plenty more coming; on the other hand, it can be volatile.
Especially with most of those big boy companies focusing on military airplanes, who knows what kind of fluctuations in defense budget could cause a major decline in business up there for some amount of time. All I know and all I care about is if the aerospace industry has any kind of major tank at any point and any of those companies pulled out of the area, the entire city of Palmdale could go down into the dumper. And quickly. Aerospace is the reason that town is alive and sturdy, so if there were to go, who knows what.
Going hand-in-hand with industry obviously, the job base around Palmdale is going to be mostly dependent on the aerospace industry. This one fluctuates a lot more than the industry as a whole does, mostly because jobs within the aerospace sector can go dramatically up or down within the aerospace umbrella without the entire company collapsing.
On one hand, aerospace companies are oftentimes thriving regardless of other industries of the world. They are a fairly elite sector, and they employee a ton of people — both salaried employees and union workers. So they cover all spectrums of employee levels. On the other hand, layoffs can happen very quickly with these companies. The minute the government’s defense budget gets cut, workers will be at risk because most of these companies are paid by through the government’s budget.
Or Boeing, for example, deals more in the commercial airline space, but how volatile is that industry? Quite! So jobs with aerospace can be extremely awesome or extremely not, depending on the political situation of the moment. The Edwards military jobs up there would be sturdier, but still, you’re looking at a smaller pool of jobs in general. The jobs there are very niche.
In short, California is tenant-friendly, and it’s been known to be tenant-friendly in an extreme way. I’ve heard numerous horror stories of property owners in California who were absolutely upside-down in getting a tenant out because it would cost them so much money to do so that it would almost be cheaper to let the bad tenant squat.
I’ve heard of fees ranging from $5,000-10,000 just for the eviction costs, and that doesn’t include the money they have to spend on a lawyer because California requires a lawyer to be hired for some aspects of it.