When it comes to rental property investing, even for passive investors, it is critical to understand how the forces of demand influence desirability for a key market. Conceptually, there are two approaches to demand analysis, Inferred and Fundamental. I will describe each using the Appraisal Institute’s definition for each term.
1️⃣ Inferred Analysis:
Demand projected on the basis of current market conditions, historical rates of change, and absorption patterns. This level of analysis, also referred to as trend analysis, describes what has historically occurred in the marketplace. Many appraisers, real estate agents, mortgage brokers and others follow this approach with the understanding that historical data can help be a determinant of the future. Examples of data observed in inferred analysis are as follows:
- Population growth
- New Construction Units
- Unemployment trends
- Rent growth
While history can be a great indication of the future, this approach is largely a lagging indicator, or the result observed from certain catalaysts in the marketplace. What are those catalysts? That is where fundamental analysis comes in.
2️⃣ Fundamental Analysis
Demand projected on the basis of the underlying factors that affect the economic well-being of real estate such as employment; population; household income, expenditure amounts, and preferences; and spatial growth patterns. In real estate appraisal, these factors are segmented to the subject property’s submarket and then to the subject property. If you have not read our market reviews, I describe both historical trends and details that shed light on the future demand of a market. Some of these catalysts for growth include:
- Future construction projects
- Migration trends for the area
- Growth in specific age or income demographics-government funding for development or opportunity zones
- Business merger/acquisition/repositioning activity
Each of these details are just a few examples of fundamentals that contribute to future demand.
🚨 As A Passive Investor…
We are likely miss out on great opportunities by investing on the basis of what has occurred versus what will occur. In other words, by reading an article “Best Places to Invest in Real Estate,” we would be too late to the game. Most of articles are based upon the trends observed by inferred analysis and not those leading indicators that drive future demand. When evaluating investment opportunities, rather simply than observe historical trends, it is critical to analyze the leading indicators of demand growth for the selected location and type of property. Understanding the fundamentals and implementing them into your investment criteria is the surest way to protect your investment and achieve the expected growth through its holding period.
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