Smaller cities are the new stars in the home-renovation movement

When commercial mortgage lenders and real estate investors pursue a fix-and-flip property, location is arguably the most significant factor in making a deal. From a macro level view of selecting a location, two crucial things to consider are the area’s population and migration trends.

Regarding fix-and-flip projects, investors and the mortgage brokers working with them should be aware of the market trends created or made more intense by the COVID-19 pandemic, especially concerning the increased mobility of workers. This change has meant there are more opportunities to telecommute and to enjoy a hybrid work schedule.

These freedoms in the working world mean that a growing number of people can live anywhere they please, including less-expensive rural areas. This has resulted in a greater demand for refurbished homes in emerging markets — including in secondary and tertiary cities where populations are growing. Of course, the contrary also is true. It’s important in this investment analysis to avoid areas where job growth is negative and residents are leaving.

Many homes in emerging areas have lower purchase prices because these locations haven’t experienced the pricing pressures that have occurred in larger metropolitan areas in recent years. In general, these markets are situated 30 to 90 minutes from large metro-area cores. They may have newer subdivisions that lend themselves to a more friendly fix-and-flip environment. For example, the Phoenix suburbs of Queen Creek and San Tan Valley are popular areas that have subdivisions built in the past 10 to 15 years, making them easier to flip than older homes in need of more costly investments and extensive repairs.

Rural America’s moment

Another demographic change is the rise of rural cities such as Billings, Montana. This city with a metro-area population of about 184,000 jumped to the top of the list of the country’s emerging housing markets this past July, according to an index compiled by The Wall Street Journal and Realtor.com. The index focuses on cities that offer appreciating home values and good quality of life.

The results, at least anecdotally, show how homebuying activities are increasing in smaller to midsized cities around the country. Second on the list, which was dominated by these smaller cities, was Coeur d’Alene, Idaho. The remainder of the top five towns included Fort Wayne, Indiana; Rapid City, South Dakota; and Raleigh.

Realtor surveys show that the reasons people are flocking to Billings include low unemployment, inexpensive housing, a low crime rate and a beautiful natural setting. Other Montana cities are growing, too, resulting in the state’s population rising by about 100,000 people since 2010 and allowing Montana to gain a second congressional district.

Economic consultant and University of Montana professor Dr. Bryce Ward reported that oil, coal, agriculture and outdoors attractions have contributed to recent job growth in Billings and other parts of eastern Montana. The result of this job growth is a demand for homes in all income brackets. And this trend should continue as future job growth in Billings over the next 10 years is expected to be 24.4%.

Billings’ current housing market lends itself to both traditional fix-and-flip projects and houses that need more extensive remodels, often known as a “wreck and redo.” Mortgage brokers should advise investors to be careful with the latter activity. When flipping these wreck-and-redo homes, there is a greater chance of having to amend the physical foundation and structure of the house — in other words, having to change the design of the home by adding bedrooms, doorways, windows and more. Obviously, this type of work results in higher renovation costs.

Another reason for your clients to consider avoiding a wreck and redo is that they will be dealing with outdated utilities such as old electrical wiring, cast-iron plumbing, rusty sewer mains and damaged drain systems. In comparison, with newer homes that truly fit the fix-and-flip title, owners are literally fixing minor problems before reselling the house. This isn’t to say that newer homes don’t have their issues, but in the majority of cases, they are significantly more cost-efficient and investor-friendly.

A search of Zillow.com shows a mix of homes in markets such as Billings. Investors should look carefully at older homes as they may cost much more to remodel. Many of the available homes that were built since 2000 offer modern-day architecture and typically only need appliance upgrades and some visual improvements to make the houses more appealing. To reiterate, this type of investment saves time and money on renovation costs and design fees. This is yet another sign that emerging markets are good opportunities for investors and incoming residents due to increased housing demand.

Know what to avoid

For lenders and property owners still wary of the concept of investing in an emerging market rather than a major metro area, there is one key thing to consider: The workforce of today has changed — and it’s likely to be permanent. Consider large tech companies with wealthy millennial employees who can enter the housing market at a young age. Companies such as Coinbase, Shopify, Quora, Zillow, Indeed, and Square have announced that they’ll allow their employees to work remotely on a permanent basis.

Commercial mortgage brokers and lenders need to help their clients do the proper research and truly master the markets that they are thinking about entering to secure a profitable fix-and-flip investment strategy. Job growth, investor opportunities, per capita income, education quality and crime rates are key factors to study. Ultimately, it is crucial to understand that there is no single best emerging location for real estate investors to focus on. If this were the case, every investor would be piling into the same place and would quickly diminish the potential investment returns.

Just as important as what to look for in an investment property is what to avoid. One of the obvious and most crucial danger signs are areas that have suffered from significant population declines and job losses. This double whammy can often be found in rural areas and is all the more reason why lenders and investors need to do their homework to find the right places to buy.

During the past decade, the fastest-shrinking city in the U.S. was Pine Bluff, Arkansas, which has seen decreases in agriculture and manufacturing employment reduce its tax base. The result is the city lost more than 12% of its population from 2010 to 2020.The second-fastest shrinking city was Danville, Illinois. In the past decade, the population declined by 9.1%. Similar to Pine Bluff, the decline was kickstarted when large manufacturers — including General Motors, General Electric and forklift maker Hyster — shut down their operations in the late 1990s.

The more time spent looking at cities with declining populations, the more patterns and similarities become apparent. In general, it is fair to say that cities with stable and growing job markets are safer places for commercial real estate investors.

When thinking about becoming involved in the fix-and-flip market, commercial mortgage lenders, brokers and buyers should keep in mind that as more concentrated metropolitan areas and primary markets continue to get exponentially more expensive, second- and third-tier emerging markets will be increasingly beneficial for investors. Emerging markets can offer substantial long-term property value appreciation, but they must be the right locations. Research into topics such as an area’s population trends and employment statistics are an investor’s best bet in finding the right location to place their capital.

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