If you are thinking of buying a rental property, you might be tempted to focus only on the best neighborhoods in the city. A nice neighborhood comes with amenities such as great schools, malls, transportation, and parks. Such locations tend to attract lots of tenants. However, another option you should consider is buying a property in a transitional neighborhood.
What Is a Transitional Neighborhood?
A transitional neighborhood is an area that may not be very established but is growing at a rapid rate. The rise of transitional neighborhoods is commonly referred to as gentrification.
What are the signs that a neighborhood is transitional, otherwise referred to as an up and coming neighborhood?
- It is surrounded by hot real estate markets – A less developed neighborhood located close to a more established one has a high chance of being gentrified. This is referred to as the ‘creep effect’. As property prices rise in hot markets, people start moving outwards to look for more affordable options.
- Rapidly declining days on market (DOM) – As the name suggests, the days on market is the number of days a property has been listed for sale. Declining DOM shows that a neighborhood is starting to heat up.
Related: How Average Days on Market Should Affect Your Investment Decision
- Accessibility – One of the clearest indicators of a transitional neighborhood is accessibility to public transport. If there is a major highway or railway passing through it (or one in development), it is only a matter of time before a neighborhood transforms into a bustling center.
- Falling crime rates – By reading local sites or following sites like cityprotect.com, you will get a good idea of crime levels in different areas. Declining crime rates are a sign that a neighborhood is about to boom.
- A vibrant art scene – History has proven that artists are usually the first agents of gentrification. When musicians, filmmakers, and fine artists settle in an area, bars, restaurants, and galleries will automatically follow. This will, in turn, attract more businesses and residents.
- Retailers are setting up shop – Big box retailers spend a lot of money on market research before choosing their next location. When you see an influx of corporate brands rolling into a neighborhood, then the area is clearly on the rise.
The Pros and Cons of Investing in a Transitional Neighborhood
Let us look at the benefits and drawbacks of real estate investing in a transitional neighborhood.
Pros
- Low prices – Property prices in transitional neighborhoods are often lower compared to those in established areas. This can be very helpful especially if your budget for real estate investing is limited.
- Extra money for renovations – When you pay less for an investment property for sale, you will probably be left with some money to spend on renovations. This will help increase the value of the home.
- Possibility of high returns – As the neighborhood becomes more popular over time, the value of your income property could also increase in value. This means that you will be able to charge higher rents and even sell your property later for a good return on investment.
- A strong sense of community – Transitional neighborhoods usually have a strong sense of community. This factor will make it easier to attract potential tenants or buyers.
Cons
- Unkempt neighboring properties – Though you can purchase an investment property and fix it up, you will not have much control over the surrounding properties. If the neighboring houses are an eyesore, it might not be easy to attract tenants right away. This could also have a negative effect on your resale value.
- Lack of amenities – Investing in a neighborhood that lacks basic amenities like good schools, grocery stores, hospitals, and parks could make it difficult to attract or retain tenants.
- Over investing in renovations – When investing in an up and coming neighborhood, it is hard to know how much you should spend on renovations. Since it is a transitional neighborhood, it can be hard to figure out what renovations will be needed to keep up with the future growth of the area and you might find yourself overinvesting without getting a return on your investment.
- High risk of failure – If you buy a rental property in a bad neighborhood, there is no guarantee that the area will transition for the better. And even if it does, it might take a very long time. This makes investing in a transitional neighborhood a very risky venture.
So, Should You Invest in a Transitional Neighborhood?
There are clearly some advantages to buying an investment property for sale in a transitional neighborhood. The general advice: if you understand the risks and have the full-capability to take them on, then owning a property in this type of neighborhood can make for a good addition to your real estate portfolio. Still, you want to try to find a transitional neighborhood that is more likely than not to be a good place to own a rental property.
How to Identify a Profitable Transitional Neighborhood
So, how can you identify a good transitional neighborhood to invest in? You can conduct a neighborhood analysis using Mashvisor’s real estate heatmap. This tool uses real estate analytics to mark the best locations to invest in rental property.
You can narrow down your neighborhood research using the following filters:
- Listing price – This is one of the most important parameters to consider when looking for the best places to buy a rental property. A property’s listing price will determine its profitability in terms of real estate appreciation, return on investment, and rental income. The listing price filter is ideal for investors that are looking for property that is within a budget. Neighborhoods with affordable investment properties for sale will appear in red and orange while more pricey ones, in green.
Related: Price to Rent Ratio by City – Where to Invest in 2020
- Rental income – The aim of investing in rental property is to generate high rental income. The heatmap tool uses traditional and predictive analytics to provide rental income data for a neighborhood. You will find data for both traditional and Airbnb properties. This will help you find a transitional neighborhood that currently offers high rental income.
- Return on investment – Return on investment is the most important neighborhood data that determines the profitability of an investment. This is because ROI considers the operating and rental expenses as well as the rental income. The heatmap analysis tool will point you in the direction of neighborhoods that offer high traditional or Airbnb cash on cash return (equal to cap rate here).
- Airbnb occupancy rate – When looking for Airbnb investment properties in transitional neighborhoods, estimating the Airbnb occupancy rate is crucial. Occupancy rate basically shows you how often a rental is occupied by guests. The higher the occupancy rate, the more you will earn from rental income. The heatmap tool will help you find the neighborhoods with high Airbnb occupancy rates in any city.
Related: Finding Income Properties Using a Heatmap
Conclusion
Investing in up and coming neighborhoods can be a very risky affair but it comes with advantages. When thinking of where to invest in real estate, you can mitigate the risk by doing your due diligence. This will help you make the right decision and enhance your chances of success.
To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.