The Top Locations to Purchase a Rental Property in the US

With the Federal Reserve cutting interest rate by a quarter basis point for the third time in year 2019, purchasing a property is becoming increasingly attractive. Typically, the interest rate is usually cut when there is some sort of economic weakening. In this case, it can be attributed to the impact of the US-China trade war. The Fed Funds rate, defined as the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis, is now hovering around 2%. The prime rate, which is the rate banks extend to their most creditworthy customers and is typically 3 percentage points higher than the federal funds rate, also will see a similar decrease. I would anticipate a further decrease in the rate as we move into 2020, given the Fed would like to protect the health of the economy ahead of the 2020 elections. With all this in mind, my current plan is to purchase a second property September-October 2020. Given this, highlighting the locations that pose themselves as the prime targets to achieve a good net rental yield seems imperative.
Before diving deeper into the net rental yields across the country, discussing the meaning and calculation of net rental yield will provide a better understanding and appreciation. Similar to an annualized rate of return calculation, net rental yield is used extensively in the real estate industry to evaluate the yearly performance of a piece of property. Cap Rate (Capitalization Rate) is also called the Net Rental Yield. Net Rental Yield can be calculated by taking the monthly income from a rental property and multiply that by 12. Then subtracting the yearly expense to take care of the property. Finally, the resulting number is divided by the purchase price including the closing costs. For example, if a rental real estate owner gets a monthly income of $2180 per month from a property and it requires a $880 per month to manage the property. The $880 expense per month is broken down into repairs, electricity, water, sewer, gas, HOA, and property taxes. If the property was purchased for $176,841 then the net rental yield is roughly 8.8%. In this particular case, this is a healthy number. Ideally, a net rental yield upwards of 7% is good. It is important to factor in the expense as excluding it results in a gross rental yield and can provide false implications.
You will notice a couple of things based on the net rental yield equation. First, the net rental yield in coastal cities with high home prices will more likely be on the lower end except if the rent prices have caught up in that city. This is the case for San Francisco, where the net rental yield is roughly 2-4%. Second, net rental yields only factor in passive cash flow from a rental property and is suited for long-term rental real estate owners since it does not include home value appreciation.
Now, to discuss the cities with the best locations to purchase a rental property, we will anchor on three things (Population growth rate, unemployment rate, and net rental yield). To start off, below is a heat map with 2017-2018 population growth by metropolitan area. What stands out when looking at the absolute numeric change in population from 2010-2018 is the Dallas-Fort Worth-Arlington area adding over 1 million new residents over 8 years. The Houston-Woodlands-Sugar Land area also exceeds this 1 million mark.
Below is the unemployment rate for the United States as of August 2019. A few things to note from the map are: there is generally a higher unemployment rate as you move away from the Heartland of the US. Ames, IA Metropolitan Area, Charleston-North Charleston, SC Metropolitan Area, and Greenville-Anderson-Mauldin, SC Metropolitan Area have the lowest unemployment rates just under 1.6%. A more thorough list can be found here. Denver-Aurora-Lakewood, CO Metropolitan Area has a 2.2% unemployment rate tied at #34. Kansas City, MO-KS Metropolitan Area comes in tied at #72 with a 2.5% unemployment rate. The Austin-Round Rock, TX Metropolitan Area has a 2.6% unemployment rate. The Dallas-Fort Worth-Arlington, TX Metropolitan Area has a 3.1% unemployment rate and Houston-The Woodlands-Sugar Land, TX Metropolitan Area a 3.6% unemployment rate.
Finally, taking a glance at the net rental yield, the one thing that is obvious is the low rental yields on the west coast. This is expected as home prices are absurdly high. The best rental yields can be found in states located in the heartland of America.
In summary, I would recommend going through this list of cities with the best rental yields. From my personal standpoint: Houston, Orlando, Indianapolis rank at the top of my list at the moment. Happy hunting!


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