Today, we're talking about an important yet easy to understand investment strategy, the 3-2-1 strategy.
Think of the 3-2-1 strategy like a rocket launch. In order to launch, the rocket has to have a phenomenal amount of energy. That's pretty similar to what we're trying to accomplish here in apartment building investing. 3-2-1 growth is simply this, when we're looking for great markets that have great risk adjusted returns for investors, we're looking for certain things.
The base layer is three things. We're looking for population growth, job growth, and income growth.
We want to find places people are moving to, where incomes are going up. We canvass the world looking for those things. When we see those things on the first layer, then the next layer is likely to happen.
The next layer is where we're looking for cap rate compression and rent growth, and those things will sort of naturally happen.
When there's a market where there's huge population growth, that's going to lead to cap rate compression, which means buyers fighting over assets and being willing to pay more for a property. When there are tons of people moving into a town, they're going to be fighting over property and that's going to bring up the price of rent.
So, when layer two is set up, we get to our top and final layer, the IRR growth, or the growth of your investment. When cap rates go down and rents go up, that is the magic formula for the return on investment going up. So 3-2-1 is how we get growth in this industry.
Back to the first layer, do we look at growth over a year, three year trends, five year trends – how far back is best to look?
What other metrics help us besides unemployment rate?
We generally don't want to get too caught up in what's happened in the last 12 months, because for instance, there might have been a global pandemic that affected rents a lot in the last year. But if you look back three years, or maybe four to five years, some of the noise in that data gets smoothed out. So we tend to look three, maybe five years out at these trends.
The other reason is because these kinds of growth – population growth, job growth – are not phenomena that start and stop every 12 months. We want to look at long term trends.
For job growth, we're looking at specific industries that are showing signs of growth in that particular area. One of our hot markets is Huntsville, Alabama. They're really big in the aerospace industry, so we're going to look at job growth in that space and see if that can help us with the economic development that creates the stable job growth that we're looking for.
When you're feeling overwhelmed with analyzing a market, just remember the 3-2-1 method help you out. Once you've narrowed down your search to a couple of key markets and are ready to take the next step in analyzing a deal, be sure to use Michael's Syndicated Deal Analyzer, which can be found at themichaelblank.com/syndicated-deal-analyzer.