Midwestern Markets Offer Best Risk-Adjusted Returns

Cities in Ohio and Texas dominated Compound Asset Management's top-10 list of the most attractive metro areas as residential investment targets. California accounted for the four worst.
Top cities for U.S. real estate investment. Chart courtesy of Compound

Steer clear of the coasts and invest in the Midwest—that’s one possible takeaway from Compound Asset Management Inc.’s new ranking of the nation’s largest urban residential real estate markets.

The company’s unique index ranks the relative performance of each market as an asset class by calculating its Sharpe Ratio, a measure of risk-adjusted return. Indianapolis was the clear winner with a Sharpe Ratio of 2.42, after seeing home price growth of 12.5 percent year-over-year through March 2019. A recent Yardi Matrix report found that rental growth in Indianapolis was driven by favorable employment and demographic trends in the 12 months ending September 2018.

Next up were Cincinnati, Kansas City, Mo., Charlotte, N.C., and Dallas-Fort Worth. More cities in Ohio and Texas, along with Atlanta, rounded off the top 10 list.

By contrast, California accounted for the four worst-performing cities on Compound’s ranking, with another West Coast conurbation, Seattle, taking fifth place. San Jose, Calif., took the crown for investment loser with an estimated Sharpe Ratio of -0.26, stemming from its 0.3 percent annual price decline.

San Diego, San Francisco and Los Angeles followed with negative risk-adjusted returns. Washington, D.C., Baltimore, Virginia Beach, Va., Portland, Ore., and Chicago also fared poorly.

A matter of risk

Worst cities for U.S. real estate investment Chart courtesy of Compound

Compound Chief Investment Officer Jesse Stein told Multi-Housing News that many of the more stable markets have experienced strong price growth over the past year. The combination of recent appreciation plus the relatively low volatility of these markets, explains their standout performance on the index.

“On the other hand, some of your high-flying markets in California and Seattle and such, that are more volatile, and oftentimes produce outstanding returns of 20 percent plus per year—they’re actually underperforming right now, which makes them even less attractive on a risk-reward basis,” he added.

The company calculates the performance of the 40 largest metro areas across the U.S. by measuring total appreciation relative to the associated risk of volatility. Return is based on the Zillow Home Value Index, while risk is measured by calculating the Sharpe Ratio for each metropolitan area’s average home price.

Founded by Stein and Janine Yorio, Compound creates city-specific real estate funds focused on residential assets that allow investors to gain targeted exposure to high-barrier-to-entry cities. The company rolled out its ReTF: NY Residential product last year, which allows retail investors to bet on Manhattan residential properties with a minimum investment of $1,000.

Stein told Multi-Housing News that Compound intends to make the trading of cities similar to that of stocks.