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Real estate is one of the largest commodities in the world, and there are many factors that affect prices. The key factors include interest rates, the economy, demographics, and more.
If you’re looking to purchase a home or invest in a property, you should know the basics of what drives home values. With a better understanding of the real estate market, you are more likely to make a good investment.
Like most things in life, the housing market is continually changing and can be unpredictable. This article will cover all of the main points of what influences the prices of residential and commercial properties.
Interest Rates
Interest rates have a lot of power over the economy and the real estate market. Lower rates make the cost of a mortgage more obtainable. When rates are low, there are more buyers, along with more demand. Low rates typically cause real estate properties to increase in value.
Higher interest rates make it more expensive and difficult to obtain a mortgage. When it is harder to get a mortgage, demand for real estate goes down along with prices.
Changing interest rates affect the value of both commercial and residential properties. Simply put, when it costs more to borrow money, the value of real estate goes down.
Supply and Demand
Just like everything else in a free market, real estate prices are driven by supply and demand. More buyers and fewer sellers mean higher property values. More sellers and fewer buyers equate to lower property values.
Supply and demand is affected by interest rates, the economy, the availability of real estate, commodity prices, and more. If there is an overabundance of homes, the values will go down. If properties become scarce, the values go up.
A rising cost to make homes can increase real estate prices. But if it becomes cheaper to build them, prices will subsequently decrease. Demand for lumber and raw materials will typically rise or fall along with the real estate market.
The Economy
How well or bad the economy is doing can have a massive impact on real estate prices. High unemployment, weak GDP, and other poor economic data will hinder the housing market.
It’s easy to associate a bad economy and fewer people making money to less demand for homes. But not all real estate markets are treated the same. Hospitality real estate like hotels and even restaurants can be hit harder than government or office real estate.
The economy goes through cycles. Home values are usually the highest at the peak of an economic cycle and lowest at the bottom.
It is quite challenging to predict which present economic cycle we are currently in. Even the greatest economists frequently get it wrong.
The Stock Market
Stocks aren’t often thought of as a driving force behind real estate prices, but I’ll tell you how they are correlated.
Millions of Americans are invested in the stock market, whether it be through 401ks, IRA, individual accounts, etc. When the stock market is doing good, people are more confident about their financial situation. Businesses are more confident; more jobs are usually created as well.
When the stock market performs poorly or crashes, fear sets in. People start to hoard money and do not want to invest in riskier assets, including real estate.
If the market sell-off is long-lasting and brutal enough, people will lose a lot of their retirement money and more. This begins to drag down the value of homes.
On the contrary, a badly performing stock market can also lift the value of homes. All it takes is for the majority of investors to decide the stock market is a poor investment. They will then begin to look for other places to invest like real estate.
An increase of investors leaving the stock market for real estate would cause values to rise, but it would likely be short-lived. The stock market losses would have a ripple effect on the economy, which would ultimately bring home values down regardless of an increase of investors.
Demographics and Location
The age, income, population growth, and more are what make up a demographic. And shifts in demographics can significantly affect the real estate market.
For example, if population growth explodes, it will likely create long-term increased demand for homes. A decrease in population growth can have the opposite effect.
A boost in younger homebuyers will correlate to higher prices for single-family homes. More retirees and older generations can create a higher demand for secondary or vacation homes.
Every location will have a subset of its own demographic, which will affect its local real estate market.
Areas with a low cost of living usually have poor job prospects and a heavy population of retirees. High cost of living areas have better job opportunities, along with a more youthful population.
Due to this and other factors, real estate values are lower in regions with LCOL and higher in areas with HCOL.
Government Policies
Legislation can largely alter the demand and value of properties. Using subsidies, tax credits, deductions, and more, the Government can momentarily increase or decrease demand.
Political changes, new policies, housing programs, they all affect real estate prices. How much of an effect depends on the actions and type of legislation made.
In 2009 the US first-time home buyer’s tax credit was offered to increase demand. Which did work, but the incentive was for a limited time only.
Real Estate Reports to Pay Attention to
When considering the residential housing market, there are several economic indicators that are worth paying attention to.
The key housing reports to follow are:
- Housing starts. This report covers the amount of new residential construction developments.
- New home sales. Covers the number of new homes sold.
- Existing home sales. Reports the number of used homes sold each month.
- The Federal Housing Finance Agency (FHFA) House Price Index. Tracks the prices of single-family homes.
- Pending home sales. A monthly report of pending home sales.
Final Thoughts
The complexity of the real estate market cannot be boiled down to the influences we discussed alone. Clearly, there are some straightforward factors that affect the prices of real estate. But there is also a lot of other lower-level considerations that can come into play.
Investing in real estate can be very lucrative. However, it involves more risk than most seem to think. Having a strong understanding of what shapes property values is crucial when making investment decisions.
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