Most people’s wealth, and this is particularly true for Americans, is derived in large part from real estate. The Federal Reserve Bank of St. Louis released economic study indicating that 66% of Americans were homeowners as of the first quarter of 2023.1.
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For many investors, the real estate market is an appealing and profitable industry due to its size and scope. Four major variables that impact the real estate market and the range of real estate investments that are accessible are examined in this article.
The data on age, ethnicity, gender, income, migration trends, and population growth that represent the makeup of a population are known as demographics.
Significant changes in a country’s demography can have a long-lasting effect on real estate patterns, often lasting many decades. These figures are a noteworthy but sometimes disregarded aspect that might influence the sorts of homes in demand and the price at which real estate is offered.
The baby boomer generation, which was born between 1945 and 1964, is one example of a demographic shift that might have a big impact on the real estate market. The market will undoubtedly be impacted for years to come by the baby boomer generation’s retirement, which started in 2010.
This kind of demographic change can affect the real estate market in a variety of ways. Some important queries for an investor may be:
As more individuals begin to retire, what would happen to the demand for second houses in well-known tourist destinations?
What impact may children moving out have on the demand for larger homes if families have less earnings and fewer children?
Investors can narrow down the kind and location of potentially attractive real estate investments before demographic changes begin by knowing the answers to these and other questions.
2. Rates of Interest
The real estate market is significantly impacted by interest rates as well. Use a mortgage calculator if you’re thinking about purchasing a property with a mortgage to discover how different interest rates might impact the cost of the purchase.
Interest rate fluctuations can have a big impact on someone’s ability to buy a home. This is due to the fact that a mortgage will cost less the lower the interest rate. Borrowers will benefit greatly from this, but it may also increase demand for real estate and drive up prices. The cost of a mortgage goes up with interest rates, which reduces demand and drives down real estate values.2
On the other hand, the relationship between rate and price in the context of an investment like a real estate investment trust (REIT) might be compared to the interest rate relationship of a bond.
A bond’s price increases when interest rates drop because the bond’s coupon rate becomes more appealing. Bond prices decline in tandem with rising interest rates.
In a similar vein, the high returns of real estate investment trusts (REITs) increase in value when interest rates decline. A REIT’s price decreases when interest rates rise because the income on the investment loses appeal.3.
3. The Financial System
The status of the economy as a whole has a significant impact on real estate values. Economic metrics like the GDP, employment statistics, manufacturing activity, product pricing, etc. are often used to measure this. In general, the real estate market is slow when the economy is.
But various kinds of real estate may be affected differently by the economy’s cyclicality.4 A REIT that invests mostly in hotels, for instance, will usually be more impacted by a downturn in the economy than one that invests primarily in office buildings.
Because of the kind of lease structure that is inherent in the industry, hotels are a sort of property that is very sensitive to economic activity. Consider renting a hotel room as a type of short-term lease that guests can simply back out of in the event of a weak economy. However, office renters typically have longer-term agreements that are unchangeable during a downturn in the economy.
Understanding the economic cycle that the country is in as well as how sensitive a real estate property is to it are crucial.
4. Governmental Directives and Grants
Another significant element that might affect the demand and costs for real estate is legislation. There are a few ways the government might temporarily increase demand for real estate: tax credits, deductions, and subsidies. You can spot possibly erroneous patterns and changes in supply and demand by being aware of the existing government incentives.
For instance, in an effort to stimulate house sales amid a slowing economy, the U.S. government implemented a first-time homebuyer’s tax credit in 2009 (but only for those who bought a home between 2008 and 2010). The tax incentive was utilized by 2.3 million persons, as reported by the Government Accountability Office.5
This was a really good (if brief) response. Investors may have assumed that the rise in home demand was due to factors other than the tax benefit.
Purchasing real estate indirectly, through exchange-traded funds (ETFs), real estate investment trusts (REITs), or other managed funds, is often less hazardous and more profitable than purchasing real estate directly.