Five main reasons for fluctuations in the Real Estate market
May 10, 2017
In times of economic prosperity - when an economy is improving and GDP output is high, the real estate market will strengthen as a result of increased demand. Demand for residential, retail and office space increases as the market’s workforce grows and companies start to expand. Due to that, there is growth in rental prices, which in turn causes an upward trend in sales prices. Furthermore, a good economy also means that the population will be financially better off and therefore have more expendable income that eventually filters down into the property market. Conversely, when an economy is struggling, the real estate market will also suffer.
Due to the impact that the economy has on the real estate market, it is important to evaluate a market’s economy when analysing a deal. If a market’s economy relies too heavily on a single industry, it could be risky to invest in that particular market as a dip in the core industry would lead to a downturn in the entire economy. For example, a market that depends strongly on the energy industry will suffer greatly from a reduction in oil prices, which will subsequently effect the economy as a whole and thereby weaken the real estate market.
Fluctuations in interest rates have huge impact on the market as the cost of borrowing rises and falls accordingly. This factor can affect the market in number of ways as most properties are purchased with debt.
For the buyer, the cost of borrowing is increased with rising interest rates, making their purchase more expensive. The recent rate hikes in early 2017 have experts forecasting a fall in property values as demand is lessened due to the steeper lending parameters. For this reason, the fluctuation in interest rates are one of the main factors effecting cap rates.
This factor, arguably has the biggest effect on the real estate market as it is used to shape and control both the economy and interest rates. A government’s attempts to stimulate its economy will affect the market depending on how successful it is.
The Government also has the ability to affect the market more directly through its legislation. A good example of this is the Dodd Frank Act. This piece of legislation was brought in to reign the banks following the 2008 financial crisis. The Dodd Frank has put regulations on the banks in order to ensure that they could no longer operate in the reckless manner that caused the crash in 2008. Nine years on, the new Trump administration is looking to do away with this act and thereby free up the banks to lend more aggressively, which, for good or for bad, will massively impact the market.
Important demographic factors to be considered when looking at a real estate market include the age, income, ethnicity and growth of a population. These factors influence heavily on the market as changes in one of the above can cause significant demand shifts within the market. An increase or decrease in the population of a market for a particular age group will affect the market accordingly.
A good example of this can be seen with the baby boomer generation (persons born 1946-1964), which consists of upwards of 75 million people. This large group of people are now aged from 53–71 and are therefore moving into an age-group where living habits change. A large portion of this demographic will be looking to sell their homes and move into senior living facilities. This demographic shift will therefore have a significant effect on the real estate market as demand for different asset classes change.
The way that consumers spend their money is an obvious driver of the real estate market. Social trends influence each of the asset classes in the market. Using the example above, the shift of people living in private homes to shared accommodation is one example of how living habits effect the market.
Another clear example can be seen with the retail market. Since the explosion of e-commerce in the last five years, the retail real estate market has suffered greatly with a large part of business being done online. Due to this fact, the traditional high-street retail market has been hit massively which in turn impacts heavily on the value of retail units. It is factors such as these that need to be considered when investing in real estate in order to forecast which way the market is going.