Following our past post on the 7 things you need to know about investing in real estate, we are going to expand on investing in the fundamentals. Why? Because this is by far the most work and, depending on how much work you put into this step, it will take your investment portfolio to a whole new level. This is the work that will allow you to predict, within a fair margin, the price of the real estate within the region in which you are investing.
What are the factors to look for when you want to predict real estate prices? There are many to consider. We’ve collected a bullet-list of the what we believe are the most important ones below. Each is important in its own right and by doing your homework on each and everyone one, you can enjoy the security afforded by such detailed knowledge.
Economic, job, and population growth. Demand for real estate is driven by population growth. Population growth is fueled by job growth. Job growth is fueled by economic change within a region (ie employment trends, net migration, industry diversification, etc.). Let’s look at these factors one by one.
Employment trends are one of the most important economic factors related to the current and future health of a market. People who have jobs have the income to afford to pay their rent. Those that don’t will not be able to afford to pay their bills, and may be forced to move to find new employment which often involves moving to another city.
Net migration is another key factor. Are more people moving into the market or moving out? This has a major impact on the market as demand for housing increases and decreases based on the total population in a given market. This increased population growth creates demand for more local housing which helps push property values and rental rates up, in addition to an ongoing need for good residential housing stock. Be sure to put yourself on the right side of the trend.
Past population growth is can be extremely persistent. The best way to predict a counties’ population growth is to look at how much it grew in the past decade. The forces that shape an area’s attractiveness have persistent impacts. If a county grew significantly in population last year, it is more likely than not to also grow this year
Local amenities include things like shopping experiences, proximity to attractive activities, good schools, good social life, conducive to both work and play. The capacity to generate and retain amenities adds considerably to the appeal of a city. The attraction to a city on the basis of its physical and social environment represents a major paradigm shift; whereas people formally followed jobs, jobs now are also starting to follow workers.
Immigration trends tend to concentrate wherever previous immigrants have settled. Kinship ties, shared language, in the existence of common amenities in public goods make; immigrant enclaves; attractive to subsequent immigrants. This might explain the growth of San Francisco’s Chinese population, which already has one of the largest Chinatowns outside of China.
Age Distribution. Countries with very young and very old populations tend to grow more slowly. Specifically, we find the population growth is negatively related to both the share of people younger than 25 and the share of people older than 65. Populations grow faster if the share of people between 25 and 60 is significant.
Industry Diversification. A market with a diversified range of industries offers less market volatility in harder economic times or recessions. A market driven largely by one or two industries tends to be affected harder than more diversified markets, and takes longer to recover afterwards. Although many investors do well in “one trick pony” markets, it’s best to mitigate your market risk by focusing on markets with a broader employment base.
Supply and demand trends. Real estate supply is restricted by availability of land, geographic boundaries (such as water and mountains), political boundaries (permit fees, restricted density policies, etc.) and economic boundaries (availability of development capital and the ability to build and sell new properties at a profit).
Market Conditions. Are you in a buyer’s market or a seller’s market? A buyer’s market is what you get when there’s more supply than demand. There are more people looking to sell houses than there are people looking to buy houses. In a buyer’s market, sellers may have to accept a lower price than they want to sell their property and may have to resort to providing incentives. This is the ideal situation for buyers because they can get a better deal. A seller’s market is just the opposite. The demand is larger than the supply. People have more money to spend on real estate, so sellers will often see several buyers competing to buy their property, which drives up the price. The buyers will have to spend more to get what they want. This is the ideal situation for sellers because they often get a better price on their properties.
Median price (the midpoint between high and low) is often a very good proxy for indicating real-time market activity. As the median price changes, this can indicate key market movements. A rise in median price means that sellers are responding to more sales in their local area which means that the local market might be “strengthening” or getting “hotter” – favoring sellers, so they will ask more for their home. A fall in the median price might indicate the opposite – few homes selling at the current price levels which causes homes on the market to drop their price and for new homes on the market to price more aggressively. A rise in median price could also mean that homes at the lower part of the market are selling and leaving the market. This means that the remaining homes on the market are at a higher price point, which causes the aggregated median price to rise.
Market Inventory Trends. Inventory is simply real estate lingo for “the number of homes for sale.” This stat shows you how much supply is available in the market you are researching. Inventory levels can ebb and flow frequently due to seasonal effects. There’s usually more inventory on the market in the spring-time as the natural rate of real estate activity picks up during this time of year. Alternately, there’s generally less inventory in the fall or winter as real estate activity slows.
Average Days on Market (DOM). Simply put, the Days-on-Market tells you how long the active properties currently for sale, in aggregate, have been on the market.
Capacity to Pay. The lower percentage of your income you use to pay for housing, the greater your capacity to pay. Lenders know this and it is a useful tool towards predicting the price as real estate.
Again, we cannot emphasize enough how important it is that this is the work that will allow you to predict, within a fair margin, the price of the real estate within the region in which you are investing. You will be glad you put in the effort.