Driving forces of the U.S. real estate market
Learn what factors impact overseas real estate investments in North America.
By Mickayla Zinsli
Interest in the U.S. real estate market has increased in recent months, in large part due to the election of a real estate mogul as President of the United States. While interest continues to grow, understanding the driving forces affecting the U.S. real estate market, knowing what data to rely on and acting on potential investment opportunities can be a daunting task for home buyers and investors alike.
Each state, city and even neighborhood has its own unique forces that drive the local real estate market. Federal laws and city ordinances can both shape the market. Yet complicating matters further, different asset classes – single family home, commercial, mixed use – in the same location can be influenced by different factors. To better identify investment opportunities within the U.S. real estate market, it is important to understand the driving forces and evaluate the reliability of market data.
DRIVING FORCES
The overall health of the U.S. real estate market is determined by a combination of macro and micro forces. It’s impossible to outline every potential influencer, but when looking forward in 2017, it can be anticipated the U.S. real estate market will be influenced by interest rates, credit availability and continued interest from foreign buyers and investors.
INTEREST RATES
As a symbol of confidence in the U.S. economy, the Federal Reserve increased interest rates in December 2016. Members of the Federal Reserve’s rate-setting board predict there will be three more increases in 2017. The 2016 interest rate increase was the second time the Federal Reserve raised interest rates in a decade, which is shocking when considering how historically low the interest rate continues to be. It was originally predicted by Federal Reserve leaders, interest rates would be increased four times in 2016, but by year’s end, officials only went forward with the one interest rate increase.
Ultimately, interest rates can cause mortgage rates to rise, potentially making it more difficult for home buyers and investors to borrow money for purchasing real estate. While interest rates will certainly affect the real estate market, it’s important to look at it pragmatically. For example, the Federal Reserve’s recent interest rate will increase a 30-year fixed-rate mortgage increase on average from 4.13 percent to 4.16 percent, according to Freddie Mac. Assuming a $241,000 home value and 20 percent down payment, buyers will pay $21 more per month compared to a year ago.
Nevertheless higher mortgage rates can influence home buyers to seek out smaller homes or consider living in cities or neighborhoods that are more affordable. According to Zillow Group, 83 percent of people planning to buy within the next three years will continue with their purchase plans –even if rates increase their monthly mortgage payment by $100. However, a quarter of home buyers say they would reconsider the type of home they are searching for should their monthly payment increase by 25 percent, according to the Zillow Group.
Increased interest rates may have a greater impact in areas that are already less affordable. The 10 U.S. cities that, according to Zillow, would see the highest increase in monthly mortgage payments if interest rates continue to rise in 2017 include San Jose, San Francisco, Los Angeles, San Diego, Boston, Seattle, New York, Washington D.C., Denver and Portland.
Kevin Wright, an EB-5 economist and consultant for Baker Tilly Capital notes, “Affordability in some markets is already tight and increased rates can have a larger impact in those areas. But it’s important to remember by historic standards that most of the country is still very affordable.”
"CREDIT AVAILABILITY CONTINUES TO ACCELERATE THE REAL ESTATE MARKET AND IT DOES NOT SHOW SIGNS OF SLOWING DOWN."
CREDIT AVAILABILITY
Credit availability continues to accelerate the real estate market and it does not show signs of slowing down. In 2017, the U.S. government-owned mortgage companies, Fannie Mae and Freddie Mac, will begin backing larger mortgages – up to $424,100 – marking the first time in over a decade for the increase mortgage threshold, according to Bloomberg. These larger loans will make it easier for buyers in expensive markets to obtain financing.
FOREIGN BUYERS AND INVESTORS
Traditionally, the U.S. real estate market has been considered a safe haven for investments by many foreigners. Foreign buyers in the housing market and investors in commercial real estate continue to shape the landscape both figuratively and literally. In fact, foreign buyers invested more than $85 billion in U.S. commercial assets from May 2015 to June 2016. Chinese investors led the total acquisition volume with $7.68 billion invested during the first two quarters of 2016, according to the National Real Estate Investor.
Given an increase in geopolitical uncertainty, specifically in Europe where a rise in terrorist attacks and the uncertainty around Brexit continues to impact potential investors, the U.S. real estate industry may attract more foreign investors who originally were looking to invest elsewhere. Local trends also play an important role in the U.S. real estate market and should be considered along with national trends if buying or investing.
FOLLOWING THE DATA
One of the quickest metrics available to evaluate the local housing market is comparing the percentage change to median home prices. Positive year-over-year change in simplest terms indicates growth. Recent data from the National Associate of Realtors, shows the median home prices increased 8.8 percent in the fourth quarter of 2016 versus the same period in 2003. Out of the 129 markets tracked, 62 had growth of more than 10 percent, according to CNN Money. The top ten cities with the largest percent change include: Las Vegas, Riverside, West Palm Beach and Boca Raton, Bradenton, Sacramento, Melbourne-Titusville-Palm Bay, Washington, Ocala, Ft. Myers-Cape Coral-Punta Gorda, and Sarasota.
Changes to median home prices, quickly shows which markets are growing. However, a more robust evaluation of the U.S. real estate opportunities is to consider housing prices-to-income and price-to-rent per location. For example, price-to-income compares housing prices to median household incomes over their long-run average.
"A HIGHER RATIO SUGGESTS IT MAY BE MORE ECONOMICAL TO RENT, WHEREAS A LOWER RATIO MAY INDICATE IT'S MORE BENEFICIAL TO OWN A HOUSE."
The further above the long term average, the less affordable the city is. In other words, the household income has not kept pace with median housing prices. If affordability is stretched, it may be an indicator the market does not have not sufficient inventory to meet demand. That said, be weary of rapid run-up in prices that are not on-pace with income, as it could suggest a housing bubble resulting in prices adjusting downward.
Another important metric used to value U.S. real estate is the price-to-rent ratio, which calculates the ratio of home prices to annualized rent in a specific location. In its most simple form, the price-to-rent ratio is a benchmark for understanding whether is it better to rent or buy a property. A higher ratio suggests it may be more economical to rent, whereas a lower ratio may indicate it’s more beneficial to own a house. The price-to-rent ratio can also be used as an indicator of other macro trends. For example, leading up to the 2008-2009 housing market crash, the price-to-rent ratio dramatically increased.
It remains to be seen what 2017 has in store for U.S. real estate buyers and investors, but as of now the market does not show any signs of slowing down. Factors influencing federal, state and local markets are intertwined and sometimes not all data points in the same direction. If you are considering buying or investing in U.S. real estate, take your time to thoroughly research and seek the guidance of industry experts and advisors before making any decisions.
