Table of Contents
The real estate constitutes one of the largest industries in the United States. Therefore, many individuals and institutional investors have invested their funds to own a stake in this lucrative market. Many companies operate in the real estate markets typically by a way of buying, developing, managing, reselling, leasing or renting commercial, industrial, and residential properties. Financial institutions also are the key players in the real estate market as they provide financing to investors for the acquisition of real properties. Over the past few years, the real estate market has boomed amidst the analysts’ claims. The market is overvalued by between 25% and 60% and could be a bubble that might cripple the US economy (Matthews, 2016). The recent report created by Morgan and Stanley projects the following fact. The prices of the commercial real estate in the United States will have appreciated by 0% in 2016, correcting a previous forecast of the growth of 5% for the same year (Bloomberg, 2016). Morgan and Stanley’s report comes as a surprise for a market that has been characterized by skyrocketing prices in the past, largely due to the high investors’ demand for high-returns real estate assets (Bloomberg, 2016). The vast research has been carried out to examine the agents that influence the real estate value. The direction of movement of prices and the value of the real estate market is a culmination of a number of agents that impact the demand for the real estate property. These factors can be examined under the following classifications: demographic, economic, and government policies, as well as physical/environmental ones. The critical assessment of these agents is essential for both the individuals’ and institutions’ investment decision making.
Demographic trends denote the movement of data on various aspects of the population. These ones have a significant effect on pricing of real estate and the types of real estate properties being in demand. The major changes in demographics of a country or a locality can have a big impact on the trends followed by real estate in a long-run. A number of demographic factors have been identified as capable of influencing the prices of real estate properties. The key demographic trends include the population growth and age.
In the aftermath of the extreme boom of the American real estate market over the last fifteen years, the research has been conducted to explain the following fact. It is related to the movement of real estate prices, in particular house prices at the state level in the US using some fundamentals or market drivers as opposed to the forces such as speculation. More focus has been paid to explaining the correlation between the appreciation of house prices and population growth. The world’s population is on its rise. Thus, it is creating more demand for assets, including real estate assets, which constitute 54% of the global wealth (Cvijanovic, Favilukis, & Polk, 2012).
According to Cvijanovic, Favilukis, and Polk (2012), demographics are a useful angle for explaining the appreciation of house prices due to the basic economic equation. It posits that the higher demand when combined with an inelastic or limited supply forces the prices upwards. They have classified their study on demographics variable into two fundamental components: the natural population growth, i.e. higher birth rates, and the corresponding low mortality rates, which occur slowly over longer periods. The other element of this classification is the non-natural population growth, that is, immigration, which differently from the natural one takes its place rapidly and unexpectedly.
Ultimately, the research concludes that the population growth influences the appreciation of real estate prices. However, this effect is largely impacted due to the non-natural component of population growth (immigration). The immense effect of immigration on real estate prices is related to its unpredictability. The builders can expect a fraction of population growth that is due to natural growth (birth and mortality). However, the portion of population growth attributed to immigration cannot be forecasted. Consequently, immigration forces prices of real estate properties upwards as it renders unanticipated shocks to the market. In other words, developers can only partially project the population growth due to immigration. Therefore, they underreact to the increased demand, which forces prices up (Cvijanovic, Favilukis, & Polk, 2012).
Further on population trends, the research shows that population density and the level of development before immigration partially influences the intensity of the immigration impact on appreciating real estate prices. If a locality is densely populated, an influx of migrants renders a stronger positive influence in pushing prices up in that locality than in the sparsely populated area. In addition, a rise in immigration has a more powerful impact on appreciation of prices in less developed real estate markets. It means that regions with comparatively less building permits per capita than in overdeveloped markets (Kyle, Spodek & Baird, 2005).
The fact that past researches focus on explaining the differences in an increase in real estate prices between various states versus what causes the appreciation at the federal level implies the following fact. While the bursting of the real estate bubble in the US does not affect their findings, the studies give a particular insight into the influences of that bigger bubble on the local United States’ real estate markets. The housing bubble that came to the end in 2006 was more conspicuous in some regions than in others. The differences are attributed to real estate fundamentals, including demographics (Cvijanovic, Favilukis, & Polk, 2012).
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The Aging American Population
The baby boomer generation refers to the generation of Americans born between 1946 and 1964. Its age now ranges between 50 and 68 years (Nguyen, 2012). The senior age group is currently the largest one in the United States. Between 2000 and 2010, this age category had grown at a higher rate than the total national population, according to the 2010 census report (Butler, 2014). In 2010, the higher population was 65 years old and above than in any other past census (Butler, 2014). It is further anticipated that by 2030, the 65 years and above group will rise by almost 100% (Butler, 2014). The aging country’s population has given its rise to the need for the development of more real estate properties such as homes for retirement, assisted care living facilities, hospitals, nursing homes, and so on, a trend which is projected to persist in the coming years (Nguyen, 2012).
The major macro-economic factors affecting prices in the real estate markets include the GDP per capita, the level of average inflation, and the interest rates.
Gross Domestic Product
GDP is a primary macroeconomic factor influencing the real estate value. It is a measure of the economy’s value of domestic production. The calculation of GDP takes into account consumers, investors, and government expenditures within the boundaries of a country. It also exports and imports (Gaddy & Hart, 2003). Since GDP indicates the health of any economy, a high GDP is associated with favorable economic conditions, which should encourage investments in the real estate market (Brueggman & Fisher, 2008). Consumers use their money in rents or buying homes; and investors apply it in developing new constructions. As for governments, they use money in infrastructure. Conversely, a low GDP points towards unfavorable economic conditions and should have an adverse effect on investment in real estate markets (Brueggman & Fisher, 2008).
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Inflation refers to the rate of increase of general prices of products and services and the resultant reduction in the purchasing power of the currency. Monetary authorities of the state, the Federal Reserve in the case of the United States, attempt to keep inflationary levels at desirable ranges. At the same time, they try to avoid deflation in order to ensure a smooth running of the economy (Kyle, Spodek, & Baird, 2005). Inflation affects the value of real estate markets in several ways. First, the investment in real estate assets is seen as a good strategy to hedge against adverse effects of inflation. The reason is that real estate assets are usually leveraged assets. Comparing the performance of real estate markets with the Consumer Price Index (CPI), it has been found out that the returns from real estate markets irrespectively of the category exceed the rate of growth of inflation (Brueggman & Fisher, 2008). The positive relationship between inflation and returns from real estate markets shows that real estate assets are the appropriate devices for hedging against inflation (Brueggman & Fisher, 2008).
Further explanations have been given to explain how inflation affects real estate markets. The construction of new houses is a common indicator of the status of the state economy. An increase in the rate of inflation results in a corresponding inducement in the cost of new constructions. Both materials and labour expenses rise when the inflation rate is high. When the new construction in the country slows down due to the high construction costs involved, the supply of commercial, industrial and residential real estate properties decline, thus forcing prices on the existing properties to surge (Gaddy & Hart, 2003).
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Further, a high rate of inflation leads to higher rents charged by rental properties owners. The owners’ factor effects inflation in determining the rent to charge. As the owners raise rental fees in order to keep pace with inflationary rates, higher rental fees cause a rise in prices of properties. Subsequently, because one of techniques of assessing the value of property is to consider its income generating potential, higher rents can cause an increase of prices in real estate markets (Gaddy & Hart, 2003).
The comparatively long period required in financing the acquisition of the real estate and the costs of financing, particularly in the form of interest rates are the key determinants in making investment decisions. The interest rate factor is more crucial in the real estate markets than in other investment sectors. The real interest rate, as opposed to the nominal interest rate, is commonly employed as it removes the impacts of inflation and enables investors to have a clearer picture of real costs of financing (Brueggman & Fisher, 2008). High interest rates increase the costs associated with borrowing, thus limiting an ability of individuals and institutions to acquire real estate properties. Subsequently, the demand and prices of real estate goes down. Conversely, a fall in interest rates reduces the costs of obtaining mortgages, which leads to the increased demand for real estate properties (Brueggman & Fisher, 2008).
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The examination of effects of interest rates on equity investments, for example, real estate investment trusts (REITS) shows a relationship similar to the connection between bonds and interest rates. When interest rates fall, the value of bonds induces since their coupon rates become more attractive to investors. When interest rates rise the value of bonds falls (Gaddy & Hart, 2003). In the same way, a decrease in interest rates in the market leads to an inducement in the attractiveness of yields on real estate investment trusts; and their value rises. When interest rates induce, the attractiveness of returns on real estate investment trusts reduces, thus pushing their value down (Gaddy & Hart, 2003).
Government policies or legislations can have a substantial effect on the demand of the real estate property and prices. The government can render a positive movement in demand in the real estate markets through a number of ways, for example, tax credits, tax deductions, and subsidies (Kallberg, Liu & Pasquariello, 2013). The policies on these issues may make investing in real estate properties more attractive that in other forms of investment. For instance, in 2009, the US federal government introduced the first time homebuyer’s tax credit in an effort to bump-start the sales of homes in a slow-moving economy. The research by the National Association of Realtors showed that this tax incentive solely culminated in 900,000 people buying residential homes (Kallberg, Liu & Pasquariello, 2013).
Physical or environmental factors can also affect the value of real estate properties and the corresponding prices. The major environmental factors include the location and weather/ climate. These agents may influence the value of real estate properties depending on whether they are desirable or undesirable.
Real estate parcels are uniquely situated geographically. The location refers to the factors such as the closeness of real estate to the center of the community, security, availability, and accessibility of various infrastructures. It determines the potential returns from the property hence strategically located real estate properties attract higher demand; and their value is also higher (Gaddy & Hart, 2003). For example, the report by Coldwell Banker real estate shows that the value of housing markets varies sharply across localities. Cleveland, Ohio, has the most affordable housing markets with the average price of $74, 502 for a four-bedroom home. On the other hand, Newport Beach, Calif, has the most expensive housing markets with the average price of $2,291,764 for a four-bedroom house (Vasel, 2015).
The climate or weather of an area directly influences the demand for real estate properties, especially housing. For example, the tropic-like weather pattern of Florida combined with an abundant coastline makes localities in this state desirable for vacation and retirement homes, as well as creating theme parks for tourist attractions. Consequently, the cost of real estate properties in these regions are higher compared to other equivalent places (Kyle, Spodek, & Baird, 2005).
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Summary and Conclusion
The real estate constitutes the substantial percentage of the aggregate investments of individuals and institutional investors. The investment in the real estate market can be made directly through a purchase of residential, commercial or industrial property to use the income generating property for resale in the future. It can also be done indirectly through managed funds such as real estate investment trusts. The real estate market is affected by a score of factors that ultimately influence the value of real estate properties and investments. The major agents that impact the real estate value can be examined from four classifications. These ones include demographic, economic, and physical factors, as well as government policies. Demographic agents affect how real estate properties are priced and impact the relative demand for different kinds of real estate properties. Major demographic variables influencing the real estate value include population growth, in particular due to migration and aging population. The gross domestic product (GDP) or the general health of the economy, inflationary levels, and interest rates are the major economic variables impacting the real estate value. Physical agents affecting the real estate value include the location of the real estate and the climate/weather conditions of the locality. These factors determine the attractiveness, demand, and price of the real estate. Understanding the high level agents that play a significant role in determining the value of real estate is important to conducting a comprehensive assessment of potential investments during investment decision making.