Analyzing Real Estate Markets – Part 2
In a previous article, I kicked off the discussion of market analysis and the cyclical nature of real estate markets. In this article, I want to discuss some of the key market factors that contribute to market cycles. In Part 3 of this topic, I’ll discuss how each part of the cycle is influenced by these — and other — factors.
While there are literally thousands of factors that contribute to the ever-changing real estate market in any given local area, there are some factors that tend to appear more often than others and that tend to have a much larger influence than others. Specifically, there are four key factors that affect many/most real estate market cycles, and they work hand-in-hand to actually drive the cycle through the various phases:
Population growth or contraction is perhaps the strongest influencer of real estate cycles. When populations grow, the demand for housing can quickly out-pace the existing supply, creating a “seller’s market.” This increased demand for housing and apartment units causes vacancies to drop, as people are willing to rent any available space. The competition by buyers causes rents to rise, and increased income pushes the value of investment properties up.
On the other hand, when population rates are trending down, supply out-paces demand for housing, and consequently rents will drop and vacancies will start rise. As property income drops in this “buyer’s market,” the value of the properties themselves drop, and prices fall.
Employment growth or contraction is important because it is a key indicator of what is likely going to happen with population growth. For example, when a big company moves into a city, it has a big impact on population. Not only does it bring employees with it and hires local talent, but it also provides a stable population of consumers who need services such as restaurants, auto repair, hair-dressers, etc. So, while a company may move into town with 1000 employees, the service industry to support those 1000 employees may bring another 1000 or 2000 people to the area. Employment growth can quickly drive population growth.
Of course, when companies leave town or lay off employees, it tends to have a negative effect on population trends, and also on the real estate market. Again, not only will the employees leave town, but there is now less demand for the accompanying service industry, and those service workers will likely leave town searching for greener pastures elsewhere.
When populations are increasing, builders go crazy trying to keep up with the demand for housing. Generally, builders are so focused on getting as much housing inventory on the market as quickly as possible that they don’t notice when supply starts to overtake demand. This leads to overbuilding, where there are too many rental units on the market than are being demanded. With too much inventory, vacancies start to rise, which leads to falling rents, and ultimately falling property values. Eventually, builders will stop building, but by then it’s often too late, as the market is more than saturated.
If there is still a strong underlying economy in the local area, population should continue to grow, and eventually the over-supply of housing units will be absorbed. If the underlying economy is not strong, it may take many years for the excess housing units to get absorbed, and the local real estate market may stagnate for long periods of time.
Trends in number of households and household income play a key role in the vacancy and income rates experienced in the surrounding markets. For example, in locations where there is a high divorce rate, families will tend to be smaller, and the demand for housing will tend to be higher. Changes in household income also play an interesting role in investment real estate; when household incomes surpass a certain threshold, people start to buy houses as opposed to renting, thereby hurting the investment market.