What factors are important when looking at real estate?

If being in the real estate industry was easy, well, then everyone would be doing it.

However, the truth is that no matter how wise or smart you are, no matter how many connections you make, no matter how hard you work, no matter how much you read and learn, there are certain factors you simply can’t control when it comes to the real estate market. Here are some things to consider when evaluating real estate, whether it is buying a home or an investment.

When selling a home, or investment real estate, there are many factors which affect market value and the eventual sale price of a home, such as location, condition, size, amenities, features, improvements and upgrades, local economic conditions, the current real estate market and mortgage interest rates, among others. Some of these factors are within the control of the owner, and others are beyond the control of the owner. Real estate ownership has been blessed with appreciation in values, but that appreciation is not always in a straight line. Real estate values are not static. Over the long term, an investment in real estate is generally considered the most valuable type of investment, one with the best financial returns.

Reality check

All owners would like to get the price they feel they should get for their home when they choose to sell. The reality is their home is worth what a buyer is willing to pay. First remember economics 101 – supply and demand. Lower supply greater demand than higher value. If supply outstrips demand, values drop appropriately. Most of Texas is in a seller’s market, where demand is outstripping supply. Also, remember a buyer will not pay more for a home than what they would have to pay for another home with similar features and amenities in a similar location, something called the “Principle of Substitution”. Put simply, what else is on the market that is similar to this price?

The price paid for a home one year ago, three years ago, five or ten years ago has nothing to do with what the home is worth today. Real estate values exist at a fixed point in time. A home may have been purchased for $300,000 three years ago, and may be worth $315,000 today. Someone else may have bought a substantially similar home for $250,000 five years ago and it is worth $315,000 today. That is a drastic difference in equity in a relatively short period of time. You cannot take the annual appreciation of one year and plan to use it as a constant portion of the equation. Real estate fluctuates in value almost every year, usually on the positive side. One year it can be less than 1% another, the following year 12%, all depending on supply and demand. That appreciation is not always in a straight line.

As stated before, all real estate is local, therefore values appreciate differently within the same local. A sale in one part of a city has little to no effect on properties in other portions of the city. The good news is that for most real estate is the one asset that maintains and appreciates in value in the long term. While it is true that that the condition of a home has a definite affect on its market value, and that a well maintained home will sell for more than a home in need of updating and repair, the actual cost of making repairs and improvements may not be equal to the increase in market value. Why? Cost does not necessarily equal value in real estate. Repairs and improvements are two different things.

Depending on the market conditions when the home was purchased, some owners were fortunate and purchased their home in a buyer’s market before the increases in real estate values like we witnessed after the tech crash between 2001 and early 2006. Others may have bought at the end of a strong real market and were forced to pay top dollar in a highly competitive sellers market, as many owners in other parts of the country are experiencing now who purchased their home in 2006. It is economic market conditions, the economy, employment, mortgage rates and supply and demand that create changes in the real estate market and cause real estate values to increase, remain stable, or perhaps drop at different periods of time. These are the factors that are beyond a seller’s control.

Real estate is typically a long hold period compared to many assets. To look to invest in real estate as a short term investment usually has harsher consequences. A great example of short term real estate investment is flipping, which entails buying the investment underneath market norms and selling around the middle of the surrounding market values. It has the risks of any other speculative investment. It can be high risk because it is a short term investment play. If the investor can hold long enough, most markets will increase in value due to the lack of inventory and demand outstripping supply. Decisions to sell may be more difficult for owners with short term ownership especially when real estate values have not increased or have dropped since the home was purchased. Home owners with short term ownership may have mortgage balances higher than the value of the home and a sale would require bringing cash to the closing to pay off the mortgage balance. Home owners with long term ownership and substantial equity can make selling decisions easier than owners selling their home without the benefit of real estate appreciation. In either case, the real estate market is the real estate market, regardless of when the home was purchased, and the home is worth what is worth.

There are many factors that affect the value and acquisition of buying and selling real estate on a national scale.

Economic factors

Like it or not, it seems like every real estate downturn gets blamed on the economy. There is a reason for this. The state of the economy plays a huge part in the amount of money that is available for people to buy homes. This is generally measured by economic indicators such as the employment data, manufacturing activity, the prices of goods, etc. Broadly speaking, when the economy is sluggish, so is real estate. However, the cyclicality of the economy can have varying effects on different types of real estate. For example, if a REIT has a larger percentage of its investments in hotels, they would typically be more affected by an economic downturn than an REIT that had invested in office buildings. Hotels are a form of property that is very sensitive to economic activity due to the type of lease structure inherent in the business. Renting a hotel room can be thought of as a form of short-term lease that can be easily avoided by hotel customers should the economy be doing poorly. On the other hand, office tenants generally have longer-term leases that can’t be changed in the middle of an economic downturn. Thus, although you should be aware of the part of the cycle the economy is in, you should also be cognizant of the real estate property’s sensitivity to the economic cycle.

The economy obviously pays a huge impact on how banks and equity or lending institutions will lend. If lenders are recovering from bad loans, the opportunity is not as great. Factors such as politics, both on a local as well as a national stage, can restrict or open financing for real estate. We need not look farther than the recent real estate and financial bust to see the effect of liberal then conservative lending parameters and its effect on not only the economy but real estate in general.

Interest rates

Politics, banks, and the global economy can all influence the real estate market when it comes to interest rates. The real estate and financial crash proved the global impact of the real estate market and increased awareness of how interest rates and loans are used in home buying. If things aren’t looking good abroad, it might affect your ability to sell homes domestically. Keep an eye on what’s happening in the global market and with foreign investment as these play large roles into the expectations of the local market as well.

Remember, banks are in business to lend, and today unlike their troubled counterparts in other parts of the world, they have good balance sheets and plenty of money available. So what’s with the apparent reluctance to open the money spigot? Remove your negative emotions towards these much maligned and penalized institutions for a moment and look from their side of the ledger. In today’s world of low interest rates and a flat yield curve a bank has less than a 3 percent net interest margin, which is the amount between what it pays depositors and what it makes on loan rates. The very best possible outcome on a loan for our forever criticized, highly regulated bank is to get paid back all its principal and make a small spread on the interest. Get paid back 95% of every loan and it goes broke. Careful scrutiny of any type of loan is judicious business practice and necessary to remain solvent. A top quality financial lending institution can be lucky to earn is 1 to 1.5 percent on assets historically.

Certain factors have the greatest impact on what lending rate a consumer will receive. Start with the general level of interest rates in the national economy, which is influenced by actions of the U.S. Federal Reserve Bank, levels of inflation, demand for borrowing money, the stock market, and a number of other factors.

Then you get to the factors for your home loan, the lending rate is influenced by the amount borrowed, what kind of loan you get, and whether you put up collateral or not. For instance, the interest rates on a home equity loan (where you use your home as collateral) are generally less than for unsecured credit. The term of the loan — how long you take to pay the money back. Even a small difference in your interest rate can have a big impact on the amount you eventually pay, so it’s worth understanding how interest rates are determined and what you can do to lower yours.

While lenders control who gets approved for a loan and on what terms, actual mortgage interest rates are largely determined on the secondary market, where mortgages are bought and sold. As with the stock market, interest rates in the secondary market tend to move up and down. When the economy is on an upswing, investors demand higher yields, forcing lenders to raise mortgage rates. In a market downturn, rates tend to drop for consumers because of increased investor demand.

While home or real estate sellers hope to get top dollar for their property – and some have an inflated idea of what to expect – establishing value can be a complex, multifaceted process.

Location

Most consumers know that the three rules of real estate are “location, location, and location”. Location includes factors such as the price and availability of recent nearby transactions and inventory, the quality and desirability of local schools, and whether the area has the lifestyle and community buyer’s seek.

What does location mean, it is more than closeness to the center of the community; does it have the qualities of a dwindling asset? Location encompasses many other considerations. Waterfront of most types is limited in any scenario, but particularly in our Texas metros. Those that have it, will demand and get a higher value / return than similar properties not on the water. What type of view? What’s it next to? Is it near retail establishments? Or a highway?

With location comes school district. The Voice covered this almost a year ago Oct. 18, 2013 with “The effect of school performance on local home prices.” The school district or even a specific school within a district can drive demand for a particular area. Ask any real estate agent you know and they will confirm that having strong schools and an overall strong district can affect home prices by as much as 10 percent over a neighboring district.

Your family doesn’t have kids of school age? Buying a home in a good school district is still smart. When the schools are desirable, homes tend to hold their value better in down markets and appreciate more in good times. A 1 percent, 2 percent, or even 3 percent difference in a home’s value can be thousands of dollars. I educate people all the time, ‘You need to look at supporting and maintaining a good school district much like you would the maintenance of the roof or siding on your house.’ Why? Both will significantly affect the value of your home. Whenever a school tax increase comes up for a vote, my thought process is it seems like a pretty small price to protect the value of your investment.

This just scratches the surface of the factors affecting real estate values. Understand that in our Texas markets, the home you look at today will be gone tomorrow. Investment property in the Texas region, particularly in any of our metros if priced correctly will sell quickly. Educate yourself with your financial planner and real estate professional on what you are looking for and the history of the neighborhood. If you think you will have plenty of time to do this after the purchase, guess again. It is a sellers market, meaning the seller decides many of the terms of purchase, which may not allow the buyer much time to analyze after the purchase.

What’s the best investment? Start with sitting down with a financial planner, real estate professional, and if financing is needed, a mortgage professional. Actually I would probably reverse the order in today’s harsher lending environment. The size and scale of the current and historical real estate market make it an attractive and lucrative market for many investors. Investors can invest directly in physical real estate (this analysts preferred method) or choose to invest indirectly through managed funds. Investing directly in real estate involves purchasing the residential or commercial property to use as an income-producing property or for resale at a future time. Indirect ways to invest in the real estate market include investing in real estate investment trusts (REITs), real estate exchange traded funds (ETFs), commingled real estate funds (CREFs), and infrastructure funds. Again this is a decision you and your family and your real estate and financial experts need to make together.

There are many factors that play a significant role in moving the real estate market, but there are also more complex parts that come in to play. And although some of these aforementioned factors suggest a clear-cut relationship between the factor and the market, in practice, the results can be very different. However, understanding the key factors that drive the real estate market is essential to performing a comprehensive analysis of a potential investment.

If you have the assets and capabilities, there is not a better time to invest than now. Lending rates are the second lowest they have been in the last 100 to 5000 years. Seriously. Values have maintained in Texas during the worst recession in my memory. Six years is the longest positive market we have had in Texas over the last 50 years. We are 2.5 year into this positive run. Other than a catastrophic economic event, your investment in Texas real estate should have a good run for 10 years are more.

The effect of school performance on local home prices

When people buy a home, a variety of factors influence their decision. The look of the home, price, size, layout, age, and proximity to all their needed amenities all play a role in the selection process.
Here are some basic questions to ask yourself when you start shopping for a home:

• Where do I want to live? (location, location, location)
• How much can I afford? (or can I afford to live in the location I want?)
• What is driving home values in the area?
• Is it in a good school district?

For people starting families, the quality of local schools is very important. We’ve always known that good schools attract families with school-age children, but recent statistics add concrete numbers and surprising trends to the storyline. Redfin, an online real estate brokerage, recently conducted an analysis on the relationship between school performance and home prices. Redfin looked at homes on Multiple Listing Services (MLS) databases used by real estate brokers that sold between May 1 and July 31, 2013 to calculate median sale price and price per square foot of homes within school zones. For this study, they analyzed home prices compared to the test scores of elementary schools across the country. School and home coverage consisted of 10,811 elementary school zones across 57 metro areas and included 407,509 home sales. What they found is what we all have know in our hearts for years – that home buyers will pay more per square foot for homes located within top-ranked school districts. The company used MLS databases to calculate sales prices per square foot of homes located within the boundaries of particular school zones and compared them against the standardized test scores of the area’s elementary schools.

What the study found is that homes could be identical and just a short distance apart, but the prices could vary by sometimes as much as $130,000+ because of the difference in school districts. A good example in the Dallas area is Highland Park, where the Highland Park ISD and Dallas ISD both exist in a very prestigious area. Homes just a short distance apart with nearly identical attributes are selling for drastically different prices.

This study suggests that potential home buyers are not only willing to pay more, but are also willing to take less in a home. The report showed that the homes in high-scoring school districts were not necessarily bigger, of a higher quality or in a prime location with nice views or quieter streets.

Arguably, there are many factors that may play in the determination of a locality’s real estate prices. These factors include proximity to workplaces, shopping and convenience, the quality and adequacy of residential housing supply, and property tax rates, to name just a few. Nevertheless, after curb appeal or adequacy of space and amenities, the quality of a community’s schools ranks high among buyer influences. In my market study days, I was surprised to see that commercial real estate was as affected by the same parameters. Why? Quality schools mean strong graduation rates, and a lack of young unemployed hanging around. In the past when we did market studies, we found that it was the lack of quality schools and community involvement that made an investment area undesirable, rather than location.

Why do we think that is? Are there clear, empirical bases for this widespread belief that schools influence housing prices? To what degree are measures of school quality capitalized in housing values? Who benefits when housing prices fall / rise? During this recession, did quality school district communities keep their values better?

First, the data we pulled show that homes in our Texas neighborhoods that have excellent schools sell for more money than similar homes in neighborhoods having lower rated schools.

Second, when the economic downturn hit, home prices in Texas metros with excellent schools did not fall as much and have recovered better than home prices in areas having lower rated schools. Almost all of these areas have a high ‘community involvement’. Which in turn affects their real estate values.

Third, consider why some areas have schools with better ratings. Families having more money and putting a stronger emphasis on education move to areas having higher rated schools. Even those with less money, but more emphasis on education as shown by the school’s rankings have better values. These families help build the reputation of the schools

Empirical data in Texas metros show as much as a 70+% difference in values over exemplary school vs. low performing. Yes, some of the value could be in the more desirable locations of those school districts, but historically we have seen schools add value, sometimes almost to an extreme.

Do better school districts have bigger homes, higher quality homes, larger lots, or more desirable locations (views, quiet streets, etc)? In general, not necessarily. When accounting for size, on average, people pay more per square foot for homes in top-ranked school zones compared with homes served by average-ranked schools. This means that the price differences for similar homes located near each other but served by different schools can range from tens to hundreds of thousands of dollars.

Whether you agree with the hypothesis of this or not, if you have kids, you personally know the importance of school boundaries. When your first child reaches near school age, you and your significant other begin house hunting with school-boundary maps in hand. If a house is one block outside of your elementary school’s boundaries or district, most scratch it off the list. The look of the home and other factors could disqualify it from our list, but for parents the first hurdle is finding something in that school boundary line.
Buyers are willing to sacrifice certain things to live in the right school district. In a Realtor.com survey this summer, results were surprising: One out of five buyers would give up a bedroom or a garage for a better school. One out of three would buy a smaller home.

In the same survey, buyers are also willing to put their money where their mouths are. One out of five home buyers said they would pay 6 to 10 percent above their budget for the right school. One out of 10 would double that to 20 percent. Considering that number could be $100,000 in a lot of markets, it makes one wonder: How much investment in a school district is appropriate?

In my history of looking at empirical data, homes in the best school districts, on average, sell for higher prices than similar homes in less-popular school districts. A simple analysis might say that good schools are wholly responsible for this added value. And because of that, more affluent families seek and live in more sought-after school districts. Statistics often show that for large sample sizes, the more affluence there is in a community, the higher test scores will be in that same community. Some of this is the effect of both parents being very involved in pushing their children’s education. These test scores are just one measure of “good schools,” but they’re a highly quoted measure. There can be a self-reinforcing mechanism here that might overemphasize the effect of the school itself on the prices of those homes. One might even argue that the high home prices make the schools better, as school districts in Texas are funded by property taxes. More valuable real estate means more tax revenue for the district.

Demand drives prices higher for a limited product like real estate. There are just so many homes in each school boundary or district. The old adage of supply and demand and limited supply drives up the price. Yes there are many other factors, but school districts are near the top on most consumers list. Making a decision on buying a home should definitely include an analysis of the school district, even for buyers who don’t intend to send children to those schools. Good schools provide stability and continuity for a community, and that’s good for the property values of everyone who lives nearby. Many quality schools and districts have been that way for years due to the quality of participation from all ages in improving school and community involvement.

The 2012 “Profile of Home Buyers and Sellers,” a separate survey released last year by the National Association of Realtors, also measured the importance of school districts to home buyers. This survey found 61 percent of recent buyers ranked the perceived quality of the neighborhood as important in their home-purchase decision, and 43 percent said convenience to jobs was a desirable characteristic. Forty-six percent of buyers who had school-aged children highly valued the quality of schools, the same proportion of this group that ranked employment proximity as important.

Earlier in this article, I mentioned that commercial real estate values are driven by the same parameters. Historically, not only do sales values remain higher, but so do rental values. To build an office, commercial, retail, etc investment in a less than desirable school district is challenging. Both from the equity side as well as the absorption velocity. ‘Shelter’ in any quality school boundary or district is historically more expensive.

This issue examined historical and current empirical research and published papers by leading economists and analysts and found general confirmation that communities with better schools are rewarded with higher housing prices, that the premium commanded by good schools can be quantified, and that ongoing investments in schools are returned to taxpayers faster in communities experiencing high housing demand. This may be one reason, that homeowners of all ages rely on the underlying principles at work in these studies when they vote to improve their local schools. Whatever motivates buyers and sellers, newspapers regularly cite instances of strong community schools in describing healthy resale markets for housing. Financially speaking, improving local schools is a matter of common sense.