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.

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