Real estate has historically appreciated at about an average of 4 percent per year, and that is just on the capital invested. Real estate (residential and commercial), just like other investments, goes through cycles. These cycles go from a high point to a low point and then return again. The two variables are value (beginning and end) and the time it takes to go through the cycle.
“Is it a good time to buy?” is a question every real estate buyer asks. If the answer is yes, it is most often followed by, “Why is it a good time and where do I need to be buying?” Today there are two compelling reasons for buying: the first is attractive prices making positive cash flow from rental income and the second is the real estate appreciation that shield this asset against inflation. On the other hand, if the answer is no, what follows is the question: “When will it be the right time again?” And “Where are undervalued or out-of-favor opportunities?”
There is a real estate variation of “the economic clock” used since the 1900s as an explanation of economic cycles, from boom to bust and back again. It has been adapted from the economic cycle clock in an attempt to explain economic ups and downs as a recurring and predictable succession of events, affecting residential real estate markets. This series of causes and effects creates or reduces wealth in a predictable sequence of boom, slump and recovery.
Common economic wisdom says low interest rates drive house prices, but research shows they have a short-term effect only. If low interest rates were the reason for a boom, then a boom could be maintained indefinitely by through interest rate manipulation.
Another short-term fix is government incentives for first-time homebuyers. These create market confusion, just like a passing rain cloud interrupts a bright sunny afternoon.
Once all the typical economic factors like interest rates, money supply, net migration and job growth have been taken into consideration, the ultimate drivers in the decision to purchase real estate are emotion and consumer confidence.
In Part 2 we will look at what happens when the media outlets say “bubble” all too often.
Doug DeShields is a member and of Metrolina Real Estate Investors Association, www.metrolinareia.com, which provides education, mentoring, and networking for real estate investing in the Charlotte region. Doug is also Board member and Treasurer of the National Real Estate Investors Association. He can be reached at [email protected].