Prices Are Rising, But Maybe Not For The Reasons We ThinkPosted on July 1, 2014 by
Really good real estate investors know and rely on valuation of their deals as the key to success and profits. The economic slump that richer countries have suffered during the past seven years can be blamed on a runaway housing bubble that started right here in the U.S. All the market areas covered by REIAComps, insure when pricing changes happen you are not caught off guard.
When it comes to the tic of the housing bubble, there were other issues like poor oversight of the broader financial system which led to the crash. But without the real estate bubble, there would likely have been no financial crisis.
Which is why the fact that similar-looking bubbles inflating in countries from Canada to the U.K. have economists worried that there might be other catalysts of future crises laying wait for us in the weeds.
Last week, in a Forbes article, IMF economist Min Zhu published an article called “Era of Benign Neglect of House Price Booms is Over,” in which he sounded the alarm over rising global home prices. Zhu explains how he determines whether home prices in a particular country are overpriced.
“Theory asserts that house prices, rents, and incomes should move in tandem over the long run. If house prices and rents get way out of line, people would switch between buying and renting, eventually bringing the two in alignment. Similarly, in the long run, the price of houses cannot stray too far from people’s ability to afford them––that is, from their income. The ratios of house prices to rents and incomes are thus often used as an initial check on whether house prices are out of line with economic fundamentals.”
Okay, that was nice high end financial speak, but what does it mean to us as investors who want to buy right to make a profit? The problem is, it’s difficult to do anything about a growing asset bubble while it’s in progress. Congress can work to make sure that credit isn’t too widely available and lending standards are tightened, but sometimes the logic of a bubble can overcome even these measures. The only reliable way to eliminate a bubble, in my opinion is to let it burst.
Here is something to think about, what if real estate isn’t overvalued? What if there is something happening in the economy that’s causing real estate to become more valuable? As developed economies become less reliant on agriculture and manufacturing, and more reliant on creative industries that thrive on close collaboration, land is becoming once again very important. These factors are merely another clear indicator of the importance in having access to solid valuation data through REIAComps.
Wrapping up, we can see the close collaboration in industry happening in the U.S., where rents in cities like San Francisco, Washington D.C., New York and other innovative cities are skyrocketing along with salaries. In an environment where the most productive workers are seeing rapidly rising property values, it makes sense that people would want to buy a home rather than rent.
Using this explanation, I have reason to believe the recent run up in real estate prices has both a rational component (the evolution of the economy is making location more important) and an irrational component (people think that nothing will stop this trend). It’s difficult to say which force could be a bigger factor pushing real estate prices higher, but it’s important to realize that just because prices have always behaved a certain way in the past doesn’t mean it will continue that way in the future.