Most people think of the real estate market as something that's measured like the stock market—bearish or bullish. In real estate, the common expressions for a bull market are “up,” “strong,” “good,” “hot,” and “seller's.” A bearish market is described as “soft,” “bad,” “down,” or “buyer's.” On a daily basis, you'll hear the media use these expressions to describe the real estate market based on facts and figures, most of which are confusing to the average investor.
Let's discuss each of the categories for the numbers you may be hearing and see how they affect the market and, more importantly, your investing strategies.
Most people think of the real estate market as something that's measured like the stock market — bearish or bullish. In real estate, the common expressions for a bull market are “up,” “strong,” “good,” “hot,” and “seller’s.” A bearish market is described as “soft,” “bad,” “down,” or “buyer’s.” On a daily basis, you'll hear the media use these expressions to describe the real estate market based on facts and figures, most of which are confusing to the average investor. Let's discuss each of the categories for the numbers you may be hearing and see how they affect the market and, more importantly, your investing strategies.
New Home Sales
Sales of new-construction homes is an indicator used by many market economists to measure the strength or weakness of the housing market. This data comes from home-builders in the form of scheduled permits for new home builds and orders for new homes from consumers. This data is somewhat relevant to your investing plan because it can show how strong the demand is for new homes. However, keep in mind that in some places — such as inner cities where there is no available land — developers aren't building new homes in mass quantities. Likewise, in suburban areas where land is plentiful, there is endless room and an oversupply results.
Note that most of the home-builders in the United States are large companies that operate in many different markets. These companies work on large volumes and may continue building houses in markets where they are breaking even or possibly losing money, simply because they've committed to building permits and plans. Therefore, while large builders are still making new homes in a particular market, they're often looking at long-range plans, not short-term financial decisions. This can create a false sense of market strength, not to mention an oversupply problem that can affect the rest of the local housing market.
A good way to tell if a builder in your market is doing well is to look at its supply of housing. A typical supply for builders is about six months of homes, that is, if they stopped building, they'd run out of existing inventory in six months. Having more than six months on hand is a sign of oversupply. The reverse is also true. Plus, if builders are selling lots without homes on them, this generally means they own too much land, another sign of a soft market for new homes in that area.
Be sure to compare apples to apples. When you analyze home-building and sales data, it's important to compare single-family homes with single-family homes. Condominiums and multifamily homes have different buyers, so it's possible to have a strong demand for one and not the other. This is why data for single-family homes, condominiums, and multifamily homes is often broken down in sources that report on real estate.
The resale of existing homes is another indicator of your local real estate market, particularly in areas where there isn't a large supply of new homes. This data comes from the REALTORS® associations such as the National Association of REALTORS® (NAR). Note that the price of home resales is more important than simply the number of homes sold. Also, home resales may be stated as, “sales of homes down 15 percent.” This simply means the number of homes sold has decreased, not the price. A decrease or increase of the number of homes sold is only part of the equation. Data for home resales can be found at www.realtor.com.
Applications for new mortgage loans show data that is ancillary to the sale of new and existing homes. Of course, some of this is refinancing, which is driven by the rising efficiency and falling cost of loan processing and in large part driven by low interest rates. Statistical data for mortgage loan applications can be found at the National Association of Mortgage Brokers' Web site at www.namb.org.
Rental Vacancy Rates
Rental vacancies are relevant to the values for multifamily housing, and they can be a good sign of what's happening in the single-family home-buying arena. When interest rates are low, home-buying goes up on the low-end of the price scale, simply because it's cheaper to make mortgage payments than rent payments. This trend leads to higher vacancy rates in an area and, thus, lower rents. Why? Because in this market, managers and owners lower their rents to make properties more attractive to the few renters that are available. Likewise, when interest rates and home prices rise, renting becomes a cheaper option. This causes a drop in the demand for single-family housing and an increase in the demand for rental units and homes. Daily interest rate data can be found at www.bankrate.com.
Cost of Materials
The increase in the cost of certain building materials can affect housing prices. For example, a rise in the cost of timber can affect the cost of housing nationwide.
It's worth noting that often these statistics are based on nationwide facts and figures. The nationwide statistics aren't as important to you if you're only buying in your local market. (In most cases, this is your own backyard or a particular “emerging” market.) The stock market uses indexes to determine the market as a whole, but is this really important if you only own two stocks? Likewise, does it matter how many homes sold nationwide when you only buy homes in Cleveland housing market? In short, you need to focus primarily on local trends rather than national trends. (The two exceptions to this rule are interest rates and income taxes, discussed next.)
Nationwide and even global factors such as the Federal Reserve rate, worldwide markets, and competing investments such as stocks and bonds control interest rates on mortgage loans. When interest rates fall, housing becomes cheaper across the nation because homeowners' monthly payments are lower. However, the flip side of the equation is that when interest rates rise (particularly for borrowers who are getting adjustable-rate loans), the mortgage default rate will increase, causing a boost in the number of properties available for sale as foreclosures. Foreclosures are generally sold cheaper than other houses, which can drive down prices. If lenders are dealing with too many defaulted loans, they may tighten their practices, making it harder for people to borrow money, particularly those with poor credit and low income as well as those who want very large mortgages (called “jumbo” loans in the business).
Federal income tax rates, particularly on investment properties, can have sweeping changes on the real estate market nationwide. A prime example was the Tax Reform Act of 1987, which changed depreciation rules on investment properties and was a major catalyst to the downfall of real estate in many parts of the country. A similar change to the tax laws in the future (e.g., a change in whether property owners can deduct interest payments) can significantly affect the profitability of real estate for investors. A drastic change could drive investors away from real estate, causing a drop in the number of buyers, thus a drop in demand, and a resulting drop in prices.