The Real Estate Recovery Debate

Both sides of the Real Estate Recovery argument are sure they’re right. One side has data on their side, and the other side has history. It’s a tough call.

The contenders:

The Housing is in a recovery camp: they have prices slowly moving up, building activity increasing, rental rates increasing, low mortgage rates and other factors on their side. And it’s true. There are plenty of data to show strengthening in the real estate market. year over year price increases and new construction activity are positive.

The not yet camp: they have history on their side because historically, government propped up activities (specifically here housing, but we could include almost the entire economy) have reverted smartly, and painfully for many. For example, Interest rates at 0% can only go in one direction supposedly, and experts explain that the move in the interest rates in just the past year alone has decreased monthly housing costs 15%.

Who’s right?

It depends. If central banks, such as the Federal Reserve in the case of the USA, can keep rates at zero % indefinitely, then financing will remain cheap and asset prices inflated. And the spread between the cost of real estate and rising rental income looks attractive to investor buyers (and let’s face it, in some areas like Florida and Las Vegas, that’s who’s buying). If for some reason, the markets reject buying government bonds at low interest rates (which would force rates to rise), then real estate prices could correct.

The point is – market forces are not fully explaining the real estate market. The market is responding to HEAVY influence from Federal Reserve monetary policies. Without that Fed influence, in my opinion, real estate prices, especially on the commercial side, would drop 25-30% as the cost to finance would jump to a place where rents can’t keep up in the short term (many commercial loans are are fixed for a maximum of 10 years, and many more are variable rate).

On the other hand, if the Fed can keep rates low without incident, then real estate could be one of the best leveraged inflation hedge, as individuals especially, can lock in low rates for 30 years, and collect rental income that can increase over time (faster if inflation if inflationary prices rise quickly).

You have to decide what camp you are in if you want to get into the real estate game. Further consideration should be given to regional dynamics. For example, in regards to Florida, I have noticed in my work that the trend of boomers buying southern second homes, which came to a halt in 2007-08, has restarted. This should be supportive for some Florida real estate. Other areas of the US have their own dynamics that affect the local real estate market.

Some extra reading:

Pro: Bill McBride

Con: Mark Hanson