The topic on the tip of everyone’s tongue these days is real estate. As the economy continues on the road to recovery, people are ready to make large discretionary purchases, which they were too scared to make earlier. In contrast to consumer staples (food, drink, gas), discretionary purchases are low to non-existent in recessionary times. Now, as the Federal Reserve has removed the word “extreme” from its “extreme patience” directive regarding its monetary policy strategy—investors, economists and the layman all agree that the United States is finally on the up and up. That being said, real estate is a highly complex investment requiring significant analysis of the market as well as some knowledge of economics and finance.
The Refinancing Effect
Our economy is perhaps the best it has been to enter into the real estate market. Although the market has been attractive in the form of low interest rates for some years now, people were still hesitant to invest a large amount of money in an illiquid asset class when the economy was uncertain. Current 30 year fixed mortgage interest rates are currently between 3.79-3.93% but are expected to increase in late-2015/early 2016. When interest rates were originally dropped, individuals took advantage and refinanced their mortgage. As years went by, that number dropped as the majority of homeowners were already sitting in a refinanced property—this drop off in refinancing is called the refinancing effect. Most of the time, the refinancing effect suggests that the percentage of homeowners will continue to taper off and never match the original first rush of refinancing. However, this was a unique recession (matched only by the original Great Depression of 1929), so it not too difficult to imagine that the recovery will be unique as well.
Low-Interest-Rate Environment
The Federal Reserve has never set and maintained such a low interest rate, and we might not see it for another 50 years. People are aware that interest rates might increase soon and (if they haven’t already) will refinance to lock in that attractive interest rate. In short, we will see behavior that goes against the theory of the refinancing effect because there will be an uptick of homeowner refinancing on the tail end of this low-interest-rate environment. Even though the economy is improving and homes are being sold, house prices have not increased significantly yet. During the 2008 recession, homes were being built quickly but not being sold at the same rate as pre-2008 time. Several years of poor sales resulted in a large inventory of unsold homes. Now with purchasing activity increasing again, developers are trying to unload their aging inventory. Supply and demand will not take effect until the existing inventory is fully exhausted.
Texas and California
Real estate rate theory is all well and good—it sets a framework of a thought process that allows an individual to be more informed about the current environment. However, let’s take a look at something more relevant, applicable and interesting than theory. There are several areas that are hot markets for real estate in the United States. The top two locations are Austin, Texas and Silicon Valley/Bay Area in California. The main theme that connects both locations is business. Silicon Valley is the most famous hub for entrepreneurs, venture capitalists and financial services professionals. Any entrepreneur with an idea moves to Silicon Valley to make it big. Meanwhile, established behemoths like Facebook, Twitter and Uber have significant presence in the Bay Area. Their incredible growth and associated hiring has raised real estate prices. The population effect is further compounded by the lack of housing supply in San Francisco, with current residential occupancy hovering around 99%. Access to San Francisco has become so prized that people are moving to surrounding cities such as Oakland, Berkeley and Marin (making them attractive alternatives to settle in for the future).
Business inflow is also benefiting Austin, Texas. Austin is looking to become the next Silicon Valley. Austin and Texas in general are modeling themselves after the success of Silicon Valley. The state of Texas currently ranks #1 in business incentives, while Austin is highly conducive to early stage companies through the Austin Technology Incubator. Texas also boasts a low tax structure (no sales or corporate tax), lower housing and utility expenses drawing huge interest from companies. Ironically, its current low-housing-price environment is sure to change as businesses increase their presence in the state.
Right Time to Buy?
It might not seem like it, but there are a lot of factors that affect real estate sales and prices. With factors such as weather, time of year, business environment and supply can drastically alter the housing market in a specific location. San Francisco and Oakland are now more expensive than New York City because of real estate demand in the Bay Area. Before pursuing an investment in real estate, it is essential to understand what could and is affecting that investment—any one factor could make all the difference.
This article is the opinion of the author and is not shared by India Currents or any of its staff. All investors should conduct their independent analysis before taking any actions and should not make any decisions on the information provided in this article alone.
Rahul Varshneya graduated from the Leavey School of Business at Santa Clara University with a degree in finance and works in the tech industry as a financial analyst. If you have feedback or have a topic you would like addressed please contact Rahul at rahul89@gmail.com.