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How Does the National Economy Impact Real Estate Prices?

“It’s the economy, stupid.”

Originally coined by James Carville in the context of American politics, this phrase holds meaning across disciplines. The economy is a massive structural behemoth that affects nearly all of our daily interactions in some way – and better understanding it can help us make better decisions across the board.

Of course, there is no better landscape for applying economic understanding than in the realm of investments – at least, ostensibly. If you could somehow perfectly understand our economy, along with all the little interactions within it, you could easily turn even a small lump of startup capital into an absurd volume of wealth.

But therein lies the problem: you can’t fully understand the economy. No one can.

So exactly how much does the national economy impact real estate prices?

And how can you apply this knowledge to procure better turnkey real estate investments?

The Elusive Nature of “The Economy”

Sometimes, you’ll hear people in deep debates about what should be an objective issue; one economics expert insists the economy is doing great, while another asserts it’s doing terribly, while still another believes it could go either way.

Why is this the case?

To put it succinctly, the national economy is complicated – and not easily reducible. Broadly, the economy encompasses the performance of countless interrelated markets, organizations, and individuals.

To give a brief snapshot, here are just a few of the factors and economic indicators that experts examine to determine how well the economy is doing:

  •       GDP and growth. Gross Domestic Product, or GDP, is a measure of a country’s total economic output. It attempts to capture all goods and services produced in an economy over a given period, estimating its economic fortitude. Economists also like to track how this figure changes, with targets for annual growth.
  •       Inflation. Inflation measures the rate at which prices, broadly, increase; it’s simultaneously a measure of the rate at which the buying power of money decreases. Monetary policymakers attempt to maintain a “healthy” level of inflation, but high levels of inflation stifle buying power and carry economic burdens. Good real estate investors know how to take advantage of both low-inflationary and high-inflationary environments.
  •       Unemployment and wages. Unemployment is a measure of how many people aren’t working, while wages are a measure of what people are making while working. Robust employment and suitably high wages are indispensable for a healthy economy. Even if GDP is high and inflation is low, high unemployment with low wages can spell a troublesome economic picture.
  •       Credit and bankruptcies. Similarly, we can examine the health of the economy for consumers by studying credit scores and bankruptcies.
  •       The stock market. And of course, some people use the stock market as a relative gauge of economic health, looking at stock prices (vis-a-vis real estate), as well as trading volume, P/E ratios, and other factors.

Rarely do these figures coalesce to form a clear picture, and even when they do, there may be pieces of contradictory evidence or reasons to doubt mainstream conclusions.

In other words, the “big picture” is always a bit fuzzy and open to interpretation, even under ideal circumstances.

The National Economy and Real Estate Prices: Supply and Demand

How exactly does the national economy impact real estate prices?

The short answer is through supply and demand.

Source

When the economy is doing well across the board, real estate prices tend to rise. People are employed, making lots of money, enjoying rising equity, and are generally optimistic about the future; this drives them to purchase real estate in larger numbers and for higher prices, increasing buying competition and driving prices up.

Conversely, when people are unemployed, underemployed, or otherwise pessimistic, the buying frenzy grinds to a halt – and prices tend to fall back down.

However, things get significantly more complicated the deeper you look.

Certain economic factors are responsible for putting pressure on real estate prices, in one direction or the other – and the effects are not always intuitive. For example, high rates of inflation are typically seen as a sign of a weak or bad economy, yet they can be beneficial for homeowners who enjoy rising real estate prices and devaluation of existing debt.

Some investors also like to play a meta game, planning their actions in response to perceptions about the economy and influencing new effects in the process. For example, in a relatively bad economy, when real estate prices decline, real estate investors see amazing buying opportunities, sometimes flooding the market and preventing prices from falling too far down.

As you can see, some of these effects are somewhat contradictory; but another way to see this is that these are natural stabilizing forces in a complex market-driven economy. In any case, it’s clear that the average investor can’t make a simple summary of broad economic performance as a driving factor for their real estate investing decisions. There’s simply too much nuance in play.

Long-Term Effects: Real Estate Prices, Business Cycles, and Time Horizons

We also need to acknowledge that a single snapshot of the economy can’t tell you much about its momentum, just as a photograph of a runner can’t tell you how fast they’re running. When considering real estate decisions, we need to think about longer-term time horizons.

The economy has taken so many surprising twists and turns – such as catastrophic crashes that rebounded practically overnight and prolonged bull runs that defied all expectations – that it’s not worth spending time speculating about how the economy is going to perform 10 or 20 years from now. But we can make reasonable speculations about the big picture; based on all the historical data we have and our current understanding of the variables, it seems like real estate prices are going to increase predictably for decades, if not centuries to come.

If you’re trying to time the market, understanding the economy, business cycles, and real estate market cycles is imperative – and even then, you’ll be prone to wrong predictions.

But if you invest in real estate with a long enough time horizon, those factors cease to be important. If you hold your real estate portfolio for 30 years or longer, even a new Great Depression in the middle of that era won’t be enough to totally derail your strategy.

Local Market Dynamics vs. The National Economy

Next, keep in mind that the national economy has only a limited impact on local market dynamics. While the broader economy is doing well, certain local neighborhoods may be totally impoverished. While the broader economy is doing poorly, certain local neighborhoods may be absolutely flourishing.

In the United States, there are always countless neighborhoods where you can find amazing properties for reasonable prices – which is one reason why there are so many foreign investors interested in building their portfolios here. If you know where to look, you can find perfect buying opportunities regardless of what the broader economy is doing. A healthier macroeconomy simply means there will likely be more thriving communities than usual.

The Power of the Individual Deal: Turnkey Properties and Beyond

If you find an amazing deal on a turnkey single family rental property, does it really matter what the rest of the economy is doing? Let’s say, for $200,000, you can purchase a property that’s going to generate $3,000 in gross monthly revenue, quite reliably. The neighborhood looks good, you qualify for a reasonable mortgage, and because it’s a turnkey property, it will require no initial repairs before you start listing it as available for rent. 

Wouldn’t you purchase this, regardless of broad, national economic conditions?

Don’t expect to find a property like this every day. The point is, you need to examine the dynamics of an individual deal as a priority over whatever happens to be going on in the national economy.

The Right Approach: National Economy and Real Estate Prices

So what’s the right approach here? How should you study and consider the national economy as you anticipate changes in real estate prices and navigate this space as an investor?

  •       Consider the past, present, and future of the economy. As you prepare for any major real estate transaction, you should consider the past, present, and speculative future of the national economy. As we’ve seen, the national economy bears a significant impact on real estate market dynamics.
  •       Consider the local economy. However, you also need to consider the local economy. Individual neighborhoods don’t necessarily fall in line with national economic momentum.
  •       Examine your personal position. In the grand scheme of things, the national economy can only tell you so much. You also need to consider your personal position, including your available cash, your credit score, your personal risk tolerance, and your existing portfolio. Even perfect national economic conditions shouldn’t move you to purchase a new property if you can’t afford it.
  •       Examine the deal. Of course, you also need to consider the individual deal. You can find good deals and bad economic conditions and bad deals in good economic conditions, so there isn’t a single “right” time to buy or sell anything.
  •       Weigh all factors together. Your job as a real estate investor and analyst is a somewhat complex one, as you need to consider many discrete factors together to make the best possible decisions. There’s no “secret code” to crack and no perfect time to buy or sell.

Are you looking at the national economy to better understand the context of your next real estate purchase?

Good! You should be.

But there’s a lot more to finding a good deal on a turnkey real estate property. If you’re ready to commence the next phase of your search, start here!

Derek Bryan
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