Main Factors That Drive Real Estate Market

Real Estate or Property as we call it, whether Residential, Commercial or Land, constitutes significant portion of most people's wealth. The average Indian has nearly one-third of his or her net worth from Real Estate, irrespective of whether it is for own use or investment.

This translates to a whopping $20 trillion dollars approximate valuation for entire market. The size and scale of the Real Estate market makes it an attractive and lucrative sector for many investors. We will try to look at some of the factors that affect the Real Estate market and investments options available in it.

Factors That Influence Real Estate

Demographics

Demographics are the data that describes the composition of  population based on criteria such as age, race, gender, income, migration patterns and    its growth. These statistics are often overlooked but are significant factor that affects how Real Estate is priced and what types of properties are in demand. Major shifts in the demographics of a nation can have a large impact on Real Estate trends for many years.

There are numerous ways by which demographic shift can affect the Real Estate market. We try to show the effect of this with following examples : 

-      How would be the demand for homes in popular cities of a country if government relaxes immigration norms?

-         How would be demand for houses on rent, if government announces the setting up of an industrial hub?   

-           How will be demand for larger homes if incomes are low and the children have all moved out?

These and other examples which can help investors narrow down the type and location of potentially desirable Real Estate investments long before the trend has started.

Interest Rates

Interest Rates also have a major impact on the Real Estate markets. Changes in interest rates can greatly influence a person's ability to purchase a residential property. That is because as the interest rates fall, the cost to buy a home decreases, as most of the properties are purchased by taking loans from banks or allied agencies. This creates a higher demand for Real Estate, which pushes prices up. Opposite is the effect of rise in interest rates.

However, when we look at the impact of interest rates on an equity investment such as a Real Estate Investment Trust(REIT) when the interest rates decrease high yields from REITs become more attractive and their value goes up. When interest rates increase, the yield on an REIT becomes less attractive and it pushes their value down.

Economy

Another key factor that affects the value of Real Estate is the overall health of the economy. This is generally measured by economic indicators such as the GDP, employment data, Inflation Rate etc. Broadly speaking, when the economy is sluggish, so is Real Estate and may be vice-versa also.

During a sluggish economy old investors get stuck with their investments, fresh investors become shy of taking a plunge till economy or rates stabilize. So Real Estate becomes dependent on end users only, who too become cautious.

However, the cyclical economy can have varying effects on different types of Real Estate. For example, if REIT has a larger percentage of its investments in hotels, they would typically be more affected by an economic downturn than an REIT that had invested in office buildings. Hotels are a form of property that is very sensitive to economic activity due to the type of lease structure inherent in the business.

Renting a hotel room can be thought of as a form of short-term lease that can be easily avoided by hotel customers should the economy be doing poorly. On the other hand, office tenants generally have longer-term leases that can't be changed in the middle of an economic downturn. Thus, although you should be aware of the part of the cycle the economy is in, you should also be cognizant of the Real Estate property's sensitivity to the economic cycle.

Government Policies/Subsidies

Legislation is also another factor that can have a sizable impact on property demand and prices.  Tax Credits, deductions and subsidies are some of the ways the government can temporarily boost demand for Real Estate. Being aware of current government incentives can help you determine changes in supply and demand and identify potentially false trends.

For example, in 2009, the U.S. government introduced a first time home-buyer’s credit in an attempt to boost home sales in a sluggish economy. According to the National Association of Realtors(NAR), this tax incentive alone led to 9,00,000 home-buyers to buy homes. This was quite a sizable increase, although temporary, and without knowing the increase was a result of the tax incentive, you may have ended up concluding that the demand for housing was going up based on other factors.

Real Estate : Is it a good investment

The size and scale of the Real Estate market make and returns attached   make it an attractive market for many investors. Investors can invest directly in physical Real Estate or choose to invest indirectly through managed funds. Investing directly in Real Estate involves purchasing the residential or commercial property to use as an income-producing property or for resale at a future time.

Indirect ways to invest in the Real Estate market include investing in Real Estate investment trusts (REITs), which is very shortly being introduced in India, Real Estate exchange traded shares of Real Estate Companies, and Market traded Shares infrastructure companies.

Due to the higher transaction costs average investors will prefer to indirectly invest in Real Estate through investments tools like REIT.