A home investment makes good financial sense for many people because the value of real estate tends to increase over time. Rising home prices over the past two years is an example of how home values increase. Prior to the recent housing boom, home prices remained flat or declined in many markets for several years after the recession that began in 2008.
Home prices can rise relatively quickly when interest rates and housing supply are low. Buyer demand absorbs foreclosures and the net effect is that home prices rise. Foreign cash buyers in search of a stable U.S. economy and the overall higher cost of renting a home are also reasons that home prices have soared in the past few years.
Historically Low Mortgage Rates
Mortgage rates are historically low, and most people who want to buy a home know that currently low mortgage rates cannot last forever. Disinflation has caused interest rates to decline over a multiple decade period and the likelihood of rising interest rates is statistically assured.
In comparison, inflation is historically one of the reasons home prices rise. According to the Federal Reserve Bank, inflation is expected to affect commodities prices within the next two years. Fed watchers expect that U.S. interest rates including mortgages will begin to rise soon.
Governments around the world have signaled that interest rates are expected to rise within the near future. For instance, the Bank of England announced that interest rates will increase around the end of 2015 or early 2016. Other central banks in Europe and around the world, including Germany and Australia, are expected to increase interest rates.
Housing Supply
Although rising home prices are driven by various factors in different parts of the country, housing supply is a strong contributor to rising prices. Home construction has increased over the past year but, after the last recession, many construction firms around the country halted new single family home building projects. These factors have limited the addition of new units and more buyers compete for existing homes on the market.
Of course, not all homes for sale have found new buyers. Some single family homes that remain vacant for longer periods are converted to rentals. Because not everyone who would like to buy a home can do so, rental prices have continued to increase at a faster pace than home sales prices.
There are many reasons that rental unit prices continue to rise, including stricter mortgage loan requirements of prime lenders, employer firms’ job cuts, or lack of down-payment funds. Many would-be home buyers are cautious about buying a new home today and continue to rent rather than purchase a home. Of course, rising rents can push more real estate investors to purchase additional real estate.
Buyer Demand
More millennial buyers with good jobs have entered the real estate market for the first time. These buyers want newer “smart” homes. They are willing to pay higher home prices to obtain the features they want. Some parts of the country are experiencing higher than average job creation growth. As new employees move or get transfers, they add to existing demand and cause home prices in these areas to rise.
Real Estate Market Liquidity and Efficiency
Simply put, the real estate market is less liquid and efficient than the markets for other financial assets like stocks and bonds. Some buyers expect similar correction or overcorrection of home prices, and we do. Unfortunately, relative adjustments in real estate and financial markets frequently vary. Real estate prices tend to over-reflect other market trends.
Housing markets strongly appreciated in the 2001 to 2006 real estate market bubble but suffered a sharp correction or decline in 2007 to 2009. Home prices in some markets over-reflected selling and became quite affordable over a short period of time. Foreign investors with cash quickly swooped into housing markets like San Diego, Miami, Las Vegas, Phoenix, and Los Angeles.
The continuing rise of real estate prices will stop some buyers from purchasing a home. As interest rates rise, price appreciation in the most attractive markets may begin to slow. As the Federal Reserve unwinds its balance sheet and interest rates increase, home prices may flatten or show declines.
However, it is important to understand that owning a home investment is different from buying property intended for investment. Each individual or family needs a place to live, whether they choose to buy or rent their home. The major difference is that homeowners receive tax benefits from the mortgage interest deduction, while renting a home offers no tax benefits to the renter. Homeowners also have the opportunity to build equity while renters help to build the landlord’s equity values.
History shows that owning a home is one of the best ways to increase net worth over time. If planning to live in a home for at least five to 10 years, owning a home may be a better investment than other financial assets in the portfolio.
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