One mantra in real estate investing is that “all real estate is local,” and that’s largely true. There are 421 Metropolitan Statistical Areas (MSAs) in the United States, and each has its own supply and demand characteristics—such as job growth, population growth, current inventory, and new home inventory—that determine home price appreciation.
However, there are also four national-level factors that affect your property values as well, which you, as an investor, should have on your radar. The first three are straightforward, but the last one is one that investors aren’t often aware of. They are:
- Interest rates
- Inflation
- Recession
- Capital Flows
1. Interest Rates
Interest rates are determined at a national level, and rising interest rates hurt investors because as rates increase, housing gets less affordable, and the pool of qualified buyers decreases. This dampening of demand usually results in a drop in home values.
In the early 1980s, for example, mortgage rates went as high as 18.6%, and as rates declined, home prices increased.
Rising interest rates could hamper your plans to sell an investment property. If you’re buying and holding, you can wait it out, and your home price should recover.
2. Inflation
Inflation is also determined at the national level, either from over-expansion of the money supply or disruption of supply chains. Inflation is a net positive for investors because it causes rents and property values to go up over time and enables investors to pay off their mortgages with devalued dollars. There hasn’t been much inflation over the last 20 years, but it has come back recently with the Fed’s rate increases and the increased cost of reshoring manufacturing back to the United States.
It remains to be seen how this will play out, but investors shouldn’t forget about inflation.
3. Recession
If inflation is when the economy is overheating, recession is when the economy has cooled down, resulting in job losses and higher unemployment.
This is shown in the previous graph. The shaded areas represent periods of recession, and home prices flattened or dropped in 1990 (post-Gulf War), 2001 (dot-com bubble), and 2009 (Global Financial Crisis).
This affects investors when their tenants lose their jobs and can no longer pay rent or they move out and create more vacancies. This effect is especially felt in single-industry markets like Las Vegas or Detroit.
When times are bad, the first thing consumers cut back on is discretionary spending, like trips to Vegas or buying a new car. Investors should protect themselves from this risk by focusing on markets with diverse economies like Atlanta. When parts of the Atlanta economy were in recession (such as Delta Airlines during the COVID-19 pandemic), other parts of the Atlanta economy (Home Depot, UPS, hospitals, universities, Center for Disease Control) continued to provide stable jobs.
Another way investors can protect themselves is to have recession-proof tenants, such as Section 8 tenants. During the Covid pandemic, many tenants were unable to work, and landlords were prevented from evicting them due to eviction moratoriums. However, the Section 8 program still paid its share of the rent, such as clockwork, on the first of each month. Finally, the good news is that the average length of a recession in post-war periods have been about 10 months, so this too shall pass. Long-term buy-and-hold investors in markets with diverse economies can wait it out.
4. Capital Flows
Capital flows are the national-level variable that’s most often overlooked by investors. Two examples are foreign money and Wall Street money.
Foreign Money
When the U.S. dollar is weak against other currencies, U.S. real estate looks inexpensive, and foreign money pours into certain U.S. real estate markets, causing prices to rise due to increased demand.
Generalizations are dangerous, but broadly speaking, European investors buy in New York or Florida; Asian investors buy in California, Seattle, Vancouver, and to some extent in Las Vegas. Latin American investors buy in Miami. These investors are primarily individual investors purchasing single-family homes. Institutional money tends to buy commercial properties like office buildings and shopping malls. If you own residential property in any of these areas, you might experience an influx of foreign capital that results in rising home prices.
Wall Street Money
Another source of capital flows is Wall Street. When real estate is in vogue, Wall Street capital can drive a market up or support a market bottom.
During the financial crisis in 2008-2010, Wall Street firms were buying up property all over the U.S. at fire sale prices. While homes didn’t necessarily appreciate during that time, the influx of money did work to provide a floor for prices and keep them from dropping even lower.
Even with today’s higher interest rates, if property values were to drop in a given metro, Wall Street money could pour in and provide a support level for home prices in that metro.
Note that this effect only applies to specific markets. Wall Street money goes to large gateway cities like Atlanta, Dallas, Houston, Phoenix, and Las Vegas and usually to newer construction homes. Don’t buy a 100-year-old house in Toledo and think that Wall Street money will provide a floor for your property price.
What’s More Important?
So, when determining whether a market will appreciate, what’s more important: Local economic drivers like job and population growth or national economic drivers like the four we just discussed?
My back-of-the-envelope analysis indicates that local factors are more important most of the time, but national factors can override local economics at the extremes. Looking at the 40 years from 1980 to 2020, I see about eight years in which national factors such as interest rates, recession and capital flows dwarfed local economics:
- 1980-1982: High interest rates
- 1990, 2001, 2008-2010: Recession, Capital Flows
That translates to roughly 20% of the time when national factors predominate and 80% when local factors predominate.
Takeaways for Investors
To sum up, here are some implications you should consider as an investor:
- Invest in recession-resistant markets with diverse economies;
- Invest in recession-resistant tenants like Section 8 tenants or retirees who don’t need a job;
- Follow the money: Where would foreign money or Wall Street money invest? This can provide some upside as well as protect your downside.
- When deciding where to invest, focus primarily on the local economic factors such as job and population growth, diverse economies, landlord-friendliness, etc., but be aware of the national factors so you’re not blindsided.
