Why Real Estate Gains Deviate So Much By Location?

Today Directory of Finance have a guest post from Troy at Market History. Troy’s blog discusses investing topics and using the past to rationally predict the future. Take it away, Troy. 

Since U.S. real estate prices bottomed in 2011, it seems as if almost everyone with spare cash has jumped on the “investing in property for rental income” bandwagon. Personally I also believe that this is a good idea because the rental income can range from 3-7% of the value of the property per annum (depending on where your property is). In addition, real estate is much less volatile that stocks over the long run.

However, it’s important to remember that gains in real estate vary widely considerably on what country/state/city you’re in. Here’s why real estate prices in certain areas significantly outperform real estate in other areas.

Factors that impact real estate price growth

The weather

Areas with gorgeous weather tend to attract a lot of foreign investors and immigrants who upon arrival, spend millions on real estate. This is why places like California and Sydney have experienced rapid growth in real estate prices over the past 2 decades. With the irreversible trend of globalization, a lot of wealthy individuals from around the world are moving to places with pleasant climates. That is why areas with good weather experience higher growth in real estate prices over the long run.

For example, did you know that the number one destination for French millionaires is Australia and not America? That is unexpected because people tend to think of America as the “land of opportunity”. But since Australian cities are safer than American cities and the weather in Australia is much nicer than the weather in many parts of the States, a lot of Europeans choose to move down under instead. Some of these individuals do not need to move to strong job markets because they already have all the money they’ll ever need! These people aren’t looking for business opportunities – they’re looking for a nice beach community to retire in.

The weather is another reason why people move from the Rust Belt and Canada to the Sun Belt, in particular, the elderly. The elderly tend to have more wealth than adults with young families, so they often spend that money on the property down South to avoid the cold northern winters.

Cities vs suburbs

Prior to the GFC, suburban homes tended to have higher values than urban homes. This is because:

  1. Suburban houses are usually much larger than urban houses.
  2. The affluent middle class and upper class prefer to live in the suburbs.

However, the urban real estate started to rise much more quickly than suburban real estate after the U.S. economy recovered in 2009. There are 3 reasons why:

1) Wealthy immigration.

Millionaires and billionaires are leaving places like China and Russia in droves. After all, why would you want to live in a society in which the state can confiscate your assets at will? Most affluent Chinese people used to live in mega-cities with 10 or 20 million people, so even a sprawling city such as Los Angeles or Toronto will seem like a comfortable “suburb” to them. In addition, these wealthy foreigners often fly between their new country and their home country, which means that they have to stay close to large cities for convenience.

2) Money laundering.

Real estate in London and New York has been used for money laundering by many affluent individuals in developing countries. For example, billionaire Russians buy apartments in NYC under the guise of a shell company in Bermuda. The transaction goes unrecorded, and any dirty money the individual may have earned from his home country is now parked safely away from the eyes of his government. Recently the media reported a Chinese government official who was taken down by the government’s anti-graft agency. The report revealed that the individual had 50 something apartment units around the world, and the individual was not even a high ranking official in the Chinese government. If even mid-level government officials in these corrupt governments have that much money parked in overseas assets, you can imagine how much foreign property the high ranking officials own.

3) The inability of millennials to afford houses and cars in the suburbs.

Unlike previous generations, the selfie-generation (as I like to call it) has graduated from college/university with a lot of debt. Job prospects aren’t that good unless you’re studying computer science. Thus, a lot of millennials live at home or rent small apartments in the big city. Who can afford a house in the suburbs and a car when you can barely afford the student loan bills? As a result, rent prices in large cities have skyrocketed. Since rents and home prices are closely correlated, rising rents result in rising real estate prices in urban areas.

These trends do not show signs of slowing down, so urban real estate will probably continue to rise faster than suburban real estate in the next few years.

Strength of the local economy

Areas whose economies are on fire have seen rapid real estate gains over the past few years. A strong economy attracts an influx of workers, many of whom will be paid handsome wages because business is booming. Many of these workers will settle down permanently, especially if they have families. This means that they’ll buy homes and push real estate prices higher. Here are a few examples:

  1. San Francisco. Everyone has heard about how ridiculous house prices in SanFran are. The cheapest house in San Francisco is $350,000, and it’s literally a shack made out of wood. The huge boom in Silicon Valley has attracted hundreds of thousands of engineers, many of whom are paid 6 figure wages at Facebook, Google, etc.
  2. Sydney. The rest of the Australian economy has slowed down from 2014-present because mineral prices have declined (Australia’s economy relies heavily on commodity prices), but Sydney’s economy is as buoyant as ever. That’s probably due to the massive influx of Chinese millionaires and billionaires who are spending their life savings here. As a result, wages are very high ($17.7 minimum wage), which attracts even more workers whom will one day look to buy homes.
  3. Like many other parts of the world, Singapore’s economy has been very robust in the past few years due to the massive influx of wealthy Asians moving to this country that has a stable political system. Singapore’s economic growth has also attracted many relatively wealthy expats to work in its financial centers, thereby pushing real estate prices even higher.

On the other hand, a weak local economy can seriously hurt local real estate.

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