Real estate usually makes up 15%-18% of America’s GDP. This number is broken down into 3%-5% from “Residential Investment” and 12%-13% from “Consumption Spending on Housing Services”. There is no doubt that this industry is an integral part of our economy, which is why it can be used as an indicator for the economy as a whole. In 2008, the industry completely collapsed, with home values sharply declining after the subprime mortgage crisis. For years after this collapse, new construction rates were cut in half and the future of the industry looked bleak. In 2007, 776,000 new houses were sold. By 2011, this number had dropped to 306,000 new houses. But have prices followed this trend?
This FRED graph shows the Housing Price Index. Clearly, prices collapsed along with new construction rates, but prices are now above their previous highs. Because of this strong price growth, some speculate that the industry is over producing and that supply is now outpacing demand. This speculation is hit and miss, because real estate as a whole looks pretty good, but some markets are definitely becoming saturated. A prime example of this is Salt Lake City. SLC has gone through extreme growth in construction and prices, while vacancy rates have dropped to an all time low. Because SLC’s market has been so promising, developers have loaded the pipeline for new constructions. According to Colliers International, SLC’s new supply will outpace demand by the end of 2017. So by mid 2018 we will most likely see prices drop and vacancy increase. Since 2011, the hotspots for real estate have been mostly located in the south, in warmer climates, and in harbor cities. Primary markets have had prohibitively high pricing, which explains why many firms and families are relocating to cities like: Tampa, Orlando, San Fran, San Jose, Seattle, Houston, etc. The following infographic gives a good outlook of relative prices by region.
Within the next few years, cities with low rents and home values will experience growth, while primary markets will remain low growth/ high price. As you can see from the infographic, most of the locations that I mentioned are in a lighter shade (lower price). In today’s technological environment, service based companies can operate from pretty much anywhere. Firms are capitalizing on this advantage by relocating to states like Indiana. For example, Salesforce.com, a growing tech behemoth, recently moved to downtown Indianapolis. Indy rents are less than half of comparable rents in NYC, so why not move there? Firms relocating to these low-rent cities will be the main driver of real estate in the coming years. Their employees will need housing, which will boost new construction rates and increase housing prices. Secondary market growth and primary market stability in the real estate industry will expand our economy as long as the US continues to add new jobs.
I appreciate the breakdown of home prices by state cause it really helps illustrate a clear picture of where houses are cheap and where they are expensive. A lot of what I knew was presented on this depiction (E.g. my previous comments about houses in Massachussets compared to Texas). Your comment – that families and corporations are moving to other places that are not as expensive – so cities with low rents and low values will experience growth is really interesting, and something that I have been observing as well. I wonder though if there’s any international affects to this and how many companies in the future will choose to locate in other cities in the United States vs. somewhere else? If this is (or will occur), I wonder to what extent it will have an impact.
The international question is a good one. Right now, most foreign capital coming into the U.S. real estate industry is going to primary markets. Not many foreign investors know or care about cities like Nashville or SLC.
Causation! – are housing prices a reflection of local economic growth? Unless big employers move to less expensive cities (how many corporate executives want to live in Peoria?) then there’s no reasons such differentials will be arbitraged.
I agree that the price differentials will be arbitraged, but that takes time, hence real estate cycles. Salt Lake City, for example, has experienced extreme growth in nearly every measurable metric but the real estate market is beginning to reach saturation (supply will catch up with demand by mid-2018). When this happens, there will be cost-efficient opportunities in other cities.
Also- I believe if a corporate execs. can get office space for half the rent of a primary market, they would be willing to live in a secondary market. This obviously depends on the viability of the relocation on a industry-to-industry basis.
Currently in Detroit there’s more growth in the downtown area with firms moving in and establishing their base in the city. The most notable example being QuickenLoans which really jumpstarted other companies to consider moving to Michigan. When younger artists and recent grads also started moving into the city, one of their talking points was how cheap everything was compared to anything they could find in New York. Back in 2015, there were a series of billboards put up with slogans like “Detroit, Just West of Bushwick”. We do see relocation based on cost, with Detroit being a new example, but the chances that Detroit becomes the new San Fransisco still remain slim.
I follow your rationale and am very interested to see how this trend plays out. Specifically, I’m am eager to learn how housing prices will change as more and more employees become “remote,” and able to work anywhere in the country. Perhaps they will do exactly as you hypothesize, and move to less expensive geographies? Sure would be a good thing for real estate markets in my native Southeast…
I like Will’s take on this. We no longer have to rely on geographic proximity to industry hubs to participate in those industries. Why spend two days of travel to attend a meeting when we can use Skype to do the same? One thing that always interests me is the diversification of local economies. For example, Minneapolis no longer relies on grain trading for its livelihood as favorable policies have encouraged growth in other sectors. I would love to see the effect communication has on local economy diversification. Why open an office in New York City if you can do the same from anywhere with lower costs and favorable policies, schools, etc.?
Exactly. Interestingly though, our generation seems to prefer larger cities (which is why we are seeing the death of many suburbs and revitalization of urban markets). Maybe the two theories are not mutually exclusive and we will see secondary urban markets grow rather than secondary suburban markets?
Interesting post. Its very interesting to learn about SLC and the saturation that is projected to occur by 2018. Being from Tampa, I witnessed this right before the recession in 2007-2008, as construction of housing way surpassed the demand. After the housing market collapse, this resulted in many vacant homes, as well as many half-finished lots/houses that were completely abandoned.
The saturation I’m referencing in SLC is much more comfortable than what we saw in 07-08. Basically, now developers are more cautious and are tracking housing/retail/office demand extremely carefully. Cap-rates will depress slightly, occupancy will decrease slightly, but rents should stabilize. I’m sure in the case of Tampa rents drastically decreased after the bubble. I guess I’m trying to say there is a difference in saturation and completely overshooting demand to the point that you have tens of thousands of empty homes.
Don’t be too quick to assume geography doesn’t matter. Tech firms from all around the world continue to set up offices in Silicon Valley, which is surely the most expensive place to run a business in the US. It also has everything radical Republicans despise – unions, regulation, liberal politics, controls on land use, heavy-handed government – and which they claim to be inimical to running a business. Apparently no one ever told Apple and Alphabet and a long list of other tech companies that.
It’s not that you can’t hold meetings remotely, it’s that you can’t network with skype. Going out drinking with groups of diverse membership is critical to developing an array of contacts, brainstorming, and checking out potential coworkers. Sociologists are better oriented to doing that sort of research than economists.
I think everybody has great points. There are definitely many factors that bring business and millennials alike to larger cities, and these will continue to grow. It is also true that foreign capital is concentrated on primary markets as well. However, I do know for a fact that the regionalism that the Professor explained with regards to tech firms in Silicone Valley exists elsewhere in differing capacities. There are areas, for example, that are loaded almost exclusively with offices and corporate headquarters. Several areas of Northern Virginia/Maryland can be characterized this way, and Des Moines, Iowa is another burgeoning center filled with office assets. This works the same for industrial assets as well. I think that, over time, this arbitrage will occur to a certain degree, and lesser known cities will see growing demand.
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