Factors That Influence Real Estate Prices

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Narrator: If you decide to invest in real estate investment trusts, or REITs, understanding what factors can influence real estate prices is essential. Like any asset, property prices rise and fall largely because of supply and demand, but what factors influence those? Let's go over some of the most significant factors and how they might affect REITs.

The first factor to consider is the interest rate environment. When interest rates are low, property buyers can generally get loans at a lower rate, which typically increases demand for real estate and can drive up prices.

For example, in response to the coronavirus pandemic in 2020, the Federal Reserve cut interest rates to spur economic recovery and kept them low, even as the economy boomed. The low interest rates contributed to historically high housing prices. This includes the rents and values of multifamily properties, which many REITs hold.

On the other hand, high interest rates typically make it more expensive for property buyers to borrow, which can lower property demand and weigh on real estate prices. However, real estate prices may still advance if the higher interest rates are accompanied by strong economic growth or high inflation.

Of course, the real estate market can be affected by more than just interest rates.

Real estate is also subject to several political risks.

Government policies can either encourage or discourage real estate buying.

For example, after the housing bubble popped in 2008 and prices declined, Congress passed several bills aimed at helping the housing market. For example, it enacted an $8,000 tax credit for first-time buyers. This incentive was designed to increase housing demand and stop falling home prices.

On the other hand, in 2021, the White House announced policies meant to boost the supply and affordability of housing.

Additionally, in 2021, the Biden administration considered changing the "like-kind exchange" tax rule, which allows real estate investors to delay paying taxes on realized gains if they're transferred into a purchase of a "like" investment. An update to this tax could affect how REITs manage capital and be a drag on growth.

Of course, unexpected events can also impact real estate. For example, in response to the pandemic in 2020, many people left urban centers, causing rents in some cities to plummet and leaving retail property vacant as restaurants and small businesses closed. Additionally, many jobs became remote during the pandemic, which has many companies rethinking the value of physical offices. By early 2022, this switch to remote work benefitted warehouse and data center real estate, but the outlook on the future of commercial real estate remained uncertain.

While events like the 2008 housing and financial crisis and the 2020 coronavirus pandemic are rare, they illustrate forces that can significantly influence the real estate market. Now that you understand that market a little better, let's see how some of the factors we've discussed might affect a REIT index, which includes many types of properties.

This chart shows a hypothetical investment of $1 in stocks, bonds, and REITs since 1972. As you may have expected, REITs were hit hard by the bursting real estate bubble and financial crisis in 2008. On the other hand, REITs emerged from the pandemic at record-high prices. Dips in some real estate, like retail and office properties, were offset by boosts in other types, like warehouses and data center properties. Just like diversification overall can provide protection to a portfolio, diversification within REITs can do the same.

Of course, past performance doesn't guarantee future results. But understanding how different factors affect real estate can help you make decisions about investing in REITs.

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