Residential and Commercial Real Estate Indicators of Economic Health
Utilizing real estate trends to understand the economy is no secret. Given the size and scope of the real estate industry, there is little doubt that a fundamental shift in real estate pricing and sales statistics can reasonably communicate the direction markets and economic health are headed.
Housing starts directly impact home sales, construction jobs and real estate related employment are key metrics used by many economy experts, but there is a great deal more to the picture as we look at how we can use residential and commercial real estate indicators to measure economic health. In fact, we can use residential and commercial real estate indicators to project or predict economic events or shifts in fundamental investment strategies.
Commercial construction and sales are possibly even better predictors of where we are headed financially and, at a minimum, you need to look at a holistic view of the real estate industry. Historically, standard commercial is a trailing indicator following the residential market. As a general rule, commercial follows residential by about 2 years. This isn't quite the crystal ball surprise you were looking for, so let's dig in a little deeper.
Opening an office or expanding offices is a result of how businesses are performing over time. Perform well and the business grows to the point where it expands beyond existing capacity. Through difficult financial times, companies will fire and layoff. These trends, while slower in the commercial arena, almost immediately impact employment and housing which carries much higher volatility.
Businesses are simply more stable and smooth transitioning by their very nature. Commercial real estate is less immediate due to the slower, wider nature of business cash flow versus personal cash flow. So when we see residential real estate go up or down, there is a fairly strong likelihood that commercial will follow in the same direction. By the same token, if we see commercial real estate expand, then we have to factor in the 2 years prior where the market was already in the process of changing.
Once we understand the nature of this complex cycle, then it is relatively straightforward to identify where we are from an economic outlook standpoint. Add to this the historical approximation of a ten-year top-to-top / bottom-to-bottom cyclical pattern and we get a pretty good idea of the economic landscape. It is worth noting however, that current economic and political conditions have greatly destabilized our cyclical patterns to the point where they are less recognizable, but the patterns still remain. To find out why is outside the scope of this article, but we cover it in the newsletter so signup now.
So standard commercial overlaps residential. Another commercial segment is multi-family consisting of 5 units or more per building. This tells us a similar but different story. Apartments fall into the commercial category because they represent rental rather than purchase. If we factor this rental component in with the overall commercial and residential models, we not get a 360 degree view of our economy all wrapped up in the housing market.
Given that we have a relatively predictable model in the real estate industry, we can surmise that the extrapolation of data is relevant and significant enough in weight to apply with confidence as a projection of economic condition. Loosely translated, this means that not only can you use a real estate model as a gauge of economic condition, you can use it as a tool for prognosticating the real estate market itself to determine investment direction and depth.