Real estate, in an economy; is like the first domino in a marching band of dominoes that need to stand upright at all times to keep everything stable and working as it should.
If something were to that first domino to make it topple over; everything would follow suit in a disastrous sight we’d call a market crash.
Governments and institutions all over the world have done their best to implement measures that better allow us to predict the state of the industry and take corrective actions when needed to avoid the consequences of being in a real estate bubble.
In this post, I’ll be covering these measures used to keep an eye on real estate; how they work, and whether or not they even work.
What Are Housing Market Indicators?
Housing market indicators came into light as tools to be used to avoid repeat catastrophes caused by the boom, forth, and inevitable pop period of real estate bubbles that can throw the industry and potentially the entire economy into turmoil.
Within the category of housing market indicators are multiple financial formulas and general economic indicators that when used together are believed by many to give accurate statements of the current state of real estate concerning whether or not the prices for real estate sales and rentals are fair in a specific region.
Fair in this context refers to appropriate alignment to what the indicators state is appropriate – the prices are justifiably valued through the foundations of economic principals.
When prices are seen as “unfair,” they are beyond the range of justifiable (either too high or too low) as would be justifiably appropriate through the foundations of economic principals.
What Are Housing Market Indicators Used For?
Traditionally, real estate indicators were created to predict and identify real estate bubbles that would potentially compromise the industry. Once identified, the government and loan institutions (banks and mortgage brokers) would be responsible to safely deflate these bubbles without compromising the industry and economy.
Aside from this historical purpose, housing market indicators have also been used for the following purposes:
Which Properties Are Factored Into The Indicators?
- Residential property.
- Commercial property.
- land real estate.
The main focus for real estate indicators is in residential property as this is the most accessible form of real estate in the market and includes rental and single-household properties.
- Residential home sales properties
- Residential home rental properties
- Commercial sales properties
- Commercial rental properties
- Industrial sales properties
- Industrial rental properties
The Types Of Housing Market Indicators?
1. Housing affordability measures.
- The price to income ratio.
- The down payment trend.
The price to income ratio.
This calculation considers 2 key real estate aspects
Firstly, there is the consideration of the average price (valuations) of homes in a specified area such as a street or neighborhood.
The second consideration to which the average valuation of homes is compared to is the average income of homes in that specified area.
The down payment trend.
This is a historical tracking of the amount needed by individuals to typically succeed in acquiring a mortgage loan from money lenders for both new homebuyers (do not own home equity) and established homebuyers (own home equity).
A trend of significantly rising down payment amounts can lead to environments where homeowners are “priced out” of purchasing a property. Being priced out presents a situation where people are unable to invest in real estate because of the high barrier to entry set because of its increased value.
Where it appears that real estate is beginning to price out individuals; it can be a sign that real estate has been in a bubble and is about to boom and potentially froth or pop.
2. Housing debt measures.
Debt service ratio
This is a debt to income ration where the average real estate debt; which primarily comes in the form of mortgage payments is compared to the average income generated in a household for a specific neighborhood.
As the ratio gets higher, it presents a situation where the households are becoming more dependent on their properties rising in value year in and year out to service their debt.
If a homes’ value rises, owners of the property can get the property re-valued by the state to negotiate lower interest rates from mortgage brokers and money lenders.
A trend of high re-valuations of homes for lower interest rates is another indicator of the state of real estate.
- A continuous positive trend signifies a boom period.
- A drop in re-valuations signifies a froth period.
- A rapid positive or negative trend can signify the occurrence of a bubble.
3. Housing ownership and rent measures.
These measures are focused on evaluations that are concerned with the predominant form of occupation households in the state and a specific area.
In general, households begin renting and gradually move towards homeownership as their incomes rise.
Measures in this category include the following:
- Historical price measure.
- The ownership ratio.
- The occupancy/vacancy rate.
Historical price measure.
A popular real estate bubble indicator comes from comparing the historical trends and variations between the price of purchasing property and the price of renting it.
In a situation where both prices rise but the price of purchasing property rises to a greater percentage than the price of renting property; it presents an indication that real estate is in a bubble.
The ownership ratio.
A measure that historically measures the number of households who own or are In the process of owning their property to the number of households whereby occupants are tenants in the property.
A stable economy should present a steady increase in the number of homeowners moving away from rentals and should be accompanied by a corresponding rise in household incomes.
If there is an irregular spike in the number of homes being owned or the rise is not supported by an appropriate rise in the average income of households; the real estate industry may be in a bubble.
The reasoning would be this, lending companies tend to become laxer during the boom period of a real estate bubble and lower their screening standards for mortgages and provide funds to unqualified individuals.
These unqualified individuals are at high risk if the market froths as they were not justifiably capable of supporting the mortgage loans with their incomes and were hoping that real estate prices would continue to rise for flipping or revaluing opportunities.
The occupancy or vacancy rate.
The number of occupied housing dividing by the total number of available housing in a specified area. A very low occupancy rate indicates a state of oversupply.
Oversupply can be caused by multiple reasons but the most common and useful explanation in the world of real estate is a rise in the construction of property as a speculative increase in demand in the future that is funded by investors.
4. Housing price indices (HPIs).
These are usually long historical audits that measure the price changes of residential housing from a specific start date and onwards.
Housing price indices are expensive endeavors that need huge resources and access to compile which is why they usually run by the government or large dedicated entities
5. Historic Nationwide measures.
These are measures that are typically gathered by government institutions such as the national real estate association and involves the gathering of a large amount of real estate data that can be used to evaluate the state of the real estate market.
These measures include the following:
- Construction spending.
- Residential construction.
- Home sales.
- New home sales.
- Pending sales.
Tracking of a nations’ spending towards residential and non-residential properties over time. Spending is separated between public and private property spending.
A rise in construction spending implies speculation in the future demand for property. The fact that construction spending includes both residential and non-residential property makes the figure vague concerning identifying the state of the real estate market.
A spike in growth is difficult to narrow down on whether or not it was caused by general economic growth which affected all markets and thus led to the demand or more construction projects or whether it was caused by just housing speculations which can imply a housing bubble.
Unlike with construction spending, the residential construction measure specifically focuses on the construction of residential property only.
Real estate bubbles are usually instigated by forms of residential properties above all other properties; which makes focusing on the construction of residential property crucial in attempts to discover bubbles before the repercussions take effect.
Rapid growth without justifiable reasoning to back it up is a signal for worry of being in a bubble.
Measures the amount of property sale transactions on a monthly and annual basis for the entire nation. The important consideration for measuring home sales is in measuring housing inventory in the market.
Housing inventory is the amount of property in the market intended for sale. When speculations are positive; there are more sales and less inventory in the market at any single point of time.
When speculations are negative there will be fewer sales and more inventory in the market at any one point in time as people are trying to sell but demand is not high in the market.
During a bubble, there is a huge spike of very high sales volume and low inventory during a boom and very few sales and very high inventory during the pop.
New home sales.
Measures the number of property transactions specifically for newly built residential homes in the state. A new home is a property that is sold within a year of being completed for occupation.
New home sales provide a measure that mixes a bit of both home sales and construction measures. When new home sales are high; it will usually imply high speculation for rising housing valuations as well as an undersupply of real estate housing inventory in the market.
The number of properties that are in the transfer process (expected but not guaranteed to close). These figures can be used standalone or to assist with estimations and trend building for home sales and new home sales.
A trend of many pending sales implies high speculation in that property valuations are expected to rise over time.