Having a proper understanding of how macroeconomic factors affect real estate investments is vital to the success of any real estate investment.
You cannot directly influence or control the risk posed by these factors but there are steps you can take to manage them and mitigate their impact on your real estate investment portfolio.
Overview of Macroeconomic Risks
While microeconomics focuses on decisions made by households on disposable income, macroeconomics focuses on the economy’s overall performance, behavior, and structure.
In the context of real estate investments, you can consider factors like individual tenant issues and property maintenance as factors that constitute microeconomic risks.
Macroeconomic risks, on the other hand, would refer to factors such as shifts in tax regimes, changes in government policies, employment, inflation and civil or political unrest.
All of these microeconomic and macroeconomic factors, and more, will influence your real estate investment portfolio in various ways and to various extents.
This article will focus on macroeconomic risks. We will consider some of the most significant factors affecting macroeconomic risks in real estate investing and ways through which you can manage them.
Factors Affecting Macroeconomic Risks in Real Estate
Macroeconomic risks in real estate investing are influenced by a number of factors. Some of the most significant of these factors include:
The trending economic cycle influences whether a real estate investor should buy, hold or sell properties. The value of real estate is directly affected by the overall health of the economy.
This can be measured using economic indicators like the GDP, inflation rate, manufacturing activity, employment data, etc.
Oftentimes, when the economy performs sluggishly, so does real estate. However, economic cycles can affect different types of real estate in different ways.
This means that the most effective strategy for investing in a particular type of real estate is dependent on its position in the economic cycle.
Population dynamics play a critical role in determining how real estate investments perform, so understanding how it works is important.
Demographics refer to the data that shows the composition of a given population along the lines of certain criteria like age, gender, race, migration patterns, income, household formation, and population growth.
A lot of investors tend to overlook this factor, despite its significance in determining the performance of real estate investments.
Major shifts in a country’s demographics can result in a tremendous effect on how the real estate industry performs for years to come.
Credit, Liquidity, and Interest Rates
Liquidity tells you how much capital is obtainable for investing in real estate, while interest rates determine the amount you have to pay to obtain a loan.
These factors are usually directly influenced by the decisions of the U.S. Federal Reserve and they affect how much lenders will charge borrowers on loans.
Changes in liquidity or interest rates can greatly affect the purchasing power of investors and consequently the value and performance of real estate investments.
The federal government seeks to keep the economy afloat by all means. One of the ways they do this is by increasing the supply of money into the economy.
If this flow is left unchecked, it could cause the economy to become inflationary. However, over the years, real estate has continually served as a way to hedge against inflation.
Subsidies, tax credits, and deductions can temporarily boost the performance of real estate investments. Other government policies and legislation can directly affect real estate investors negatively or positively. In some cases, both could happen simultaneously.
Awareness of these policies and incentives can help you stay on top of the situation.
Unemployment and Income Distribution
Unemployment is pretty straightforward. You can measure this factor using the data on the number of people within the working class who are not employed and are seeking employment.
Having either high unemployment rates or low unemployment rates can be worrisome. High unemployment rates may indicate economic distress while low economic rates may suggest economic overheating.
Income distribution paints a picture of how much each segment of the economy earns in income. It can reflect why specific real estate trends are peculiar to certain income brackets.
Ways To Manage Macroeconomic Risk
Investments are generally characterized by risks and rewards and real estate investments are no exception.
However, there are certain steps that you can take, as an investor, to help you manage or mitigate macroeconomic risks to your real estate investment portfolio.
Diversification is one effective way to manage how macroeconomic risks affect your real estate investment portfolio.
You can achieve diversification by ensuring you invest in different kinds of real estate properties, preferably positioned in different parts of the economic cycle. This way, when one aspect is hit, the impact on your real estate portfolio is spread out.
Another way to diversify your real estate portfolio is through ownership of real estate investment trusts (REITs) or Delaware Statutory Trusts (DSTs).
The kind of tenants you have also determine how macroeconomic risks can affect your real estate investment portfolio.
Tenants who are creditworthy are usually in a better position when it comes to handling volatile economies. This means having creditworthy tenants reduces your exposure to certain macroeconomic risks.
This is, by no means, suggesting that you ignore startup tenants that have lower credit scores. What is important is that you understand how well different types of tenants operate in the current economic cycle and even in the forecasted cycle.
One of the causes of the global economic crisis of 2007-2009 was debt. A lot of borrowers took loans that required little or no equity and used these loans in financing their real estate investments. Things have changed since then and there are now more stringent lender qualifications.
Leverage can be an effective way of realizing increased returns on your real estate investment portfolio but it comes with increased risk. The amount of leverage you plan to use should be given thorough consideration.
Successful real estate investment portfolios require more than just examining your goals or carrying out due diligence. Macroeconomics can affect your investments, influence the demand, value, and rate of returns on real estate investments. Understanding them well is key to achieving and maintaining a profitable and successful investment portfolio.