The Economics of Real Estate

[Music] today you're gonna learn to talk I hope you get there I'm gonna use this video to give you the basics in addition any marketplace any area ah yes the family home a haven of comfort a great place to raise a family and on top of everything a prudent investment a home is in most developed countries in the world be centerpiece of the family finances it is simultaneously the largest investment and the largest expense of almost any individual lucky enough to break into this increasingly unattainable market but is this all for the best have houses been conflated with poker chips as people no longer look at them as shelter for a growing family but rather as an asset to make wild speculative moves on in the hope of equally wild returns the property market was at the center of the last financial downturn in 2008 and as it seems we're on the precipice of another major recession there's probably a prudent time to re-evaluate what is going on in the world of real estate to do this we are really going to have to look at a few things on a few levels from the micro economic factors like an overdeveloped and over leveraged household to issues on an economy wide level which is ultimately going to boil down to answering a few key questions what does a strong property market mean for the wider economy are there better investments out there and are we over leveraged right now if we can understand these factors we will be much better equipped to deal with the biggest investment in our lives now I don't want this to be an argument for one side or the other I'm not particularly bullish or bearish on housing as it stands realistically the people talking about never buying a house ever because you'll lose all of your money are probably just as irresponsible as the people advocating for owning 25 properties by the time you're 25 with zero dollars down by following these 25 different steps maybe it's just that the latter are slightly better at marketing but there is still a lot to be said for housing as a good investment it is just important to understand what it is that makes housing valuable on a granular economic level a house is a function of two things land you know like the dirt plot of land that it sits on and the structure the actual building with the bedrooms and bathrooms and all of that fun stuff now land is normally what appreciates in value when you are looking at real estate markets if the land is in a desirable area like say a city center that is home to a lot of good jobs then the land will appreciate in value take for example San Francisco and Silicon Valley these are cities filled with tech companies that pay armies of developers and engineers hundreds of thousands of dollars a year to develop the new and exciting technologies of tomorrow now these tech pros all need to be housed somewhere so there is a lot of demand for real estate close to these offices what's more is that given these high incomes the people demanding these homes bring a lot of monetary firepower to make some serious offers low and behold you get some pretty serious prices now on a social level this can price non-participants in the industry out of the market in a city they may have well lived in for all of their lives and that's probably a bad thing but there is no fundamental economic issues here despite constant concerns about over inflation in these very very high cost of living areas there actually isn't anything to be too worried about so long as income levels of these areas continue to rise in the same way we would expect that even small towns in the USA demand a higher price tag for their properties and let's say real estate in sub-saharan Africa it just comes down to how rich the inhabitants of the area are the second thing to consider is the appeal of an area to foreign purchasers or renters take a place like Aspen Colorado it's a nice area but it's not exactly investment bank or tech startup central the reason properties here are worth so much is because people from outside this area be that another area in the United States or another country altogether will pay a lot for a holiday home or seasonal rentals to come and enjoy the ski slopes during the winter the same is true on a larger scale for entire cities places like Sydney Vancouver and London have had their property market significantly influenced by high-income earners buying properties from abroad now all of this is what appreciates the value of the land land around these areas is ultimately a limited resource with a constrained supply there is only so much habitable space within a 30-mile radius of Silicon Valley or Manhattan or the village chairlift at Aspen so as with anything with growing demand and constrained supply the price will rise so does housing make a good investment well yes so long as you take the same approach to purchasing a house that you would do in purchasing shares does it have good credentials a good history a good path to future growth and also is it just overvalued if all of these questions work out then sure go ahead but just remember it's an investment like any other and growth is not guaranteed beyond this in some areas paying off a mortgage may actually be cheaper than just paying rent so even if prices don't grow at all you still end up ahead and on top of that it can't be forgotten that sometimes we just have to stop being cold-hearted over rational economists and realize that at the end of the day people don't always make the most logical decisions sometimes it's nice to say my home is my castle and it's all mine now with that out of the way let's look at where this investment gets a little bit weird a house in an economic sense is just a good like a car or a bar soap or a bottle of water it's a thing that we can buy and sell and get some kind of value out of but it is kind of hard to define exactly what type of good it is many would argue that housing is a commodity like oil or gold or coffee it is frequently traded in speculative markets and at the end of the day it is something that is a means to an end for the end-user the big distinction here is that realistically it's just the land that is a commodity this thing here the actual dirt the structure is a consumer good it is built from raw materials and it depreciates in value just like a car would a brand new home sounds lovely and oftentimes people will actually consider that both the house and land will appreciate in value with the market but the reality is that houses fall apart and fall out of style the same way that any other advanced manufacturing good does the only thing is that a house often masks this depreciation with the appreciation of the land that it sits on if you are in an area with a land value is equal to or less than the value of the structure considerations have to be made over the appreciation of the land verse the depreciation of the structure because this can cause issues very very quickly which leads us on neatly to what this means for the wider economy housing is an essential service for everyone as far as human needs go shelter is right up there alongside water air and food but this inherent requirement does not mean that markets are immune from the impacts of over leveraging and the nasty stuff that comes with it real-estate prices from the get-go are one of the strongest drivers of inflation to explain why we have to look just outside the residential market for a second and look at real estate inclusive of commercial real estate commercial real estate is things like shop fronts office buildings and warehouse Lots most of these are still owned by investors and rented out to business the same way that someone might rent out a house now if the property market is going well prices are increasing so too will the rent on these commercial properties in most businesses the primary expense centers are staff wages and then rent if the business is seeing a three to four percent increase in their rental expenses every year which is probably on the more conservative side they are going to have to absorb that as a loss or pass that expense on to their consumers with more expensive items this is effectively a secondhand form of cost-push inflation where things are getting more expensive because they are harder to supply not because there are more people demanding them and this is generally agreed as the bad type of inflation or at least the type of inflation that is harder to control things like retail shop fronts are huge employers in most countries but we have seen a huge shift in the prevalence of online ordering now partially this is because of convenience why would I go outside and interact with people if I can just stay in my basement and get everything I need in life brought to me but partially it's also because it's just cheaper online retailers aren't as exposed to the impacts of rental increases as their brick-and-mortar counterparts so they alleviate this kind of expense the reason this gets particularly bad is because physical presence retailers employ far far more people than online distributors so undercutting these stores can mean that a lot of low come owning households suddenly are unemployed as their business is driven out of work now a lot of people write this off as the inevitable march of technological process but in reality at least in the short term it has more to do with the march of real-estate prices now this kind of effect permeates throughout all areas of an economy and applies when real estate is going well so what happens when this all starts to turn around well that all has to do with debt we have explored the debt predicament we're in now here in 2020 in our video exploring the economic crash we are in at the moment and if it could be the next Great Depression I don't want to repeat too much of what was said there but there is something very very important to understand and take away from that video real estate prices are ultimately a function of demand and demand is in turn a function of how much people earn and how much they can borrow now when we looked at property appreciation in high-income areas that was okay because the higher incomes justified the higher property prices but in most areas in most developed countries around the world real estate prices have been rising while wages have been more or less stagnant so the missing piece of the puzzle and what is driving all of this is that lending has become more liberal there was a huge cutback on lending in the wake of the 2008 subprime mortgage crisis as banks saw firsthand how irresponsible lending could hurt their bottom line but since then it has slowly started to creep back up the issue in 2008 was that mortgages were being written to individuals with very little employment prospects bad credit and unstable personal situations fortunately that scenario has not really been repeated that perhaps we will be at the mercy of another form of ill-advised lending at the other end of the spectrum real estate investing even with wealthy landlords is odd for two reasons the first is that is a highly leveraged investment if you put a 10% deposit down on an investment property and borrow the other 90% that is a ten to one leverage position sure if the property appreciates 10% you magnify your returns to 100% but if it goes the other way well you have lost all of your money almost nobody out there would realistically recommend to take a ten to one leverage position on the share market at the end of the day housing is just another speculative investment a lot of landlords have been caught out even at the start of this crisis because they went into investing into real estate with the idea that it could only ever go up rents would keep on increasing and they would get rich but the reality has hit that property is just another speculative market and you want returns you have to accept the risks the second reason this all gets weird is because you can use the income from a property to qualify for a loan for a property that you haven't even purchased yet most banks around the world will consider the income that you will get if you rent out that property and they we use this in their decision-making process to see if you get approved or declined for the loan that you're after now this isn't important to people buying a house to live in but it is starting to come back to bite the people that have bought a house to invest in take a situation like we are in now rentals have dried up as many people have lost their jobs and things like Airbnb don't exist anymore we now also exist in a market where more investors than ever a relying on these returns because they never had enough regular income to pay off their mortgages so they are either forced to sell their house at a down time in the market further depreciating this over leveraged asset or alternatively they can just default on their mortgage which will cause severe problems in financial market and eventually ends up in a Bri possessed home that will be sold at a down time in the market further depreciating this over leveraged asset now many people will turn around and say well banks lend money to businesses all the time to fund their ventures based on projected income why is this so different here and well it's different because businesses are rarely this over leveraged for starters but more importantly for the wider economy businesses actually produce something this thing here the family home with four bedrooms and three bathrooms is a really useful tool in providing shelter but it doesn't actually produce anything when economists consider investments they are thinking of capital goods typically people invest into a company through shares and that company will use this funding to build new machines or buy up new computers and excavators or whatever these are all capital goods eg goods that are used to produce more goods these normally make for pretty good investments because if you buy a machine that turns a raw material into a consumer good you can profit off the difference in the price between the input and the output this is the essence of value-added manufacturing now houses are sometimes considered capital but they aren't really the land that they sit on is well land and the structure itself is effectively a consumer good if anything by having expensive housing you are denying land another factor of production to genuinely profitable industries that will add value to goods to produce a wealthier economy the foundation of economics is the idea that we have unlimited wants and only limited resources in which to fulfill those one's good economic management is built around the ultimate desire to expand the productive capacity of a given nation so that more resources are made available to more people shuffling around blocks of land and prescribing even higher values to them does not produce anything of value it is paper wealth at its purest form in the best scenario it achieves nothing but realistically it is going to put consumers into debt over leverage a nation and drive out real genuine industry to an area where they can get this crucial factor of production for a lower price so is real estate a good investment on an individual scale well yes probably so long as you take the kind of critical analysis that one might take to pick a stock and so long as you understand that this is a highly risky highly leveraged and undiversified investment you will be just fine even population growth and the constant pressure to borrow more or it might not be a terrible call to at least make the home that you live in your own on an economy-wide level though a strong housing market is a real burden it sucks money away from people that could have otherwise spent it on goods or services or invested it into things at genuine value and it's smothers industries that are trying to get a foothold into the economy the solutions are complex because oftentimes a government has to toss up the liability of an unaffordable housing market with the alternative been ripping value out of people's largest investment which is not likely a move that is going to win them the next election the real answer is to make sure that lending is responsibly managed record low interest rates mean that more and more people can borrow more and more money and think they are savvy investors after selling it to other people who have borrowed even more money taking on debt to invest into something that doesn't produce anything is almost always a bad idea on a macroeconomic level will this ever be properly controlled well it's hard to say at the end of the day the banks are their own entities with their own profit motives and they want to make sure that they aren't missing out on a good deal if it comes up the same as individual speculators but in the meantime all we can do is avoid confusing leverage with genius and understand that no great economy was ever built by shuffling around piles of dirt hi guys thanks for watching I hope you enjoyed the latest video if you did please consider liking and subscribing if you really enjoyed the video please consider supporting the channel on patreon like these lovely people did it really helps to make these kinds of videos possible otherwise I will be hosting the Q&A stream same as ever on our second channel linked in the video description or add discord server that is also linked in the video description hop on over there if you have any questions comments or concerns about the video I always love to hear your feedback guys thanks bye

Channel: Economics Explained

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Keywords: is real estate really a safe investment, the economics of real estate, real estate economics, the economics of real estate explained, real estate explained, real estate investing economics explained, is real estate a safe investment, how does real estate impact the economy, how does the economy impact the real estate market, how does the real estate market impact the economy, the economics of the real estate market, economics of the real estate market explained, economics explained

Id: f4o9aPFI3I0

Length: 18min 12sec (1092 seconds)

Published: Sun May 03 2020