You'd have to be living under a rock to not notice the big rise in real estate prices across major metropolitan cities. Chances are, it's not just your country.
We're seeing similar movements across Australia, the UK, Canada and the US as economies return back to some level of normal life again.
Many have been asking me — how long can these rises continue and are recent gains sustainable.
Real estate is about interest rates
If you want to know the future of real estate prices, keep a close eye on interest rates. Most people think bricks and mortar but really when we buy it sell real estate, we are trading for dollars and those dollars are dependant on what happens to interest rates.
Real estate prices are rising because governments want them to rise. They encouraged central banks to cut rates to unbelievable levels last year.
The UK and Australia announced huge government stimulus for housing projects, such as home building grants and stamp duty discounted. This is all intentional.
When house prices rise, so too do many other things in the economy. Housing has a big push factor. Workers demand more money from their bosses, these bosses start to put up their prices and so on.
Low interest rates have one purpose — to push up asset prices. Real estate is the largest asset class in the world.
Is it sustainable?
What we learnt from the 2008 US housing collapse is when markets are left alone, without government controls, they can blow up spectacularly. The sustainability of this book will come down to close monitoring of the banking system and checks to ensure things don't move up too quickly.
We're likely to see interest rates remain low for some time BUT there will be close monitoring on the levels of debt ordinary investors can take out.
For example, most banks have a hard debt/income ration of 7x which means the maximum amount of debt a borrower earning $100k can take is $700k. The higher the income, the more debt.
As house prices rise, debt/income ratios will probably remain the same. This means some price points will be more sustainable than others.
As an investor, if you stick to markets where the debt/income ratio of 7x is similar to median prices, you're likely to stay out of trouble.
Houses will soon become unaffordable in many major cities. Apartments will be next to move because of low rates and hard rules on debt/income ratios.
There will be income growth too. Don't discount the ability of a $100k annual salary to become $140-160k within 3-4 years as the pandemic winds down and economic activity boosts.
A $50k salary rise can add $350k of additional borrowing capacity for a home buyer. All of a sudden, they can go from borrowing $700k to $1.05m if the debt/income ratio remains unchanged at 7x.
Small income changes can make a big difference.
The most important thing in real estate investing is stepping away from your own limiting thoughts and acknowledging the big picture.
Things can sometimes look crazy at face value, but there is often a good explanation. The cost of money has never been this cheap in modern history and the level of government support during 2020 was unprecedented.
There are consequences to creating cheap money and that often means higher house prices. But with that also comes a new reality, more income, more tax revenue and a reset in what we think is expensive or cheap.
Residential real estate, supported by good fundamentals and backed by solid rental income is always a good investment option. Buy the best quality real estate you can afford.
Start small, think big and keep growing.