Why the housing market is important to investors

The term ‘investment’ is a broad one. We typically associate it with some kind of involvement in the financial markets, but the term in itself just describes a generic situation in which money is put into an entity with the expectation of return upon the initial investment in the future. The reward to the investor for putting up his capital is that it will be returned to him with said interest.

Now this “investment” can take a variety of forms. You might venture down the trading route yourself, putting money in stocks, bonds or currencies. You might give your money to a financial advisor or entity to invest for you, through a mutual fund or ISA. Or you might purchase material objects, typically investments are made into art pieces, cars or even restaurant franchises.

Another common sector that sees heavy investment is real estate. Whether purchasing a house just for yourself, for your family or for the purpose of renovating and collecting rent payments, real estate has become an increasingly popular method of getting a significant return on your investment. In particular, with the rise in prominence of a concept called OPM - Other People’s Money - people that may not be able to afford to own property outside their home now can, as they are provided with the ability to borrow money from wealthier individuals or institutions for that purpose and you will see many instructors selling courses online to help begin your journey in real estate investing if this is something you’re interested in.

From an economic perspective however, the housing market represents much more. By investing in real estate, you’re agreeing to begin a journey for which you will only see returns in the long run. In addition to this, down payments are generally very sizeable and if you’re purchasing a property in addition to your current home, you need to be in a financially comfortable position. All this leads to growth in the housing market being indicative of one thing -> stability. In most circumstances, if someone is purchasing a house, it’s one that they have extensively researched, secured a loan for and done the maths on the repayments. It’s a property that they believe they will be able to cover the costs for over the next 30-odd years in which they are paying off the mortgage. The ability to put multiple $20,000 down payments on multiple properties for renting purposes for example, means that you have significantly more than that in the bank and are confident that you can make ends meet until the properties begin to generate an income.

Stability is a good sign for an economy. More people purchasing houses typically means more people are in stable, well paid jobs, with savings that they are willing to spend in order to move to the “next stage” of their lives and careers. This typically is positive news for a currency as well, as increased demand for housing also increases the demand for that currency, from either global investors looking to purchase property in said country, or through increasing applications for mortgage loans.

One of the key components of understanding any financial market that I mentioned in the first article written on this platform was that of sentiment, in this case investor sentiment. The housing market is one of the clearest indicators of this. When an entire country is purchasing houses, there is a positive sentiment amongst its inhabitants that they have had stable income for an extended period of time and they expect this to continue.

There is of course, no single factor that determines the movements of the markets and the housing market has, although infrequently, shown its limitations in the past. This manifests in the form of a housing bubble. A housing bubble is a period of time characterised by abnormally high or rapidly increasing housing prices, usually driven by some form of manipulated demand or speculation. Typically, this may come from a significant increase in credit supply from banks and extremely low interest rates. Banks with excess cash will look to quickly disseminate this money into the economy and may reduce their requirements for mortgage applications and offer extremely attractive interest rate to potential buyers. Even for banks, money sitting idle is money that is losing its chance to grow. Typically, these rates won’t be reflective of the state of the economy and therefore an artificial bubble is created. As always occurs in bubbles, eventually banks will increase their rates again and impose stricter standards for supplying loans, upon which the bubble will burst and house prices will come crashing back down. The famous historical example of a housing bubble was in the early 2000s in the US, following the dot com bubble. Many economists believe in fact that the bursting of this housing bubble was a catalyst for the 2007/2008 financial crash.

In an ideal world, housing markets would be hugely indicative of economic performance. They still do provide us with a wealth of information, but we need to be careful of, in the case of positive news, where this influx of money is coming from and we need to ensure that, for the most part, demand is being driven naturally and not artificially. There are techniques that we can use to study this which we will cover in future articles. Next week, I’ll take a more detailed look at sources of housing data from multiple economies and chart these against currency pairs.