How to Use Economic Indicators in Residential Real Estate Investing

In the past, uses of economic indicators reside in the domains of governments, corporations, educational researchers, large institutions and sophisticated investors. These entities understand the importance of possessing …

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In the past, uses of economic indicators reside in the domains of governments, corporations, educational researchers, large institutions and sophisticated investors. These entities understand the importance of possessing an awareness of the statistics regarding current economic conditions and likely regional, national and international trends. Economic indicators provide essential information, which affects customers, tenants, buyers, workers, businesses and investment strategies.

Consider economic indicators indispensable tools for any investor. Today, small business owners and investors must employ economic indicators in their investment analysis to help determine current economic conditions, forecast future economic possibilities and make better decisions.

Real estate residential investors can benefit from using economic indicators in their real estate investing business.

Three Types of Economic Indicators

Economic indicators fall into three categories: coincident indicators, lagging indicators and leading indicators. Below is a description of each indicator:

  1. Coincident indicators change simultaneously with the condition of the general economy. Therefore, coincident indicators provide information regarding the current state of economic affairs. Examples of coincident indicators include the Gross Domestic Product (GDP), Nonagricultural Employment, Personal Income, Inventory and Industrial Production. Coincident indicators serve little use to real estate investors for predicting future economic events.
  2. Lagging indicators provide investors insight into movements in the economy after changes have occurred, establishing a certain pattern or trend. Investors use lagging indicators to validate long-term trends (where the economy has been) and current economic conditions. Lagging indicators include New Home Sales, Home Prices Index, Employment, Corporate Profits and Labor Cost per Unit of Output.

    Do not rely on lagging indicators as tools for predicting future trends in the real estate market or the general economy.

  3. Leading Indicators detect economic changes before they become apparent in the economy. Think of leading indicators as a preview of coming economic events. Some of the most used leading economic indicators include the New Residential Construction Report, Weekly Jobless Claims, Durable Goods Orders and S&P 500. Leading indicators function as short-term predictive tools.

Each category of economic indicator gives investors a reading on a specific marker at a certain point in time– past, current or future.

Popular Economic Indicators

With numerous economic indicators covering just about every aspect of the economy imaginable, the data can seem overwhelming.

Some of the widely used economic indicators used by real estate investors include the following markers:

Gross Domestic Product

Well-informed investors track the pace of growth for the general economy over a certain quarter by watching the Gross Domestic Product because it offers the broadest measure of the U.S. economy– the cumulative monetary value of all goods and services for a period.

GDP figures do not include the monetary value for international production. The U.S. Bureau of Economic Analysis publishes GDP data on the last day of the quarter for GDP metrics calculated for the previous quarter.

Historically, the U.S. economy has expanded at an annual rate of 2.5 percent to 3 percent annually. When the economy or GDP exceeds the historic growth rate, economists consider the expansion unsustainable and possibly inflationary.

When the GDP’s growth rate falls below 2.5 percent or contracts, businesses stop buying new equipment, cease hiring and lay-off employees. In addition, consumers become concerned about their jobs and prospects for the future.

Consumers’ anxiety about their financial circumstances typically leads to a slowdown in consumer spending. Consumer spending makes up about 70 percent of GDP.

Housing Prices Index

This lagging indicator provides a broad gauge of the movement of single-family home prices, regionally and nationally. Home prices indexes closely watched by economists and investors include data by the following entities: S&P/Case-Shiller, CoreLogic, Census Bureau, Federal Housing Finance Agency and National Association of Realtors.

Since the housing market collapse, home prices have declined an average of 34 percent, according to the S&P/Case-Shiller Housing Price Index. Generally, a drop in home prices might signal an oversupply of homes or the need for a market correction to adjust inflated home values. Falling home prices have a negative affect on homeowners’ wealth and employment in construction, manufacturing and other sectors of the economy.

For example, although construction workers in the U.S consist of just six percent of the workforce, they encompass nearly 25 percent of workers who lost their jobs during the recession, which followed after home prices collapsed.

New Residential Construction Report

This monthly press release consists of three components: Building Permits, Housing Starts and Housing Completions in the privately owned real estate segment. The U.S. Census Bureau and the Department of Housing and Urban Development release the joint report around the 12th day of the month. Data covers the prior month’s activities.

Housing Permits provide information regarding the level of future residential construction activities. Housing Starts monitor the number of groundbreakings for new home foundations. Housing Completions track the number of housing units finished for the month reported. The New Residential Construction Report expresses each component as an annual percentage rate of negative or positive growth.

Consider the New Residential Construction Report as one of the most important economic indicators available for predicting future trends in the economy. The National Association of Home Builders reports that the housing industry accounts for approximately 27 percent of all investment activities in the United States. Investments in residential construction account for five percent of the Gross Domestic Product and housing-related services add another 12 to 13 percent to GDP.

New home construction activities directly affect as many as 122 industries. Consequently, an increase in residential construction activities indicates economic expansion, while a decline signifies economic contraction. 

Conclusion

Real estate investors willing to spend time and effort can easily understand economic indicators and incorporate valuable insights into their decision-making. Remember, an increase or decline in figures for the measured term — week, month or quarter, does not necessarily foretell an impending recession or boom. Data must show a persistent decline or increase to establish a trend. Sometimes, statistics send a mix message.

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