What is the pathway to success in commercial real estate investing? Making the cut in this highly complex market depends on many factors, but the key drivers fall under macroeconomics. There’s no substitute for knowledge. Understanding how the macro factors can significantly influence your return on investment (ROI) is crucial.
The Ideal Environment For Success
Many investors fail because they jump into buying commercial real estate without taking time to evaluate the health of a country’s economy. Economic indicators, such as gross domestic product (GDP), employment rate, and stock index, can adversely affect real estate investment profitability.
Your business would thrive in an economy characterized by a stable stock index and a low unemployment rate. A sluggish economy is bad news to investors, as the value of investments may stagnate or drop.
While the macro factors are nearly beyond your control, knowing what drives the market and what to watch out for can’t be emphasized enough. A knowledgeable investor will make better financial decisions to protect their projects.
Let’s dive into the macroeconomic factors that commercial real estate investors should keep top-of-mind.
1. GDP Per Capita Consumption Growth Rate
One of the aspects worth your attention is the real GDP consumption growth rate. If the economy is expanding, the growth rate will be positive. A boom translates to an increase in businesses, jobs, and personal income.
As such, people interested in buying properties won’t mind taking mortgages because they’re confident they can afford it. Also, lending institutions will be more willing to offer them loans at competitive rates.
When the economy contracts, many people tend to adopt a frugal lifestyle. The income of businesses will drop. Consequently, this will compel business owners to hold off investing in new purchases. Producers, too, will cut down on domestic production and distributions.
This chain of changes can contribute to job cuts, salary reduction, and delays in hiring new employees until businesses are confident enough that there will be positive progress in the economy. Unfortunately, an increase in unemployment will depress a country’s economy. People will have less money to spend on significant projects like real estate.
GDP per capita growth rate formula
Here’s how to calculate the GDP per capita consumption growth rate:
- Divide the real overall economic output by the number of citizens in a country
- The answer you get is subject to inflation adjustment
The growth rate reflects on the quality of living in a country within a specific period. You can use it to compare countries and see which have a decent track of favorably strong economies worth commercial real estate investing.
2. Term Structure Of Interest Rates
Term structure of interest rates is critical in identifying a country’s current state of the economy. The phrase refers to the yield curve that shows the relationship between interest rates of similar quality bonds, factoring in different terms and maturities.
A yield curve helps paint a picture of market participants, reflecting the expectations regarding the future interest changes and monetary policy conditions.
The term structure of interest rates can take a normal, inverted, or flat curve shape with economic value predictions at varying periods. It can be three months, two years, five years, ten years, or even thirty years.
In a normal yield curve, long-term yields exceed short-term yields. An upward slope depicts an expanding economy.
When it comes to an inverted mode, the curve slopes downward, meaning the short-term yields exceed long-term yields. Such a curve signifies an economy in or about to enter a recession.
With a fat curve shape, there’s little to no difference between yields and maturities. It is difficult for commercial real estate investors to project the direction of the economy.
3. Real Treasury Bill Rate
Treasury bills are short-term, government-backed bonds sold to investors in denominations of $1,000 and up to $5 million to help pay the federal debt. The maturity of these widely regarded low-risk securities is usually 12 months or less.
Since these bonds are considered an ultra-secure form of investment, you can use them to predict the economy. The demand for T-Bills tends to rise when there is an economic crisis. An increase in demand for the bonds will lead to lower interest rates. If the demand drops, the Department of the Treasury will increase the rates to attract investors.
When the treasury yields rise, the interest rates on other similar securities also rise to maintain a healthy competition.
Generally, longer maturity dates will attract higher interest rates.
4. Unpredicted Inflation
Inflation can be predicted, but not always.
Sudden inflation is the last thing an investor would want, especially if they’ll make losses from an investment they’ve been nurturing for years. Inflation has the power to negatively influence the market prices, profits, investment, and employment opportunities.
Sometimes unexpected inflation can be good news. There’s no better feeling than experiencing growth overnight when you least expect it.
However, this type of inflation can affect you in one way or another. For example, the lending costs tend to increase rapidly. An increase in premiums and other monthly contributions can make many people interested in commercial real estate hold back a bit, waiting for the economy to improve.
While commercial real estate business is attractive, achieving a good return on investment requires making smart decisions. You have to be armed with the right information and always keep an eye on the changes that drive the economy, affecting property value.
Please note this post only covered some of the high-level macro factors with a significant bearing on property buying and selling. Some involve complex parts, even though the above discussion may indicate a clearly defined relationship with the market.
When you put all this in practice, the results can be a little bit different. Nevertheless, being informed of these factors can make a positive difference when evaluating potential real estate investment projects.
You can also turn to a professional and experienced real estate broker. They are your best bet to staying up to date with the current economic indicators. Professionals will offer you real-time tips and insights to make the most of your business.
For more information on my services, contact Arthur Nachman at (703) 864-2900 or by email at ARTHUR.NACHMAN@Longandfoster.com