Hello, my friends and welcome to another episode of Ask Marco where I answer your investing related questions.
Today’s question comes from Samantha and she says, hi Marco. I am currently trying to study up on the real estate in San Antonio. And while your article helped me a lot with the residential areas, I was just curious about how the market looks with non-residential or is it the same?
Great question Samantha. So there are a lot of similarities and overlap between residential and nonresidential or what we would call commercial real estate, but there are some differences. And so I will give you a quick overview here of what those differences are.
So there are plenty of forces that dictate the real estate market. Some of them being political, some of them being economic, some of them being psychographic, these are all influencers. Um, but those are the major ones.
So these influences are better measured by what we’ll call market drivers. And they are the underlying force behind the actions of a real estate market. So when it comes to commercial real estate, there are three key drivers. The first one being yield, the second one being business confidence. And the third one being the occupancy rates are what some people might look at as being vacancy rates. But let’s begin with kind of a basic and define what a market driver is. Simply put, a driver is a principal force that is positively influencing a market. So when a market driver is present, there is likely to be a positive market or industry trend that’s showing up. And when that happens, you see values go up and down because demand may increase or it could just decrease. But when a market driver is not there or it’s there but weak, you have less force behind that market.
And what ends up happening is that demand drops and you see prices drop along with it or the yields go down with it. And with commercial real estate yield determines market value. Now if you talk to some sharp real estate investors, they’ll tell you that that’s a good time to go into a market. It’s the, you know that whole saying of BI-LO sell high or just buy low and keep forever. But when you’re going in with low demand, the theory is that you can get a better deal. So let’s just talk about these real quick. The first key driver being yield is simply based on income. When you are a commercial real estate investor, you want income from your investment. Obviously it’s not really just the big payoff from the principal because with commercial you may eventually sell that property and you get a capital return, but it’s really an income-based investment.
And so in the commercial world, the income is called yield and it is the annual return on an investment, not including any capital growth. So yield is a big deal and a key focus area in the commercial space. The second key driver is business confidence. You’ll often hear people on TV in the media, in other words, talking heads. Commentators often talking about their view on commercial real estate and commercial properties. By looking at business confidence. If those businesses are confident, the economy will perform better in the coming year, it’s likely they’re going to see a good flow of foot traffic. If they’re a retailer or plenty of work coming in. If they’re in the industrial sector or if they’re an investment based business, then they’ll see good returns, whether it be in the stock market or whatever it may be. So business confidence is also a driver that drives the commercial space.
And then that third driver, our occupancy rates true with any investor. Investors in the commercial space don’t like to seek empty properties. And because the underlying value of a commercial asset is actually aligned to its tenants, having a vacancy is arguably the biggest fear in the commercial property investment space. And so it’s one that has to be avoided. And this is why management is so critical in the commercial world. But those are three key drivers when it comes to commercial real estate. So if you’re looking at San Antonio or any other market for that matter, you want to look at those three key drivers. You also want to look at the political environment. You also want to look at trends that are going on. Just to exaggerate that point, if you know that a big company like Amazon, for example, is coming in, that certainly will have an impact, especially in the area, the submarket within that big metropolitan area.
But just to quickly compare this to the residential real estate space, residential real estate has four key drivers. There is overlap between these two of course. Um, but residential real estate is more sensitive to the following. For one, our interest rates, interest rates have a major impact on the real estate markets. As interest rates rise, the cost to obtain a mortgage increases and that lowers the demand and therefore the prices on real estate, residential real estate is very sensitive to supply and demand. So when you see those dynamics change, it highly impacts market values. And you will see as we go through the next two or three that they’re all based around what will ultimately be supply and demand. So the second key driver are demographics and demographics are the data that describe composition of a population such as their age or race or gender income migration patterns.
And one that I especially like to pay attention to is population growth. So these statistics are an often overlooked but very significant factor that affects how real estate is priced and what types of properties are in demand. Those demographics do impact the supply and demand, particularly demand for real estate. So as real estate demand goes up, puts price pressure on the real estate in a particular market, even in a local market like a hyperlocal market. And that pushes prices up. When you see demand diminish or go away, it does just the opposite prices come down. Uh, for example, let’s look at the baby boomers. People born between 1945 and 1964 they are a well-cited example of a demographic that has a huge as had and still has a huge influence on real estate markets all around the country, particularly in Florida. And that’s where you see a lot of baby boomers move to and retire.
So these trends affect real estate. Again, because it goes back to that whole supply and demand thing, you increase demand, it absorbs the supply, and as that grows you tend to see prices go up, even rents go up. Okay. Thirdly is another factor which we’ll just call economic indicators, but it is another key factor that affects the value of real estate and the overall health of an economy. So this is generally measured in terms of economic indicators such as gross domestic product or what we hear as GDP. You can also look at employment data, which is something that I also look at closely and I’m sensitive to manufacturing activity and just the overall general prices of goods. And that often translates down through inflation. Broadly speaking though, when the economy is sluggish, so is the real estate, and the flip side is true too. When the economy is vibrant and there’s a lot of productivity, low unemployment, things are moving along, people are making a good living.
You tend to see demand go up because people tend to move up, rent, more expensive properties, larger properties. They’re willing to spend more and often can afford more or they’re buying more property jobs. And job growth are very important when it comes to economic indicators, especially at the local level because jobs tend to fuel consumer confidence and the income needed to support the housing and the lifestyle of the people who live there. So keep that in mind when it comes to economic indicators and just the local economy as a whole. And then the last point is not directly a driver but has an impact, an influence on what is going on in a market, particularly economically, but sometimes demographically, I think that’s a real word, but that is what has to do with government policy and subsidies. So legislation is also another factor that can have a sizable impact on property demand and pricing.
So when you look at things like tax credits, deductions, and even subsidies in some cases, those are some of the ways the government can temporarily boost demand for real estate for as long as those things are in place. And again, the operative words there are boost demand. So when you boost demand, again you start putting price pressure on the local market and you see prices increase. Most of the time being aware of what the current government incentives are can help you determine or foresee changes in supply and demand. And if you’re able to do that, it just gives you, you know, just one more leg up on what is going on and what you can be looking to do in terms of investment strategy and where you should be investing. So those are the things that drive real estate on the residential and commercial side there.
Like I said, there is overlap obviously yields important to a residential real estate investor, but the yield, unlike commercial real estate doesn’t drive pricing in the residential space. All right, so Samantha, I hope that helps and if it doesn’t, let me know and I’ll clarify. All right. If you have any questions about real estate or investing or finance, let me know. I registered a new domain name. It is simply Ask Marco so you can go to askmarco.com it will take you to the passiverealestateinvesting.com website. So you could use either website or URL. Just click on the Ask Marco button at the top and I’ll be happy to answer your question. If you haven’t already remembered to subscribe, help us share the show with other likeminded people and thanks for listening. I will see you on our next episode.
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