What is Driving the Current Appreciation of Real Estate?
Low Interest Rates
What is driving the current appreciation of real estate? In a nutshell, extremely low interest rates, and access thereof. The majority of real estate is purchased using debt. And as we know, the availability of debt increases the demand. Why? The utilization of debt increases one’s purchasing power. As long as you can afford the debt, you can move forward with the purchase. Henceforth, increased demand relative to supply causes increased price valuations. If you find this analysis to be a bit subjective, then explain the runaway pricing associated with our educational system as well as or health care system.
Debt has clearly been the primary fuel expanding both economies. Well if that is the case, then what will happen when interest rates return to their historical norm? The simple answer, asset valuations will reset to a lower level of demand, henceforth lower price valuations. By in large, the availability of credit creates the demand necessary to fuel higher asset valuations in economies relying on debt purchases.
The Breaking Point
A better question is when will interest rates return to their historical norm? The simple truth, not likely in the near future. Why would I say that? I say this because a large part of government funding relies on high asset valuations (i.e. property taxes for schools, etc.). Further, a large part of mandated economies relies heavily on debt (economies created by the government).
My conclusion is that until we reach a point where your production-based economy can no longer fund the mandated economy interest rates will remain low and available, whereby furthering asset valuations. I guess the good news is smart investors will continue to make money. The bad news, it will not end well.