The global economy’s effect on local real estate

Global forces make themselves at home

Given California’s enormous size — both geographically and economically — it’s a real player in the global economy. In fact, it has the largest gross domestic product (GDP) of any other state, and the ninth largest GDP in the world.

How does California real estate fit into this global puzzle? Most home sales are actually excluded from GDP measures, as only new home sales are included in GDP. However, a large portion of the state’s wealth is held in the housing market, and it’s not just U.S. citizens who want to get into California real estate.

Migrants pour into California from other countries, far surpassing migrants from other states. We consistently gain over 100,000 international migrants each year, while actually experiencing a net loss of several thousand households to other states yearly.

To that point, 14% of real estate agents surveyed by the California Association of Realtors assisted in a home sale with an international client (including buyers and sellers) in 2014.

The survey also showed:

• 78% of agents who closed with an international client assisted an international buyer (sometimes in addition to an international seller).
• The majority (one in five) of these sales transactions took place in Los Angeles County.
• International buyers primarily came from China, Canada and Mexico.
• Two-thirds of international buyers purchased a single family residence (SFR).
• Half of international buyers purchased homes in the suburbs.
• Two-thirds of international buyers paid in cash (compared with about one-quarter of all homebuyers in the Southern California housing market).

Most interestingly, 43% of international buyers who purchased in California during 2014 planned to use the home as a primary residence. 33% planned to use it as a vacation home.

Why do foreign investors like California real estate?

The biggest reason international buyers purchased a home in California was to be closer to family or friends already in the state, according to the CAR survey.

California is simply a pleasant place to live, with warm weather all year (the only other state international homebuyers frequent more than California is Florida). Since nearly half of all international buyers plan on using their purchase as a primary residence, our friendly climate is especially important.

Another reason why the Golden State is a great place to establish a primary residence are the world-renowned universities here (three of the top ten universities in the world are found in California, according to U.S. News & World Report). More international students study in California than any other state, with 111,400 international students here as of the 2013-2014 academic year, according to the LA Times. International student enrollment continues to rise, with most international students consistently coming from China.

The next biggest reason to buy was for investment purposes and/or for the tax advantages of homeownership found in the U.S. and California.

They follow the money

For those strictly concerned with dollars and cents, the U.S. is a great place to invest. The value of the dollar is relatively strong, especially viewed through the lens of less stable economies like Mexico or the European Union. In fact, it’s only grown stronger in the past year (beginning mid-2014 and continuing today).

On the flip side, a stronger dollar (essentially a more expensive dollar to international clients) reduces the buyer purchasing power of international homebuyers. This means that you may see fewer international buyers in 2015, as buyers wishing to pay with all cash now find their cash unable to purchase as much house.

Editor’s note — A similar loss of buyer purchasing power occurs when mortgage rates rise, reducing mortgage amounts. More on that here.

An example of profit gained

Then again, the fluctuating exchange rate is one of the reasons why U.S. property can be such a good investment. Consider a buyer from China who purchased a home in California in January 2014.

At the time, the Chinese Yuan Renminbi (¥) was trading at approximately 6.1 Yuan per one U.S. dollar. The purchase price was $400,000, equivalent to ¥2,440,000.

Today, in April 2015, the Yuan is trading at ¥6.17 per $1. In other words, the U.S. dollar has become more expensive to purchase using the Chinese Yuan. With this increase, the same investment has grown from ¥2,440,000 to ¥2,468,000. This is an increase of ¥28,000 or $4,538 due to the strengthening dollar alone.

Further, consider the intervening increase in home values witnessed in California. Mid-tier homes have risen in value approximately 6% over the past year. Thus, the full increase would be closer to ¥176,000, or $28,500.

This example covered just one year. However, real estate can be an excellent long-term investment vehicle, as property values tend to rise with or above the rate of consumer inflation. Foreign investors are rarely looking for a short-term flip (unlike U.S. speculators). Rather, they usually hope to park their cash for a long-term investment, helped by the fact that many international buyers plan to reside in their U.S. homes.

Are foreign investors good or bad for today’s real estate market?

The issue is, once again, two-sided.

The good: investors from other countries give home sales volume and pricing extra support.

This is especially helpful in today’s recovering real estate market, when owner-occupant homebuyers are still bouncing back from the lean years of the extended recovery. California just regained all jobs lost to the 2008 recession in mid-2014. With the population increase over the intervening five and-a-half years, we won’t likely reach a full jobs recovery until around 2019. Thus, from a short-term perspective, international investors are a boon to today’s real estate market, thirsty for end user homebuyers.

However, there is a more complicated aspect to international investment in our real estate market.

Foreign instability

The growing presence of foreign real estate investors signifies the instability of other nations’ economies. Thus, there is a small concern that the Federal Reserve (the Fed), which controls U.S. economic policy, will make policy decisions based on our relative success in the global market, perhaps acting too soon for our fragile economy.

Foreign investors turning in larger numbers to the strong dollar pseudo-inflates our economy. In this case, the strong dollar does not indicate an innately strong U.S. economy. Rather, it reflects a relatively strong position, in relation to the economic chaos across most of the rest of the globe.

The Fed has kept the short-term interest rate at essentially zero since 2009 in an effort to stimulate lending, and in turn other things like jobs and wage growth. This has allowed mortgage rates to remain low. However, the Fed intends to raise the short-term rate – likely later in the year and then very slowly by only a couple of percentage points over two years or so. If the Fed increases interest rates before the economy is ready, the results will be further economic stagnation (and an even worse flattening of volume and prices in the real estate market).

Further, when the Fed does increase the short-term rate, economists warn the effect on global markets will be negative — particularly for residents of China, who have borrowed more U.S. dollars than any other country’s residents. When rates rise here in the U.S., the cost of borrowing will go up for international investors. Along the same lines, a stronger dollar also means more foreign dollars are needed to repay previously borrowed debts.

To summarize, international real estate investors do not damage California’s market. But their increasing presence means you need to keep an eye on mortgage rates and prepare for their eventual rise, which is coming closer every day. And remember — it’s not a matter of if, it’s a matter of when rates will rise. As soon as rates do rise, expect home sales volume to fall off, followed within a year by reductions in home prices.