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Realities of Real Estate: How the economy affects real estate

Real estate is such a large part of the nation’s Gross Domestic Product (GDP) that some believe significant changes in the housing market can affect the trajectory of our economy as a whole. Case in point would be the Great Recession, where deflating the housing bubble nearly collapsed the entire financial system.

However, that situation was the exception, rather than the rule. Under normal conditions, the relative strength or weakness of our overall economy is what charts the course for housing. In a vibrant economy, jobs are plentiful and the personal mobility/income that results is translated into strong numbers for home sales. Conversely, in a weak economy, major purchases (like a new house) are quickly tossed into the discretionary dump bin as families hunker down and focus on the necessities.

As a result, understanding how the economy works and what makes it go up or down is an essential part of projecting the future for real estate.

To illustrate, let’s examine how the Maryland economy performed over the last couple of years and how that might have affected real estate.

On most measures, the performance for real estate in 2014 was weaker than many expected. In retrospect, there were a number of dynamics that contributed to this weakness, most principally was the fact that they Maryland economy tanked in 2013. In that year, Maryland’s growth in GDP was 0.0, ranking it next to last out of all 50 states. Only Alaska came in lower at -2.5 percent, unless you include the District of Columbia, which was also bottomed out at -0.5 percent.

By comparison, 2013 GDP growth nationally was +1.8 percent. The top four states for GDP growth included Oklahoma (+4.2 percent), West Virginia (+5.1), Wyoming (+7.6) and the energy boom state of North Dakota (+9.7).

So, why did the Maryland hit the skids in 2013, leading us into a downdraft for housing during 2014? Various political philosophies can disagree, but here’s our take. Over the last several years, Gov. Martin O’Malley has smacked the state pretty hard with a lot of regulations, tax and fee increases that inspired many businesses and individuals to leave the state.

At the same time, the biggest industry in the state of Maryland (government) began to contract. You see, 2013 was also the year that the federal sequester was implemented. This had a severe impact on the defense industry and the federal workforce as a whole. It’s no coincidence that the biggest losers for 2013 in terms of GDP growth (Virginia, Maryland, the District of Columbia and Alaska) are also the four states with the nation’s highest percentage of government workers.

We used to think that when the economy was good, the government would grow, and when the economy was bad, the government would also grow. But with the sequester in 2013, that axiom was no longer valid. Plus, O’Malley’s additional taxes and regulations were fuel to the fire, ultimately bringing Maryland’s economy to a screeching halt. Additionally, mortgage rates spike toward the middle and end of 2013, making a bad situation worse. All in all, we were poorly positioned to generate growth for real estate in 2014.

The next obvious question is how will the economy influence real estate going forward? Well, looking in the rear-view mirror is a whole lot easier and significantly more accurate than crystal ball gazing. Nevertheless, we’ll at least point out what to keep an eye on. First, actions by the Federal Reserve Bank are most likely to be the primary driver of economic changes in 2015. If the Fed increases rates, which they are expected to do sometime mid-year, mortgage rates will also rise. This will be an obvious deterrent to continued growth for real estate.

Second, we have a new governor who is dedicated to holding the line on taxes and regulations. But, Gov. Larry Hogan will need to find a certain degree of common ground with a state legislature that has different ideas about what makes the grass grow. And third, although we’re likely to experience more gridlock in Washington, D.C., neither the Republicans nor the Democrats like the sequester (for different reasons). Consequently, they might come together for a brief moment to do away with it, or at least lessen the impact, and that will help bring back some of the positive halo effect associated with Maryland’s proximity to D.C.

The only wild card is what the Wall Street crowd refers to as Black Swans. Black Swans are essentially the unknown and the unpredictable events that always take place. Like every year, we’re sure there’ll be some of those for 2015. But like the sudden drop in gas prices, Black Swans don’t have to be a negative, they can also be a positive!

Bob and Donna McWilliams are practicing real estate agents in Maryland with more than 26 years of combined experience. Their email address is [email protected]