Level 13: Valuation and Pricing - Chapter 2: Supply and Demand
Demand Factors: Expectations
Finally, a buyer's expectations of their future financial situation, and of the economy as a whole, will affect the demand for real estate. Consumers are less likely to buy a home if any of the following situations apply: They expect their income will decrease in the near future They expect the price of housing will decrease in the near future They expect the price of housing will decrease at the time they expect to sell their current house
Everyone Wants a Contract
You might think that, if the seller wants the highest price and the buyer wants the lowest price, and if the two agents involved are trying to deliver for their clients, no contract could ever be consummated. 😮 But don't worry, Mustafa. Remember that, in this scenario, there are at least four motivated people. The seller wants to sell, the buyer wants to buy, and the real estate sales agents both want a commission. As long as four people are motivated, negotiations will be completed. 👍
Buyer's Market
A buyer's market is the condition of having fewer buyers than the supply of homes for sale in an area. In a buyer's market, there is relatively low demand for real estate. Prices and negotiations in a buyer's market will tend to be more in favor of the buyer (go figure!). It may be easier for a buyer to negotiate a lower price or even get the seller to pay the buyer's closing costs. Yay buyer! Summing it up: The active license holder should always know what type of market they are in so they are ready to properly negotiate for their client.
Demand Factors: Price
As I mentioned earlier, demand can be defined as a consumers' ability and willingness to buy a good or service at a certain price. Though the demand for real estate is affected by several factors, price is the clearest example. When real estate costs more, fewer people are willing to buy. The price of a particular piece of real estate is also influenced by many factors. Prices can increase because of increases in construction costs, the cost of financing, and property values. Additionally, the price of purchasing real estate can be affected by the prices of other commodities. For instance, if the cost of leasing an apartment is low, the cost of purchasing a house might also decrease to attract more buyers.
Supply and Demand
As you might imagine, supply and demand plays a big role in how property is valued and priced. It's a relatively simple concept, but what really drives demand in the real estate market? If demand were simply a measurement of how many people would fancy owning their own property, demand would usually be a different number than it is. Demand tells us how many consumers are willing and able to afford property. Supply is determined by looking at the amount of properties that are vacant or are available for sale or rent. Supply and demand are both affected by many factors, such as employment rates, wages, interest rates, and more. Characteristics of the population, the social attitudes prevalent at the time, and the legal and tax structure of the economy also shape the demand for and supply of real estate. Property values can change often. These changes are mostly driven by good ol' supply and demand. As the demand for real estate rises, supply will decrease. When demand is high and supply is low, property becomes more valuable and prices rise. On the other hand, if the demand for real estate falls, supply will increase. When demand is low and supply is high, prices fall.
Demand Factors: Employers
Cities experience significant changes in supply and demand when a major employer sets up shop or closes down. A new major employer will stimulate the local economy and lead to an increase in population. This will result in less supply and higher prices. If a major employer closes or moves away, the local economy takes a hit. People will tend to move away, resulting in more supply and lower prices.
Supply Factors: Expectations
Finally, expectations affect supply as much as they affect demand. If sellers expect the price of real estate will go up in the near future, they will be less likely to sell right now. If sellers expect the price to go down soon, they will be more likely to sell right away. The case is similar for lenders when an interest rate is expected to increase or decrease. However, lenders are much like apartment managers: they cannot afford not to receive interest for any significant period of time. Similarly, market expectations only sway sellers if they have the luxury of a flexible schedule.
The Real Estate Market
For real estate finance, more than for any other type of real estate studies, it is necessary to know the basic workings of the market and, most especially, the impact of supply and demand. For instance, the sale of residential property constitutes a specific real estate market with its own trends and rules. Similarly, the sale of loan products by lenders constitutes another, different market. If you want to be really successful in your market, you have to get to know it first.
The Supply of Money
In short, one very important factor affecting the supply and demand of housing is the supply of money. In general: The higher the supply of money available to finance real estate ventures, the higher the demand for housing.Result: When the demand for housing becomes higher than the supply, property price increases. The lower the supply of money available to finance real estate ventures, the lower the demand for housing.Result:When the supply becomes higher than the demand, property price decreases.
Supply and Demand in the Market
Levels of supply and demand differ between different areas and markets. A market can be as small as a neighborhood or as large as a city, state, or country.
Buyer's and Seller's Markets
Most experienced real estate agents will tell you that the industry is rarely in a "normal market." Rather, most will say that we are either in, or moving towards, either a buyer's market (where it's good to be a buyer) or a seller's market (where it's good to be a seller). Whether the market is advantageous for buyers or sellers is closely related to the greater economy (nationally and locally) and where we are in the real estate cycle. Yes, just like the moon, the real estate market waxes and wanes in cycles. The real estate market's phases include: Recession 🌘 Recovery 🌗 Expansion 🌖 Hyper supply 🌕
Supply
Next up: supply. Supply is an economic term for the available amount of something. In real estate, it's based on the willingness and ability of sellers in a given market to sell their property. Several factors affect supply: Selling price: As the price of housing increases, owners become more willing to sell. Loan price: As the price of a loan increases — that is, as the interest rate goes up — lenders become more willing to lend and buyers become less willing to take out loans.
Supply Factors: Price
Price plays an important role in the supply of real estate (high prices entice owners to sell and builders to build), but there's a limit to its influence. For example, consider the leasing side of the real estate market. Apartment complex managers are always willing to rent, whether the price of apartments increases or decreases, because renters = income. If landlords can command higher rent during a certain period (if apartment prices are increasing), they may be more interested in offering long-term leases, but there is always an incentive to fill units.
The Makeup of a Market
Supply and demand are the basic forces that control all markets. But what's a market? A nice place where you can stroll around and pick up some seasonal vegetables? 🍅 Yes, but for our purposes a market is a theoretical construct that isolates the selling and purchasing of any one particular commodity from the economy as a whole.
The Demand Curve
The demand for any commodity, such as real estate, can be illustrated using a demand curve. You will notice that as price increases (vertically), the amount of real estate that buyers are willing to purchase (horizontally) decreases. The opposite is also true: As price decreases, the quantity demanded increases. (We'll cover the equilibrium in a moment.) Demand for real estate and average price are correlated, although there are other factors that keep this from being a perfect 1:1 relationship.
Supply and Demand Affect Price
The impact of supply and demand differs when applied to value and the market, respectively. If the supply of real estate and the demand for it are proportional, values will remain stable. If there is an under-supply, prices will increase. If there is an over-supply, prices will decrease. So, supply and price move in opposite directions. Demand and price move in the same direction. As demand increases, the prices increase, and as demand decreases, the prices decrease.
Demand Factors: Income
The second factor affecting real estate demand is personal income. If the average salary goes down or the unemployment rate goes up, the demand for certain types of housing is likely to decrease. If the average salary goes up or the unemployment rate goes down, the demand for certain types of housing is likely to increase.
Impact of the Economy
The state of the economy has a strong impact on the real estate market. If the economy is strong, first-time buyers will be buying homes and current homeowners will be wanting to upgrade or upsize to a new home. If the economy is weak (or consumers are feeling unsure), more homeowners will stay with their homes and fewer people will be interested in buying. You may not have control over the health of the United States economy, but you can at least stay on top of economic news. I'm not saying you have to read the whole Wall Street Journal every morning, but try to follow economic news and trends through the medium that suits you best. This stuff affects your career!
It's all Connected
The supply curve and the demand curve for any particular commodity are independent of each other; however, they are not independent of the curves for other commodities. For instance, because most real estate is purchased with borrowed money, the supply of loans affects the demand for real estate. The supply of loans is in turn affected by the supply of money and the interest rate. This will be important to know when we discuss the Federal Reserve's monetary policies and their effect on the real estate market.
Supply Factors: Cost of Production
The supply of real estate is also affected by the cost of its production. If construction costs go down, it is cheaper to build houses, apartments, and office buildings, so more of them will appear on the market. If the cost of construction goes up, there is a greater expense to builders and new housing becomes scarcer. An increase or decrease in the price of raw land has a similar effect. However, because real estate is a long-lasting commodity, there is usually an existing supply (on the market) of houses that have already been built.
Supply and Demand
Together, the two forces of supply and demand help determine the actual price, and quantity of, real estate on the market. The law of supply and demand states that the forces of supply and demand push the market price of any commodity to one particular point, the market equilibrium. This equilibrium is the point at which the supply and demand curves cross. (Remember this graph? There's the equilibrium in the center.)
Seller's Market
What is that, Ace? Well, a seller's market is a market condition in which the number of properties for sale does not meet the demand (number of people looking to buy). The pricing and negotiations of a transaction are typically in favor of the seller (hence the name) - though this is not a hard and fast rule. Seller's market example: If there is high demand for a certain area and relatively few homes on the market, the seller probably will not have to lower their asking price or give concessions to a buyer. Yay seller!