As a real estate investor, thinking about investments and cash-flow is not the only way to think. Real estate investors and businessman alike must also know how to think like an economist. Understanding economics and how the economy works can go along way in helping you become a better investor, entrepreneur, and a better citizen. As the authors of Common Sense Economics says, “a nation of economic illiterates is unlikely to remain prosperous for very long.” Further, there are many economic tools and skills to enhance investments, entrepreneurship, and real estate decisions. Understanding real estate supply and demand will make you more successful in real estate investing and it is just the tip of an iceberg when delving into the details and substance of economics.
This article examines real estate supply and demand and the importance of developing economic skills for your investments. We will cover the following topics:
What is the Market?
In economics, a market can be defined as a group of sellers and buyers of a certain service, product, or good. A market, essentially, is a place where a service or goods are sold and bought. Markets may be a complex system of services and goods throughout the world or involve a specific location, such as a shopping mall, retail store, and even though e-commerce, (e.g. Amazon.com). Regardless, the functions of a market are to establish market value. Where the buyers, collectively, determine the demand for a good or service, and the sellers, collectively, determine the supply of a good or service.
What is the Competition?
The market for real estate, is very competitive, much like most markets in the economy. In economics, an economist uses the term competitive market to refer to the market by which there are many sellers and buyers that influence the market price. The real estate market works just like any other market, in which, the price of real estate is greatly influenced by sellers and buyers as they interact in the real estate market.
Moreover, a seller has very little control over the price of the real estate because of other sellers offering similar real estate. A property owner has very little reason to sell real estate property below the going rate, and if the seller tries to sell the property for more, then buyers will purchase other property that is on the market. Therefore, the real estate market is affected by the competition of the real estate supply and demand. A competitive real estate market is a market, in which, the real estate market is active with many buyers and sellers, and because of the many buyers and sellers the price of real estate becomes influenced by the real estate supply and demand.
Real Estate Supply and Demand
Prices for a commodity is established by supply and demand. The demand for a commodity depends on an individual’s willingness to purchase over a certain time period. The supply for a commodity refers to the producer, in that, the producer is willing to sell over a certain time period. In other words, supply and demand dictate the price. If the supply of the good or service is consistent or the same and if the demand increases on a good or service the price will increase if the demand decreases the price will also decrease. On the other hand, if the demand for the good or service is consistent or the same, and if the supply increases the price decreases, and if the supply decreases the price increases.
Obviously, in the real market prices change all the time. This is because the demand and supply change all the time. Although, there are trends and as a real estate investor you can predict with very little risk.
Supply and Demand in Real Estate
In real estate, the pressures of supply and demand may have many variables in play. However, there are two characteristics that control the supply and demand in the market, immobility, and uniqueness. Immobility is the fact that real estate cannot be relocated from one place to another to satisfy the demand where there is low supply, nor can buyers relocate to markets where supply is greater. Uniqueness refers to the fact that no matter how identical property may be to each other, no two pieces of property will be truly alike because each property sits on its own unique geographical location.
Because of immobility and uniqueness, real estate markets are centralized by locality. In other words, each geographical market will determine its own situational and conditions that determine prices. For instance, real estate property in Wyoming may be cheaper than property in California. A waterfront property may have a higher price than a non-water front property. Further, due to the real estate’s immobility and uniqueness, the real estate market adjusts slowly. Although, there may be spurts of growth, e.g. a development for new houses, construction for a new shopping mall, or a business that brings in thousands of jobs. All these factors can bring a spurt to the market price. Also, the market can act negatively as well, e.g. the loss of businesses, high taxes, a natural disaster. All of these scenarios could affect the market’s supply and demand.
Causes Affecting Supply in Real Estate
In economics, the law of supply states that the quantity supplied of a good increases when the price of the good rises. Therefore, in the real estate market, the supply of real estate will increase when the price of the real estate market increases. There are two categories where supply greatly affects the supply in real estate; the construction and labor industry and also the monetary and government policies.
Monetary and Government Policies
One reason why studying and learning economics and the importance of being involved with your government is in how it can affect the real estate market. Governments can make or break an economy and can either create opportunities where individuals can prosper or governments can hinder economic growth and sadly make people poor. Policies can directly affect the real estate market. Take rent controls, for example, these policies enact a price ceiling on rents that landlords charge for their tenants. It’s been said of one economist in regards to rent control, “it’s the best way to destroy a city, other than bombing it.”In other words, the real estate supply and demand will not determine the rent. There will be a set limit that a landlord can charge. The idea of rent controls is to increase affordable housing for those who can’t afford their rent. However, what it actually does is create a shortage of rental properties and even lower the standard of quality in the area (a landlord will not appease to satisfy their tenants in quality any longer).
Moreover, one of the biggest culprits of governmental control or interference in the economy is taxation. Taxation comes in the form of many types, and how, where, and what is taxed, capital gains, property taxes, business taxes, local and state taxes, income taxes, etc. An investor in real estate must understand taxes and finance.
In addition, the Federal Reserve and the lending industry also has a great effect on the real estate market. The Federal Reserve Board dictates gives discount rates to commercial bankers and in return impacts how borrowers are charged with their loans. Overall, when interest rates are low, people are more willing to borrow money to buy houses. If the interest rates are increased people are less willing to purchase houses. Further, other government agencies, e.g. the Federal Housing Administration (FHA) and Government National Mortgage Association, local and state governments can influence real estate markets.
Construction and Labor Industry
One of the ways taxation affects the real estate market directly is the supply and demand for skilled labor and construction projects. That is, when businesses have a higher tax burden it affects their transaction cost and this burden rolls down to the consumer or the home buyer in the form of higher rents or higher sales prices. This is another reason why many people are migrating away from higher-tax states to lower-taxed states.
Causes Affecting Demand in Real Estate
In economics, the law of demand states that the number of goods falls when the price of commodities increase. Therefore, in the real estate market, the quantity of real estate will fall when the price of real estate property increase in the market. There are three categories where demand greatly affects the demand in real estate; wage and employment, demographics, and population.
Wage and Employment
There is a strong correlation between the demand in real estate with job opportunities and the level of wages available. People make decisions on whether or not to move into a location or purchase property based on job opportunities and level of wages. As a real estate investor, the investor must be informed and stay up-to-date on the business market within the area of investment possibilities. For instance, many small towns in rural areas were founded, based on this simple concept. For some, a factory, coal mine operation, or some other business opportunity, opened-up in the area. The town grew out of the response of the business operation growing and succeeding.
A general rule of thumb, the more businesses flood a market the higher the property value will increase. In 2018, Amazon announced the expansion of its headquarters (HQ2) to Crystal City, Va. And out of response the real estate market values are incrementally increasing.
Demographics is the science of statistical data of a population. As a real estate investor and further, you as an investor understand real estate supply and demand. Understanding demographics will allow you to develop your market niche. For instance, in Florida, there are real estate subdivisions that strictly only allow senior citizens. This is because many are retired and these retirees pay into the community knowing that there are people who are similar in their demographic tastes, namely, their age. As an investor, you can build your portfolio around your niche. Another example, focusing on HUD homes and a poorer class of people who may need government assistance to rent out properties that you purchase within the area.
The real estate demand for housing grows alongside the increase or decrease of population. As the population continues to grow so will the demand for houses. In some cases, the population grows faster than the market supply of homes, therefore, the prices increase more rapidly than otherwise. Further, there are many variables on the increase or decrease of population, job opportunities, school and education quality, climate changes, and even environmental hazards (a nuclear power plant). However, as a real estate investor, understanding the population statistics is another key factor in your investments.
As you have seen, the real estate market is greatly influenced by the forces of economics. These forces have many variables from governmental policies, monetary policies, population, demographics, location, and businesses can all affect the real estate supply and demand. Further, as a real estate investor, economics and the continuous study of economics can greatly enhance and develop your investing skills.
 Mankiw, N.G.(2008). Principles of Macroeconomics.