Real estate economics is the application of economic principles to real estate markets. This is affected by the people involved in real estate, such as owners and developers, as well as macroeconomic forces like supply and demand. Specifically, real estate markets are affected by factors like demographics, interest rates, government policies, and the overall economy.
How Real Estate Markets Work
Real estate markets, and the real estate economy that they influence, are affected by several factors. The overarching principle at play, however, is supply and demand. The members of society who look for, purchase, build, or sell homes determine the balance of supply and demand in any given market.
Supply and demand, while a universal economic principle, has a unique definition in real estate. In this industry, demand is the number of houses buyers want to purchase and is determined by factors like demographics, income, and the price of housing. Supply is the inventory that is available to buyers and is typically generated by developers and renovators.
This supply and demand is ultimately influenced by market participants like owners, renters, and developers. The building or use of properties by these participants is ultimately controlled by interest rates; the health of the overall economy; and the availability of credit, subsidies, and other incentives. With their personal finances affected by these factors, market participants determine when, how often, and for what amounts properties are bought or sold.
The buying and selling behaviors of market participants dictate overall supply and demand, which in turn impacts the economic health of the real estate industry. If supply and demand are equally moderate or high, the economy is healthy; if, however, they are equally low or one heavily outweighs the other consistently, the industry suffers.
Why Real Estate Economics Is Important
Real estate agents and brokers should study real estate economics to better understand the forces that impact the price and transfer of property in their real estate farm area. Having a comprehensive understanding of the drivers behind real estate economics enable agents to predict patterns of housing prices, supply, and demand. This, in turn, allows them to more accurately price homes for sellers and draft competitive offers for buyers.
For homebuyers or sellers, real estate economics can help determine the best time to buy a house or list a property. This is because the relationship between supply and demand dictates real estate values and available home inventory. For example, if there has been a sudden influx of home inventory due to increased development in your area, it may not be a good time to get top dollar for your home; buyers can easily buy a new home for cheaper in new developments.
Participants in Real Estate Economics
Real estate economics is substantially impacted by the supply and demand of property — factors driven by market participants like property users, owners, and renters. These parties create real estate demand, while the business decisions of developers and renovators drive real estate supply.
Participants in real estate markets include:
- Owner users: This group includes people who both own their homes and live in them, making them investors and consumers. Stated another way, these owner users account for all owner-occupied homes in each market.
- Owners: Real estate owners are people who exclusively invest in real estate and do not reside in the property themselves. Instead, these participants generally rent the property to a third party after purchasing it.
- Renters: Renters are real estate consumers, meaning that they do not invest in real estate. Rather, they exclusively “consume” it.
- Developers: Developers are real estate investors who prepare undeveloped land for construction and build new housing for the market.
- Renovators: This group of real estate market participants supplies renovated buildings to the housing market for investors to purchase or renters to live in.
- Facilitators: Facilitators include banks, real estate brokers, lawyers, and others that facilitate the purchase and development of real estate.
6 Factors That Affect Real Estate Economics
Real estate markets are influenced by several factors, including demographics, interest rates, and the economy. Markets are also affected by government policies and subsidies that make it easier for people to buy real estate by reducing down payments and taxes. Taken together, these factors affect supply and demand and dictate real estate economics.
The six factors that affect the real estate market are:
1. Housing Demand
Demand for housing is the number of houses buyers want at various price points. In general, housing demand is determined based on a number of factors, with demographics having the most substantial impact. Demand is also influenced by income, the price of housing, cost and availability of credit, consumer and investor preferences, and other ancillary factors.
Some of the main determinants of housing demand are:
Demographics are data about the makeup of certain populations; in real estate, these data focus on household characteristics like family size, age of residents, number of children, death and divorce rates, and marriages. However, general population and population growth are also demographic considerations; there will be a greater demand for housing where there are more people.
Housing demand is also affected by income because someone with a high and stable income is more likely to purchase a home or invest in other real estate. In real estate economics, analysts look at permanent income — or the way income and spending are spread out over a lifetime — rather than annual income. This is due in large part to the high cost of real estate and, therefore, the need for consistently high income to purchase property.
Price of Housing
The price of housing also factors into housing demand because it determines how many people can afford to invest in the market. Generally speaking, the higher the price of housing, the lower the demand. Housing prices are generally based on factors like the current inventory — or supply — of housing, location, and interest rates.
Cost & Availability of Credit
When interest rates are low and lending standards are more relaxed, the demand for real estate generally increases. This is because it is cheaper and easier for consumers and investors to get real estate financing.
2. Housing Supply
Housing supply is generated by developers and renovators and made possible by facilitators like banks. The number of new homes built by developers in any given year is generally dictated by the cost of existing real estate inventory and development expenses like land acquisition, site improvement, labor, materials, finance, administrative work, and marketing.
Demographics are the characteristics that describe a population, including race, gender, age, income, and overall population growth. In real estate economics, these factors affect markets by dictating real estate prices and demand. For example, the transition of the baby boomer generation into retirement signaled a shift in real estate markets, wherein older homeowners were interested in selling their larger homes and investing in smaller properties.
4. Interest Rates
Lower interest rates give consumers the opportunity to secure more financing for home purchases. Conversely, high interest rates make buying a home less appealing because they increase the overall cost of the home. For that reason, the real estate market will typically suffer when interest rates are high — especially in the absence of favorable government policies or subsidies that make large purchases more manageable.
5. The Economy
The real estate market is generally strong when the economy is strong; likewise, if the overall economy is suffering, real estate economics are also likely to slow. This is determined by factors like the gross domestic product (GDP), employment, manufacturing activity, and prices of goods. However, certain types of real estate with longer lease periods, like office buildings, may be less sensitive to an economic downturn.
6. Government Policies & Subsidies
Government policies and subsidies include incentives like tax credits, deductions, and subsidies that make it easier for people to buy homes. For example, the first-time homebuyer’s tax credit reduced the tax bill for homeowners who bought a home between 2008 and 2010. Staying apprised of the most up-to-date government incentives can make home buying more feasible for first-time and low-income homebuyers.
Characteristics of Real Estate Markets
Evaluating real estate economics can also be challenging because of the unique characteristics of the real estate market as a whole. For example, real estate often lasts much longer than other types of goods, making it difficult to model real estate inventory as you would inventory for a store. In addition, while real estate often appreciates in value, that value is affected by many more things than standards goods or products sold in stores.
Real estate uniquely impacts economics because of these characteristics:
- Durability: Real estate is more durable than most consumer goods so real estate market health is not determined by the standard “stock and flow” of inventory as it is for other, less expensive goods. After a home is built, it can become part of available inventory on the market multiple times over before it is demolished or repurposed.
- Uniqueness or heterogeneity: Due to location, building characteristics, and financial implications, real estate transactions are inherently unique. As such, pricing can be difficult and it is more challenging to substitute existing inventory with new supply.
- High transaction costs: Real estate is expensive and related costs like real estate fees, moving costs, legal fees, land transfer taxes, and deed registration fees only make transactions more expensive for consumers.
- Lengthy time delays: It takes time to finance, design, and construct new housing supply. For this reason, market adjustments to demand are typically slower than for other consumer goods.
- Real estate is for both investment and “consumption”: Participants in the real estate market can purchase real estate to live in it (consumption) or to lease it to someone else (investment). This makes real estate markets more complex because real estate sale prices may be higher than properties are worth on an open market — simply because of the perceived value of renting them over a long period of time.
- Immobility: With the exception of mobile homes, real estate cannot be moved. For this reason, any adjustments to a local real estate market can only occur as a result of consumers moving to the area; homes cannot be moved to a more appealing market.
Frequently Asked Questions (FAQs)
Why is real estate important to the economy?
Real estate is important to the economy because it affects the national gross domestic product (GDP). The housing market also impacts consumer health because the affordability of home ownership and rentals affects the overall wealth of property owners and tenants. As a result, low real estate supply and high property costs can reduce consumer spending.
How does the housing market work?
The housing market works by balancing housing supply and demand, both of which are influenced by demographics, interest rates, and the overall economy. As more people become interested in buying housing due to the availability of financing, demand increases, property values rise, and developers increase the housing supply.
What determines the housing market?
The housing market is determined by the relationship between housing supply and demand. Demand is typically dictated by the overall health of the economy, income, interest rates, and changes in population size. The housing market is also impacted by supply-related factors like the cost of new construction and the price of existing inventory.
Bottom Line – Economic Real Estate
The application of economic principles to real estate is referred to as real estate economics. Real estate markets are impacted by real estate supply and demand, which are affected by market participants like owners, renters, and developers. Markets are also affected by factors like interest rates, government policies, and the health of the overall economy.
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