What I know about Real Estate I learned in Economics 101
by David Peerless
My career in Real Estate has spanned thirty years and focused on the sale of residential properties and the management of Real Estate companies in the Vancouver, British Columbia market place. During that time I have had the opportunity to train and mentor many hundreds of Realtors during good markets, great markets and some much more challenging markets. Looking back I realize I learned the most valuable lessons about how Real Estate markets work from a first year business course; Economics 101.
Ironically, this was the first class of the day and after working late shifts at my job I frequently slept in this class. I did, however, pay attention to the principles of supply and demand. The instructor pressed home the idea that all markets are driven by the demand for a product and the price of that product is then a function of the available supply to satisfy that demand. If at any point in time the supply is less than demand, prices will rise and if greater than demand the price will fall. This revelation has been the backbone of how I have learned to identify market trends and in time has greatly helped my decision making in terms of buying and selling Real Estate and in the operations of Real Estate companies.
Real Estate markets or the factors that influence supply and demand can be identified in any market location and analyzed to determine trends or directions in prices. While I have never been able to control factors such as the rate of interest, the number of new homes being built, demographics of population movements or such things that affect supply and demand, by keeping track of some of these factors one can predict the future real estate cycles. A bold statement.
The supply side of the real estate cycle relies on such factors as how many new homes are being built in the area one is analyzing. Statistics are kept by the government both locally and regionally through building permit applications and approvals. This will indicate how much new supply is likely to be available in the near future. Builders and developers are encouraged by demand and favourable prices for their product and simply put will seek to build new housing when a reasonable profit is likely. The more profitable the market, the more the supply will increase and inevitably will to lead to an oversupply as the balance in this real estate equation starts to tip in favour of Buyers. At this stage in the cycle prices will flatten or drop as supply outstrips demand. Naturally as demand weakens and the profit potential drops, developers will pull back from the market and supply will drop re-balancing the equation and re-setting the cycle for new homes.
The largest part of the real estate supply in any market is that of used homes. This supply is largely influenced by factors of cost; prices, interest rates (affordability) and as well as the need for a change in housing as families grow or shrink. The overlying factor that controls these influences is that of confidence. If a buyer population feels confident in the economy, secure in their jobs and the future of real estate in their community, they will be inclined to spend money and increase their housing consumption, purchase property for investment or perhaps a second home for vacations. This confidence in a real estate market increases sales and reduces supply causing prices to rise. In time if the supply declines too much the market shifts to favour the seller and further pushes prices higher. Eventually as the prices start to affect affordability and the costs too high for the average buyer, sales will start to decline and supply increase. The real estate cycle continues. This process can be greatly affected by other factors that will influence the speed of change such as a change in interest rates, economic changes, population shifts among others.
Paying attention to these influences on supply will help spot trends in the real estate market and when combined with a sense of demand in a local economy, will give strong insight into where we are in the real estate cycle.
Demand in this context is the interest in acquiring real estate for personal use and investment. Like the supply side of the real estate equation demand is influenced by a number of factors such as the price of real estate, cost of borrowing, population growth and as before, the confidence in the market. In any local market if individuals feel that prices are affordable and borrowing for a purchase is reasonably priced the demand will rise and in doing so will put pressure on prices to rise. As this stage in the cycle takes hold demand is strong and large volumes of sales take place reducing supply and further affecting prices. In time, as affordability declines, demand slows and we move from a seller's market where demand exceeds supply to a balanced market where prices stabilize or perhaps start to decline into a buyer's market. Once again the real estate cycle moves on. Confidence in the economy will also affect demand. If a population feels insecure about real estate values, their job or about where the economy is going demand and prices will decline to a point where affordability is once again in balance between the existing supply and demand.
The normal ebbing and flowing of the real estate markets are generally local in nature with modest swings in values however they can be significantly affected by world events more likely to influence confidence. The principles of supply and demand are however reliable if carefully tracked. Trends follow similar patterns and in fact history does repeat itself. Every time I hear that this time the market and those factors that influence markets are different I realize that the effects are not. During the past thirty years there have been at least four distinct market cycles in the area I practice and in speaking with others active in real estate markets prior to my experience these cycles have behaved in a similar fashion for decades. One only needs to look at historical pricing data in a region over time to see these cycles in action.
I have learned over time to take comfort in the real estate market as a good place to invest, to have a business and to provide a home for my family. Time and patience have proven to be the greatest positive influences in owning real estate. Paying attention to those factors that consistently impact supply and demand will help you spot trends in any local real estate market.
It would seem economics 101 had a lasting impression after all.