Real estate is a tangible asset made up of property and the land on which it sits. While it is unmovable, real estate, like other assets, is also subject to supply and demand. This means that housing values are highly influenced by the law of supply and demand. But just what kind of relationship does the housing market have to this law? This guide on the basics of real estate supply and demand will help you learn more about how this economic theory works, and how it impacts the real estate market.
The law of supply and demand
The law of supply and demand is a theory that describes how sellers of a resource interact with buyers of that resource, and how that interaction affects the price of that good or service. As a result, the theory defines the relationship between a good’s or product’s price and people’s willingness to buy or sell it. People are often inclined to supply more and demand less when prices rise, and vice versa as prices fall.
As a good’s price rises, the law of demand implies that consumers will have less and less demand for it. Lower prices also boost demand, since customers value and purchase more when something is less expensive.
According to the law of supply, a higher price encourages producers to supply a greater quantity to the market. Similarly, when supply is limited, prices will rise as people compete for scarce resources.
The basics of real estate supply and demand
At higher prices, real incomes will fall and individuals will reduce their demand. In addition, at higher prices, the alternatives to owning a property, such as renting, appear more attractive and individuals are more likely to rent. When housing prices are lower, the opposite is true: people are attracted to buy since their real income is higher and renting appears less appealing. However, because property demand is partly speculative, a rise in prices can lead to an increase in demand as buyers expect a speculative gain.
Total property demand is driven by population size, changes in population structure due to migration, and long-term changes in birth and death rates. The overall demand for property will rise as the population ages.
2. Incomes of households
Changes in both the volume and distribution of national income can have a substantial impact on property demand. Income increases can lead to a larger percentage increase in demand. Many people switch from renting to owning a home as their income grows, or they move to a larger home.
3. Social trends
Social and lifestyle trends, such as a tendency for later marriages, might change the pattern of housing demand and the overall demand.
4. Interest rates
Interest rates significantly influence the cost of mortgage repayments. Higher interest rates make property less affordable, and therefore demand will fall.
House prices, along with several underlying determinants, play a function in determining the supply of private housing. The link between supply and house prices is positive, with higher prices promoting supply. Price increases in real estate will incentivise housebuilders to construct more property and encourage existing homeowners to sell.
1. Government legislation
Legislation can influence housing supply in a variety of ways. Severe requirements for obtaining planning clearance for new construction may deter homebuilders. Relaxation of rules, on the other hand, is likely to boost construction.
The introduction of new building processes, such as “pre-fabrication,” and new building materials have increased the speed with which new houses are created, and hence increased the supply of property. This has increased the supply elasticity of properties at the lower end of the market.
In the case of new-builds, building costs may also have a significant effect on supply. These costs include raw materials and labour costs.