Chapter 19 (The Real Estate Market) Flashcards
Introduction
The word market has many meanings, depending on usage.
It can mean a place where farmers and tradespeople display their produce and products for buyers.
It can mean a place where securities are exchanged, such as the commodities market or the stock market.
Regardless of difference in form, the basic principles of market operation hold true for all.
A market can function only when sellers and buyers interact.
*Many markets use intermediaries to facilitate activity between seller and buyer, and the real estate market is one such market.
Three Key Questions
Every economy in every land in the world has to deal with the following three basic questions:
- What will be produced?
Any producer can place a product or service in the marketplace, where it competes with similar products or services offered by other producers.
Consumers evaluate the worth, quality, and price of the competing products and services.
The products or services sold and the profitability of the producers’ efforts tell them which products or services are preferred by consumers.
Those products or services that do not generate a profit will no longer be produced.
So the consumer actually decides what will be produced.
Products not desired by consumers will produce little or no profit and will be replaced by new products for consumers to evaluate.
- Who will do the producing?
Imagine you are a producer of canned grapefruit sections. You are competing in the marketplace against four other producers of canned grapefruit sections of similar quality and price.
After a thorough analysis of your production methods, you conclude that a change in procedure will permit you to reduce your price slightly below that of your competitors, while retaining the quality and quantity of the product.
Gradually thereafter, consumers begin to select your product more and more frequently. You decide to expand your factory and increase the amount of grapefruit sections produced. In time, other producers obviously must either become more efficient, as you have, or face being forced out of business because of a decrease in their sales and profits.
The most efficient producer of a comparable-quality product will go on doing the producing.
- Who will get what is produced?
If more than one person wants the same article, the one willing to spend the most money usually gets the item.
Therefore, those people who have money and are willing to spend it in the marketplace will get what is produced. We do not worry about whether there will be enough television sets or cars for us to be allowed the privilege of buying one. We know that television sets and cars will be available. Our problem is in selecting between products and services within the limits of our income.
So it is with real estate.
The marketplace determines sale prices, not sellers and not real estate agents.
The consumer is the individual who exercises freedom of choice in the marketplace and, therefore, is the real decision maker.
- Thus, one of the characteristics of the free enterprise system is that individual consumer desires and decisions are the primary determinants in the system. In a controlled economy, the government makes those decisions.
- Another characteristic of a relatively free enterprise system is the “automatic” working of the system.
No committee from the Department of Commerce or any other agency has to survey the national market to determine which goods and services are selling well and which ones should be removed from the marketplace.
Better results are accomplished automatically by the millions of individual consumer choices exercised every minute of every day.
Those products that sell well will be replaced with more of the same.
Those products that do not sell well will be removed and replaced by other products.
Characteristics of the Real Estate Market
There are five characteristics of the real estate market that set it apart from other markets (see below):
- Immobility of real estate.
The geographic location of real estate is fixed. The land and the improvements on the land are immovable. Because of the immobility of real estate, the surrounding area largely influences the value of a particular parcel.
- The market is slow to respond to change in supply and demand.
Design, land acquisition, site preparation, and construction phases of real estate are time-consuming. For this reason, when the equilibrium between supply and demand is upset, it can be years before the imbalance is corrected.
- Land is indestructible.
Land is permanent. The physical structures (improvements) on the land are durable; however, they deteriorate and become obsolete over time.
- Real estate is unique.
No two tracts of land are identical. There is no standard product. Even two lots side by side have different geographic locations. The uniqueness of land is also called heterogeneity.
- Government controls influence the market through zoning, building codes, taxes, and so forth.
Government controls play an important role when compared with other markets. Zoning, building codes, and health ordinances that govern septic tank use and other health-related matters are examples of direct controls.
The government also uses indirect controls such as the monetary policies of the federal government.
Supply
Supply is the amount and type of real estate available for sale or rent at differing price levels in a given real estate market.
The following variables influence supply:
Availability of skilled labor
Availability of construction loans and financing
Availability of land
Availability of materials
Availability of Skilled Labor - Supply
Numerous skilled laborers, such as carpenters, roofers, and electricians, are required for construction.
The availability and cost of labor depend on such things as unemployment rates, skill levels required, and the influence of foreign labor.
When an area is growing rapidly, the growth usually is characterized by much construction with resulting high employment in the construction industry.
These conditions cause competition for labor and its cost increases.
Availability of Construction Loans and Financing - Supply
New construction is directly related to the availability of construction loans and short-term financing.
As money becomes more available and less expensive, more speculative homes will be built, increasing the available supply of housing.
The same is true for commercial development.
Availability of Land - Supply
Although land seems physically plentiful, the supply of the type and location of land most in demand is always scarce.
Two factors influence the availability of land:
(1) the scarcity of readily usable land and
(2) the regulations affecting its use and cost of development.
Availability of Materials - Supply
The availability of construction materials influences the supply of new housing.
In the late 1970s and early 1980s, the construction industry nationwide was severely crippled by a shortage of drywall.
Drywall couldn’t be found anywhere. New construction was stalled, and construction costs spiraled.
Demand
Demand is the desire and ability to purchase or rent goods and services.
In real estate, demand is the amount and type of real estate desired for purchase or rent in a given market at a given period of time.
The following variables influence demand:
Price of real estate Population numbers and household composition Income of consumers Availability of mortgage credit Consumer taste or preferences
Price of Real Estate - Demand
There is an inverse relationship between price and the demand for real estate.
- When prices rise, demand goes down.
- When prices decrease, demand goes up.
Population Numbers and Household Composition - Demand
Other important variables related to demand are population numbers and household composition.
Most of the transactions in the real estate market are residential property transactions.
*Shelter is a basic need and cannot be long ignored.
However, the demand for dwelling space depends on both numbers of the population and composition of households in every market area.
*An increase in population creates demand for additional shopping centers, office buildings, and so forth.
Mere population size does not provide sufficient information for accurately estimating the demand for dwelling space, nor does a count of households.
Modern lifestyles, changes in economic conditions, and reduced family size have caused the household to become the basis for most population analysis.
*A household, as defined by the Bureau of the Census, U.S. Department of Commerce, is any person or group of persons occupying a separate housing space.
Thus, a household may be a single person living in a rented apartment, a husband and wife with four children living in their own home in the suburbs, or two unmarried adults living in a condominium near the city center. Each constitutes a household.
It is only when Bureau of the Census data are analyzed that the benefits of demand trend forecasting are realized. Just before the end of the 19th century, 100 dwelling units housed 490 people, due to the average size of households at that time (4.9 persons).
The 2010 census revealed that the decreased size of the average household (about 2.58 people per household) required approximately 190 dwelling units to house 490 people.
The change in average household size alone had therefore caused an increase of 90% in demand.
Demographers and others who study population trends state that a further reduction in average household size is anticipated.
This again will change the demand for housing, not only in numbers of units but also in size of dwellings.
Demand for new dwellings every year does not mean that each of the 50 states and the District of Columbia will share this growth on a proportional basis.
Natural increase in population (that is, the number of births exceeding the number of deaths) and in-migration—new residents moving to a location from other places—are two important components of the population factor. Increased longevity of the elderly contributes to the natural increase of population by increasing the number of births over deaths, even if the birth rate remains static.
As a result, Florida, along with a few other states, such as California and Arizona, has experienced exceptional population gains.
- This has been reflected in increased demand for housing.
- The most important cause of population increase for Florida as a whole has been in-migration.
Every reason exists to suppose that this trend will continue.
Income of Consumers - Demand
Whereas change in price is inversely related to change in demand, income is directly related to demand.
As individual income increases, so does demand for dwelling space.
Any change in local employment numbers or salary-wage levels causes a change in demand for dwelling space and related loan considerations.
Availability of Mortgage Credit - Demand
*The availability and cost of mortgage credit has been called the barometer of the real estate market.
Because the typical purchase of residential property involves two or three times the buyer’s annual net income, it is easy to understand why a large number of homebuyers use credit to arrange the purchase.
If a potential homebuyer can afford the monthly mortgage payments (principal and interest), plus property taxes and hazard insurance, the total cost of the house is of secondary importance.
*The amortized (principal) portion of a monthly payment can be increased or decreased by:
(1) the amount of the down payment made on the property and
(2) the term of the loan.
*Both of these have a direct bearing on demand for housing.
When a tight money market develops and interest rates rise, a corresponding drop is reflected in housing demand because the amount of money needed to make monthly mortgage payments increases.
For example:
A $90,000 mortgage loan at 7% interest for a period of 30 years requires a monthly payment of $598.77, not including taxes and insurance.
The same amount of money for the same period of time but at 9% interest requires a monthly payment of $724.16, an additional $125.39 per month.
An increase in mortgage interest rates of even 1% causes a definite drop in demand for housing.
Consumer Tastes or Preferences - Demand
Another factor related to demand concerns changing consumer tastes or preferences.
Different architectural designs are sometimes introduced into the residential market and may enjoy brief periods of popularity.
Generally speaking, however, enduring changes in consumer tastes occur slowly, over extended time periods.
In recent years, the “green movement” has consumers preferring energy-efficient homes.
Whatever style and type of house the buying public prefers at a given time is the type of dwelling that will be built more often, until a new demand creates a new preference.
*Changes in demand for condominiums or second homes for vacation purposes also reflect changes in consumer preferences.
For years, empty nesters (those parents whose children are grown and have moved away) continued to live in the same house where they had reared their children; although, it was then entirely too large for their needs as a couple.
The numerous chores of the homeowner related to maintenance, repairs, and grounds upkeep were often a joy but sometimes too physically demanding.
The advent of condominiums and other forms of smaller, maintenance-free housing units offered a solution to these empty nesters and other small families.
Interpreting Market Conditions
Whenever the supply and demand equilibrium of a market is upset by excess supply, a buyer’s market develops.
The number of excess units in that particular market allows a potential buyer to shop among anxious owner-sellers to obtain better prices and terms.
When this condition exists, more intelligent builders may stop building because the excess supply results in a lack of profit. On the other hand, whenever the supply and demand equilibrium is upset by excess demand, a seller’s market develops.
This allows sellers to demand higher prices from buyers, who are forced to compete for available space. More building again takes place until market equilibrium occurs.
What the average real estate sales associate and broker would like is some sort of dependable reference guide to help interpret market conditions.
Fortunately, several indicators help to clarify what the market is doing.
Market indicators include:
price levels,
vacancy rates, and
sales volume.
