How Does the Real Estate Market Work?6 min read
The real estate market works according to the laws of supply and demand. When supply is greater than demand, prices fall. When demand is greater than supply, prices rise. In this way, the real estate market is like any other market. But several factors, including seasonality, durability, and locality, set it apart.
Want to know more? We’ll break it down piece by piece.
What Is Real Estate?
Real estate is property consisting of land, the buildings on it, and any natural resources within the property boundaries, such as minerals, water and crops. Real estate can be categorized into four types: residential, commercial, industrial, and land.
Residential properties include structures for domestic residence such as single-family homes, condominiums, townhouses, mobile homes, and vacation rentals.
Commercial properties include structures used to produce income such as offices, stores, hotels, services and other businesses.
Industrial properties include structures used for manufacturing, such as factories, warehouses, and research centers. Generally industrial is for the production of goods and commercial is for the distribution of goods.
Land properties include few or no structures such as vacant land, farms, ranches, and reclaimed sites.
What Is the Real Estate Market?
The real estate market is all properties available for sale in a given area. For example, all properties for sale in the Kansas City Metropolitan Area could be referred to as the Kansas City real estate market.
Economic forces in a given area can cause an increase (or a decrease) in the supply of properties. This can in turn cause prices generally to fall (or rise). This is what people mean when they say the market is up or down.
The United States real estate market is actually made up of hundreds of smaller city and regional real estate markets. While prices in these markets mostly move independently, there are some factors that can affect the U.S. market as a whole.
What Drives Supply and Demand?
Supply and demand are driven by local and general factors.
Local factors, which may affect one market but not another include:
- Income – Income affects local real estate demand. If incomes in a local area are high, people have more money and are more likely to want to buy a house.
- Job Availability – Jobs also affect local real estate demand. If a city loses a major employer, those workers will need to look for a new job. This will limit their ability to buy a new home.
- Accessibility to Credit – In some rural areas the nearest bank may be several hours away. This can limit demand simply due to the difficulty in obtaining a loan.
- Land Constraints – Land constraints are a classic example of a supply factor. There is very little room on Manhattan Island to increase supply, so prices remain persistently high.
- Transportation – Easy access to transportation can make a locality a desirable place to live, increasing demand.
- Exposure to Extreme Weather – San Diego is thought to have some of the best weather in the world. It’s no wonder the demand for property there is so high.
- Retirees – Many retirees choose to sell their property and downsize. This provides more homes for the market and increases supply.
- Upgrades – As families grow, they often upgrade to a larger house. This can lower demand for small homes and increase demand for larger homes.
- New Construction – New Construction increases supply to the housing market by providing new properties to be bought and sold.
General factors, or those that affect the real estate market as a whole include:
- Interest – In the United States, the Federal Reserve Bank sets interest rates, which by extension affects the cost of borrowing. When interest rates are low, the cost of a mortgage is lower, which allows more people to buy property.
- Inflation – Inflation affects a consumer’s real income. When the price of goods and services rise, an individual’s income is worth less, which limits his or her ability to purchase a home.
- Taxes – The federal government has, at times, provided tax credits for first-time homebuyers. The latest example was between the years 2008 and 2010 as a way to stimulate demand during the recovery from the great recession.
- Social Tastes – Owning a home has long been seen as a social status symbol, which increases demand.
- Investment – Property values tend to rise over time, which make them an investment opportunity and increases demand.
These are just some of the many local and general factors affecting supply and demand in the real estate market.
What Else Drives Real Estate Market Changes?
Much of the real estate market is driven by economic principles. But not all of it.
In the real world, there are any number of drivers that can push people to buy or sell. There are fads and styles. Think of wood paneling and the effect it has on the desirability of a home today.
There are also family and business changes that may cause people to relocate. There is also the fact that real estate is relatively illiquid, meaning it is difficult to convert to cash.
It takes time and effort to buy or sell a home, which prevents people from doing it more often.
Why Is the Real Estate Market Unique?
It’s also true that the real estate market is unique. There are several factors that separate the real estate market from a typical market. Many of these factors have to do with real estate itself and how it behaves as a good.
Real estate is not consumed in the way that many goods are. Instead, real estate persists. And in many cases, it appreciates. This gives real estate different properties than say, pizza. For example, real estate can serve as a personal or family investment. Pizza, for all its benefits, cannot.
Real estate activity varies by season. In the winter, when the climate is harsh in many places, activity dwindles. In the summer, when the weather is nice, it picks up. This makes it difficult to compare real estate figures month-to-month. Instead, these figures must be “seasonally adjusted” to provide an estimate of what real estate activity would look like all else held constant.
Real estate has many attributes that make prices and market activity specific to one area. First, real estate is not portable. Unlike oil, which can be bought where prices are low and shipped to where prices are high, real estate cannot be transported and stored. Second, human activity is limited. Most of us spend the vast majority of our existence within a few miles of our home. This means the determinants of the value of that home are limited to the area within those few miles. All of this serves to make real estate a local good in which prices vary widely even within the same region.