Real estate is a tangible asset made up of property and the land on which it sits, and while it is unmovable, real estate, like other assets, is also subject to supply and demand. This means that the prices of homes, like those of stocks and bonds, depend heavily on the law of supply and demand. With more demand, prices tend to rise; with more supply, they tend to fall.
But what kind of relationship does the housing market have with this law? Learn more by reading below about how this economic theory works and how it impacts the real estate market.
Key Takeaways
- The housing market is a good example of how supply and demand work within an industry.
- When the demand for housing is high but supply is low, home prices often rise.
- When there is a glut of housing available in a market, homeowners may lower their prices due to less demand in the market.
The Law of Supply and Demand
The law of supply and demand is a basic economic principle that explains the relationship between supply and demand for a good or service and how that interaction affects the price of that good or service.
When there is a high demand for a good or service, its price rises. The price falls if there is a large supply of a good or service but not enough demand for it. The reason is that people will bid up the prices when there is relative scarcity, and there will be unsold items when there is an oversupply.
The theory of supply and demand is one of the most basic principles in economics. Supply and demand work against each other until the point at which the equilibrium price is achieved—that is, the price where supply is equal to demand in the market. That happens, of course, when all other factors remain equal.
Demand
The law of demand dictates that people will have lower and lower demand for a good as its price rises ever higher. Similarly, lower prices drive demand, meaning consumers value and purchase something more when it’s cheaper.
Supply
The law of supply says that a higher price will induce producers to supply a higher quantity to the market. Likewise, prices will rise when supply is low as people scramble to buy up scarce resources.
Real Estate Supply And Demand
The housing market, too, relies heavily on supply and demand, which is why it is a much-looked-at indicator in the industry. Each housing transaction, of course, involves a buyer and a seller. The buyer offers a property, leaving the seller to accept or reject the offer.
The law of supply and demand dictates the equilibrium price of a property. A low supply or housing inventory may drive prices up, which is what tends to result in bidding wars. A specific property may be in demand by multiple parties who all try to outbid each other by increasing their purchase price offer.
The bidding war ends when the seller accepts one of the offers, which then also removes a unit from the available supply. When there is a high demand for properties in a particular city or state combined with a lack of supply of quality properties, the prices of houses tend to rise.
On the other hand, when a weak economy and an oversupply of properties lead to low or no demand for housing, the prices of houses tend to fall.
Factors Affecting Housing Supply And Demand
The precise values attributed to the supply and demand in a market are not easy to measure in the real estate market. This is partly because it takes a long time to construct new homes or fix up old ones to put back onto the market.
Similarly, real estate is not like other industries in that it takes a lot of time to buy and sell homes and other properties. This means that transactions can take a long time to consummate, making real estate somewhat illiquid.
Some of the factors that will influence housing demand include lower interest rates or borrowing costs. When interest rates are low, people are generally willing to take on more debt because they can afford relatively more debt for the same monthly outlay. Put differently; they may be able to finance the purchase of a home because the amount of interest they have to pay is not as burdensome at low rates.
As more buyers enter the market, the demand for housing increases in turn. And if there remains a limited supply of housing inventory, prices in a low-interest rate environment may rise even more.
Meanwhile, the supply of housing is in a constant state of flux. Inventory may increase when people are moving elsewhere—some may be downsizing, others may try to make more room for an expanding family, and others may purchase their first home. Similarly, there may be an increase in development and new home construction, adding to the existing inventory.
On the other hand, housing inventory decreases during natural disasters such as floods and earthquakes or when existing properties are demolished. Land property is also a finite resource, so the amount of new developments is generally limited.
Read More: The Difference Between a Cash-out Refinance and a Home Equity Loan
The answers to a few popular questions about the housing market can be found by understanding the impact supply and demand have on each other.
- Is there a reason that prices are rising?
- Where are prices headed?
- What does this mean for people who are buying a house?
Is There A Reason For The Rising Prices?
Home prices have risen by 18.1% compared to last year, according to the latest Home Price Insights report from Core Logic. But what is causing the increase?
The recent buyer and seller activity data from the National Association of Real Estate helps answer that question. We can see that the demand for homes is much greater than the seller traffic when we compare it to the buyer activity data.
Home prices are going up because of this combination of low supply and high demand. By some measures, house prices seem high, but the recent increases make sense from a supply and demand perspective, according to Bill, author of the Calculated Risk blog.
Read More: Is Now A Good Time To Refinance Your Mortgage?
Where Are Prices Headed?
In the coming months, the supply of homes for sale will have a big effect on prices. According to Keeping Current Matters, prices will likely increase at a slower rate. This is good news for buyers who want to purchase the home of their dreams. It’s important to remember that a moderate drop in home prices doesn’t mean the prices will fall or increase.
Home prices will continue to appreciate through 2022, according to the real estate market forecast of Realtor.
What Does This Mean For Home Buyers?
You may end up paying more in the long run if you wait too long to enter the market because you’re expecting prices to drop. Even if the rate of price increase is slower next year, prices are still projected to go up. The home of your dreams will likely be more expensive in 2023.
Read More: Is 2022 A Good Time To Buy A Home?
Final Thoughts
High demand and low supply are driving up home prices in today’s housing market. Experts still expect prices to rise even though prices may increase at a slower pace in the coming months.
Do you have any questions about the housing market? Leave a comment below. If you want to discuss what that could mean for you if you wait even longer to buy, contact us for a free consultation.