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Real estate is a fixed, tangible and immovable asset in form of houses or commercial property (Seldin & Richard 1985). Real estate market involves developing, renting, selling/purchasing and renovating of these assets (houses). Market participants includes developers (contractors, engineers, and so on), facilitators (mortgage companies, real estate brokers, banks, management agents and so on), owners, renters (leasers) and renovators (Seldin & Richard 1985). Like other economic markets, real estate markets have internal and external forces that make impacts in the market (Seldin & Richard 1985).
Demand and supply forces have the major impact in the industry as they determine growth or decline in the market (Seldin & Richard 1985). Owner, renter and user are on demand side of the market that is they are consumers. Developers, financiers and renovators are suppliers (Acton et al 1999). Unlike commodities market demand and supply forces do not float easily. This is because of the uniqueness of this market. Real market industry has these unique characteristics, durability of products as buildings can last for decades or centuries. Each product (house) is unique in terms of buildings, location, and financing thus market has heterogeneous products (Acton et al 1999). Transaction costs are high and the process is usually long. Though there are mobile homes, but the land underneath is till immobile, real estate is an immovable asset (Acton et al 1999).
The main factor that affects demand in real estate industry is demographic features. The demographic variables include population size and growth, cultural background, beliefs and religion (Acton et al 1999). However, other factors like income, price of housing, cost and availability of funds, consumer preference, supplier’s preference, price of substitutes and compliments (Acton et al 1999).
Shift in supply of housing is affected by cost of using land, labor, building materials and other inputs like electricity (Pascal 1967). Price of existing houses and the technology of production also affect new supply here (Pascal 1967).
Price elasticity of house demand measures the sensitivity of price of houses due to changes in their demand (Pascal 1967).
PED (Houses) = % Price
% Units of Houses demanded
In the short-run the price elasticity of demand is high, however, in the long run the elasticity is not very high (Pascal 1967).
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In the long run, if there is an increase in demand of houses may be due to increased consumer preference on certain location, the supply side will have adjusted to their increased demand and build more houses inorder to gain on these prices (Miles et al 1991). When the houses increases relative to the demand increase, the price of houses stabilize and there is small change in the price of house. Thus the demand of the houses is price elastic in the long run (Miles et al 1991).
Price elasticity of house supply (PES) refers to the measure of responsive change in price of houses due to changes in their supply (Miles et al 1991), that is,
PES (House) = % Price of House
% Units of Houses supplied
In the short run, the price elasticity of house supply is inelastic. To build a unit of house it takes longer time, thus in the short run, suppliers cannot make to build enough units to have impact on their prices (Miles et al 1991). In the long run price elasticity of supply is quite high. Developers and other suppliers’ activities of building houses causes increased in number of units in the long run, when the units increase their prices will fall as the suppliers will compete with prices to get renters (Miles et al 1991).
Cost-benefit analyses of the real estate industry vary from different geographical regions. Different real estate markets adopt market code of ethics (Costello et al 2001). In markets which are adequately regulated like US the marginal benefits the society get from the real estate industry exceeds the cost to the society (Costello et al 2001).
Negative externality occurs when a firm in making and executing their decisions on their operations do not have to pay the full cost of the decision they make (White 1983). A product or service has a negative externality when its cost to the society exceeds benefits the society gains. In markets where real estate industry is unregulated, developers do not take responsibilities for external cost, thus they pass them to the society (White 1983). This usually results in inefficiencies as these cost impacts negatively in the economy. Examples of negative externalities in real estate industry include degradation of ecosystem. Materials used in building are extracted from the natural resources for example timber (White 1983).
Positive externalities exist when a firm in making the decisions about their operations, take into account all external costs (Ben-Shahar 2002). The benefit to the firm or an individual is less than the society’s benefit and this occurs mostly when the industries are regulated (Ben-Shahar 2002).
In real estate markets, an example of positive externality is building of public access roads adjacent to a villa. Positive externalities increase efficiency in the economy (Ben-Shahar 2002). Government or local authorities do encourage positive externalities in the industry through providing incentives to those who take responsibilities of their external costs especially on environment (Seldin & Richard 1985).
Wage inequalities refer to differences in wage (labor price) between individuals or within a group of workers (Ben-Shahar 2002). In the late 80s and early 90s, wage inequality greatly increased. Before the 80s, inequality was usually based on age, sex, education and so on. But recently, it has been noticed that inequalities are based on skills acquired, experience and educational and professional levels (Pascal 1967).
In real estate industry, wage inequalities also have increased. Real estate firms demand quality labor and thus advanced skills in architecture, engineering, surveying, home economics and project management is required (Pascal 1967). Experienced labor gets top positions and better pays (). However, wage inequalities vary from country to country. Countries like US set minimum wage that is usually adjusted to take into account physical output and inflation (Pascal 1967).
Countries where wages are regulated, the inequalities are not very wide. In countries where wages are set by the industry players, that is, employers, inequalities are large (Costello et al 2001). There have been reported cases of labor abuses where casual laborers are under paid. This occurs mainly in the developing world where the labor supply highly exceed the labor demanded (Costello et al 2001).
Various real estate industries have adopted labor policies that address discriminative inequalities. Inequalities that are based on age, sex, religion, race, ethnicity and so on usually results in inefficiencies in the industry and economy at large (Miles et al 1991). This is because workers who feel they are under paid do not perform their tasks effectively and efficiently as they are demotivated (Costello et al 2001).
Governments usually develop and implement fiscal policies as a strategy to achieve their budget objectives (Costello et al 2001). Fiscal policies involve plans on how the government is going to raise revenues and how they are going to spend (Costello et al 2001). When governments want to have budget expansion, that is, increases in public expenditure, they usually increase their taxes (Costello et al 2001). Also, government licenses organizations to raise revenue and also regulate them.
Taxes on inputs used in building, increase costs and hence price of houses. Increased prices reduce the demand of houses (Ben-Shahar 2002). Also, increased government expenditures in roads or buildings increase cost of inputs as their demand increases (Ben-Shahar 2002). Government can also increase licenses charges to developers and thus increase their cost of business (Miles et al 1991).
The government can use tax concessions and rebates on building materials to reduce cost of housing. To increase the investment on real estate industry, the government can give tax holidays to developers and other stakeholders (Miles et al 1991). This will ensure more housing units and hence better living standards of its citizens (Ben-Shahar 2002).
To ensure market participants in the real estate industry improves their environment, the government gives licenses to firms that are engaged in measures that improves the environment and gives them exclusive rights to their resources (Seldin & Richard 1985).
Real estate industry is a subject of the overall economy. As they operate with an economy, changes that happen in that economy affects the industry (Acton et al 1999). When there is an economic growth, disposable incomes increases and hence demand for the house users’ increase.
Increased investment in the inputs reduces cost of building houses premises (Ben-Shahar 2002). This will cause a boom in the real estate industry as developers can manage to build more units and benefit from economies of scale (Miles et al 1991). Reduction in interest rates, reduce financing costs (Miles et al 1991). Mortgage borrowers pay less than when rates are high. This decrease in finance costs will bear a positive impact on the housing industry as more units are developed at lower costs (Miles et al 1991). Inflation on the other hand, increases the cost of inputs. When the cost of inputs increases, only a few developers will manage to put up units and will only build less units. This will make the real estate industry shrink (Pascal 1967).
In conclusion, real estate market has had turmoils that were imported from other market. Financial market dynamics have had a huge impact on real estate industry in the United States of America. Inflationary pressures reduce the disposable income of the demand’s side and supply’s side. On the supply’s side, investor’s value reduces and their returns also consequently reduce. Thus, they reduce their investing activities. On the other side, users and real estate consumers on the demand’s side reduce their spending on real estates leases or rents and search for less costly alternatives, thus increasing their investing activities.
Acton, Michael J.; Hopkins, Robert E. (1999). Where Does the Return Come From? Using the Risk-Adjusted Performance Measure in Real Estate. Real Estate Finance, Volume 16, Number 2, pp. 23 – 3
Ben-Shahar, Danny. (2002). Theoretical and Empirical Analysis of the Multi-Period Pricing Pattern in the Real Estate Market. Journal of Real Estate Research.
Costello, James M.; Hopkins, Robert E.; Sivitanides, Petros S.; Southard, Jon A.; Torto, Raymond G.; Wheaton, William C.. Real Estate. (2001). Real Estate Finance, Volume 18, Number 3, pp. 20 – 28
Miles, M.E., et al. (1991). Real Estate Development. Washington, D.C.: Urban Land Institute.
Pascal, Anthony. (1967). The Economics of Housing Segregation. Santa Monica, Calif.: The Rand Corporation.
Kris Feder. (1997) Real Estate and the Capital Gains Debate The Jerome Levy Economics Institute of Bard College, Working Paper No. 187.
Seldin, Maury, and Richard H. Swesnik. (1985). Real Estate Investment Strategy. 3d ed. New York: John Wiley and Sons.
White, John R., ed. (1993). The Office Building: From Concept to Investment Reality. Chicago: Appraisal Institute and the Counselors of Real Estate.