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Supply and Demand in Real Estate

Posted on 13/09/2022 11:07 AM | by NaijaHouses

Supply and Demand in Real Estate

If you’re in real estate, it pays to understand how supply and demand impact your business. The basic economics of real estate are the same as for any other good or service. When supply and demand are perfectly matched—when every prospective buyer can buy what they need, and every seller is able to sell all they are offering—the market is said to be balanced, or in equilibrium, and prices are stable.

But supply and demand in real estate aren't easy to balance. Creating more saleable properties takes time, considerable work, and a lot of effort. It's not possible at all in some cases, and even when it is, it might not be possible for supply to increase in time to meet consumer demand, as we saw during the housing market boom in 2021.

Understanding the basic economic principle of supply and demand can help consumers decide the best time to buy or sell their properties. Knowing the forces at play can help real estate brokers and agents prepare for and respond to them as well. 

  • In real estate, as with other businesses, when demand is higher than supply, prices rise, and if supply outpaces demand, prices fall.
  • Factors that impact real estate supply include labor and materials supplies, government policies, and local sentiment about development.
  • Factors that impact demand include interest rates, buyer demographics, and consumer financial well-being.
  • The COVID-19 pandemic added other factors that threw supply and demand out of balance.

How Supply and Demand Work in Real Estate

Real estate follows the law of supply and demand: When there are more buyers than properties for sale, prices rise. Tip the balance the other way, and prices go down.

It’s easy to see this in operation. If you bought and sold homes in 2021, you dealt with an extreme seller’s market in which house hunters and investors lined up to bid for a near record-low number of homes for sale, and home prices skyrocketed.1 In 2022, demand has fallen as rising interest rates have made homebuying more expensive.

A rough barometer of supply and demand is a statistic the National Association of Realtors (NAR) creates called “months’ supply.” That refers to how long it would take to sell all the current homes on the market at the current pace of sales. Typically, a six-month supply means a balanced market with moderately appreciating prices, and anything lower than that means prices accelerate faster.2 In January 2022, the months’ supply got as low as 1.6 months, an all-time record low.

Factors That Affect Housing Supply

Let’s take a closer look at why housing supplies go up or down.

Existing Inventory

The inventory of homes for sale consists of previously-owned houses as well as new ones being sold by homebuilders. These two pools of homes referred to as “new” and “existing” homes, generally are tracked separately and subject to different influences.

The National Association of Realtors estimates the number of existing homes for sale using data from real estate listings. The supply of existing homes is influenced by how many people are putting their homes on the market, especially when homes open up because of aging and mortality in older generations.

Some experts estimate that one-quarter of existing homes will be up for sale by 2040 due to baby boomers transitioning out of their own homes or eventually dying.1

Homes are also listed when people sell one house and buy another, but this has a net-zero impact on the total housing supply since they’re taking a house off the market somewhere else.

New Home Construction

The number of new homes for sale comes from a survey of builders that the U.S. Census Bureau conducts to calculate the number. New home construction changes depending on:

  • How confident builders are that they can find buyers 
  • How easily builders can get workers and materials they need
  • How good the weather is for construction

Government Policies

Federal and local policies both have important impacts on supply and demand in the real estate market. Zoning controls and opposition to new construction by local residents with Not-In-My-Back-Yard (NIMBY) attitudes in certain areas slows development, according to Freddie Mac. That’s because NIMBYism can feed into local decisions to discourage development.

Local laws may also restrict building height or the number of homes allowed to be built per acre, which decreases the supply of homes and makes them less affordable.

To help increase the housing supply, the administration of President Joe Biden launched a program in 2022 that favors state and local governments applying for federal transportation funds if they reform their land-use policies to promote housing density, among other goals. The intention is to close the housing gap within five years. The Biden administration also allocated more funding to subsidize the construction and repair of affordable housing.

Factors That Affect Housing Demand

Housing demand also is subject to various economic and societal forces that affect real estate businesses.

Mortgage Interest Rates

Interest rates are major factors in how much buyers can and will pay for homes. When mortgage rates are low, it doesn’t cost as much to finance a house. That means homebuyers are able to afford more expensive homes on the same monthly budget.

For example, a buyer with $40,000 for a down payment and a $1,500 monthly budget for mortgage payments could buy a home worth $412,242 at the ultra-low interest average rate of 2.65% for a 30-year fixed mortgage that prevailed in January 2021, according to Freddie Mac. That same buyer could only afford a home worth $310,122 at the typical 5.3% interest rate offered in July 2022.