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Real Estate
Economics
Overview of real estate markets:
The various participants in real estate markets are:
1. Owner or User - These are both owners and tenants. They purchase houses or commercial property to serve as an investment and also to live in or utilize the property as a business or office space.
2. Owner - These people are sole investors. They do not cause depreciation of the real estate that they purchase. They usually rent out or lease the property to a third party.
3. Renter - These are pure consumers, who consume the property.
4. Developers - These people prepare raw land keeping in mind the sole purpose of building, which results in new product being made for the real estate market.
5. Renovators - These are people who supply refurbished buildings to the market.
6. Facilitators - These include banks, real estate brokers, lawyers, and any others that might prove instrumental in facilitating the purchase and sale of real estate.
While the owner / user, owner, and renter comprise the demand side of market dynamics, the developers and renovators comprise the supply side. In order to apply simple supply and demand analysis to real estate markets several modifications need to be made to the standard microeconomic assumptions and procedures. In particular, the unique characteristics of the real estate market have to be accommodated. These characteristics usually include:
1. Durability - Real estate is said to be durable in the sense that a building can last for decades or even centuries, and the land underneath it is practically indestructible. Owing to this, real estate markets are modeled as a stock/flow market. While about 98% of the supply consists of the stock of existing houses, only about 2% consists of the flow of new development. In order to arrive at the stock of real estate supply in any period, the existing stock from the previous period, the rate of deterioration of the currently existing stock, the rate of renovation of the currently existing stock and the flow of new development in the current period are considered. The effect of real estate market adjustments do sometimes tend to be mitigated by the relatively large stock of existing buildings.
2. Heterogeneous - Every piece of real estate is unique, in terms of its location, the building and its financing. This is the aspect that makes pricing difficult, increases costs involved in searching, creates asymmetry of information and greatly restricts the property's substitutability. To arrive at a work around for this problem, economists define supply in terms of service units, that is, any physical unit can be deconstructed into the services that it provides or as an unobservable theoretical construct. Housing stocks are susceptible to depreciation making it qualitatively different from a new building. The market equilibrating process operates across multiple levels of quality. Further, the real estate market is normally divided into residential, commercial, and industrial segments. It can also be further sub-divided into categories like recreational, income generating, area, historical or protected, etc.
3. High Transaction costs - Buying and / or moving into a home is usually much more expensive than most other types of transactions. These costs include costs involved in conducting searches, moving costs, legal fees, real estate fees, land transfer taxes, and deed registration fees. Transaction costs for the seller usually ranges between 8 - 10 % of the purchase price.
4. Long time delays - The process of market adjustment often result in time delays due to the length of time it takes to finance, design, and construct new supply, and also owing to the relatively slow rate of change of demand. Due of these lags there is a major potential for disequilibrium in the short run. Adjustment mechanisms tend to be slow, in relation to the more fluid markets.
5. Both an investment as well as a consumption good - The beauty of investing in Real estate lies in the fact that it can either be purchased with the expectation of attaining a return (an investment good), or with the intention of using it (a consumption good), or both. These functions can be separated (when market participants concentrate on one or the other function) or can be combined (in the case of the person who lives in a house and also owns it). This dual nature of the good means that it is common for people to over-invest in real estate, that is, to invest more money in an asset than it is worth on the open market.
6. Immobility - Real
estate cannot be moved from one place to another. Consumers hence have to
come to the good rather than have the good going to the consumer. Because
of this, there cannot exist a physical market-place. This spatial fixity
implies that market adjustment must occur by people moving to dwelling
units, rather than the movement of the goods. For instance, if tastes
change and more people demand suburban dwelling places, people must find
housing in the suburbs, because it is impossible to bring their existing
house to the suburb. A spatially fixed nature combined with the close
proximity of housing units in urban areas suggest the potential for
external elements' inherent in a given location.