Economics behind real estate market
Real estate denotes a significant portion of most people’s wealth. It is especially true in a country like India where investing in real estate property is the first advice given to anyone who starts off with a stable career.
According to the most recent Survey of Consumer Finances by the Federal Reserve, 65.2% of American families owns their own primary residence. The size and scale of the real estate market make it an attractive and lucrative sector for many investors.
Factors influencing the real estate market
Let’s look at some of the main factors that influences the real estate market and how real estate affects the economy.
1. Demographics:- It is the data that describes the composition of a population such as:- age, race, gender, income, migration patterns and population growth. At first it may look oh cmon! how does it matter and it can be easily overlooked, but these statistics affects how real estate is priced and what types of properties are in demand. If there is substantial shift in the demographics of a nation, then it can have a huge impact on real estate trends for many decades.
Let’s take an example:- India got independence in 1947, the average age of a retiree today in India is roughly around 60 years. In other words, people who were born between 1945 and 1965. Now these people who were born between 1945 and 1965 has tremendous potential to influence the real estate market. The time at which they will retire (which is around 2005 – 2025) is the most interesting generational trends in a century. Now many have retired since 2005, the evidence is right in front of us as to how the prices of real estate has shot up in the past 10 years. And we will see this trend for another decade.
Now if you are an investor – before investing you could ask some key questions like:- what is the income level of retirees, do they have a big family or a small family, whether they will prefer a big house or a small house, then what are the places where people can afford to buy homes. So these are some questions that can help you to narrow down certain type and location of your desired property.
2. Economy as a whole:- When we think of the word economy, all these economic terms like GDP, unemployment rate, manufacturing growth, prices of goods and services. All these terms are associated with the economy. Because these terms are the key economic indicators that tells us about the health of the economy. Whether the economy is growing or slowing down.
It is simple to understand – if the economy is sluggish or poor, then the real estate sector will be sluggish as well and vice versa. Because think about it, if unemployment is high, prices of goods and material is high then it discourages people to invest in properties. After all, if the purchasing power is low and the cost of building a house is high, then hardly anyone would like to invest in such a market condition. But then the interesting thing to notice is that there will be certain types of property in real estate that will not be affected. For example, office leases, they are a form of property that is leased for a longer period of time and there rates cannot be changed in the middle of an economic downturn. That’s why these big corporations enjoy that perk and they carry on with their work even if the economy is low. Of course there will be cost cutting, but then rarely we see a big corporation shutting down in a blink of an eye. So the health of the economy is another key factor for the real estate market.
3. Interest rates:- Interest rates are the cost for borrowing money. When you go to a bank or any financial institution and ask for a loan. They will lend you the money along with a certain interest rate based on the time period. That means you will have to return the principal amount along with the interest rate. The same goes for the banks as well when they borrow from the central bank RBI. Now if the interest rates are high, then you will not prefer to take a loan, therefore that decreases the money supply in the economy. Generally RBI uses this mechanism of changing the interest rates to control the money supply, which will then control inflation in the economy.
Now changes in interest rates can greatly influence a person’s ability to purchase a residential property. You see buying a property is not always dealt in loose cash. You will mostly apply for a mortgage. Hence, higher the interest rates, higher will be the cost to obtain a mortgage, which will reduce the demand for real estate, and that further pushes the prices down. Understand this trickle down effect. Similarly if the interest rates are low, the cost to obtain a mortgage will also be low, which eventually increases the demand of a property, and that further pushes the prices up. So interest rates is one of the most important key factor that affects the real estate market.
These are the three high-level factors that affects the real estate market. Although there are more factors that come into play like:- development of the surrounding location where the property is, availability of civic amenities and things of that nature. However, these three factors shows a clear cut relationship between the market and the demand. The purpose of this article is to give you an overall view of how these factors create a certain type of market demand in the real estate sector.