Understanding Real Estate Basics: Supply, Demand and Elasticity

Understanding Real Estate Basics: Supply, Demand, and Elasticity

Economists are always throwing around economic terms as if everyone in the world speaks their language. Most real estate agents probably understand the basics of supply and demand, but might not be familiar with the concept of elasticity, unless they studied macroeconomics at some point. An understanding of these terms can help you to determine the economic context of a property purchase.

It is a commonplace saying that supply and demand are the most fundamental concepts in economics and are the central force in a market economy. This is also a key concept in the real estate industry. As with housing availability, the relationship of supply and demand largely determines the allocation of resources within the economy. Understanding economic terms boosts your understanding of the economy in general and helps you with investing.

Supply

The supply of anything, in economic terms, refers to the amount of goods and services that are available at a given price point within an economy. Suppliers are willing to provide more supply as the price increases.

You, like most others, would probably be willing to save a larger deposit if you found out the selling price of a property would be higher than you originally expected because there were not that many properties on the market that have the features your desire. Similarly, if there is a glut in the real estate market a lower bid could be accepted in an effort to make the sale.

Demand 

Demand is simply the desire of the members of an economy to consume a given product or service, such as the number of people looking to purchase a 3-bedroom home. This is largely a function of price. Assuming all other factors are constant, many try to purchase property as the price drops and fewer wanted an item as the price increases. This is reflected in real estate where some suburbs are more sought after, and therefore more expensive, than others. Who wouldn’t want to in an affordable beachside property? However, how many such properties are available for sale? Another example of the role of demand is that you probably wouldn’t consider purchasing a Mercedes at the moment but if the price dropped significantly, say by 30% you would be more inclined to purchase.

Equilibrium of Supply and Demand

When supply and demand are exactly equal, the economy is considered to be in equilibrium. This is considered to be the most efficient condition for the economy because the goods being supplied are equal to the goods being purchased. In general, everyone is satisfied when the economy is in equilibrium. The manufacturers are selling everything produced and the consumers are able to purchase all the goods they demand.

Unfortunately, equilibrium only exists in theory. But, when there’s a difference between supply and demand, there’s an opportunity for investors to make money. That’s why it can be important as an investor to attempt to predict future supply and demand for the products and services produced by companies you’re considering investing in.

Elasticity

Elasticity is simply how flexible demand is as a function of price. For instance, many consumers are loyal to either Coke or Pepsi, as long as the prices are comparable. But most individuals will quickly switch brands if the price increases.

Luxury items tend to be rather elastic. You probably wouldn’t take a cruise if the price went up dramatically because no one needs to take a cruise. Taking a cruise is a luxury. Similarly, if the price of a new Mercedes dropped by 30 % compared to the competition there might be a 45% increase in demand indicating that the demand is elastic. The demand for some products is not very sensitive to price increases. Utilities would be considered relatively inelastic because you probably purchase about the same amount of electricity, gas, and water, regardless of the price. When the economy is struggling, companies with non-essential, luxury type items tend to struggle. People are more focused on necessities and are hesitant to spend money on things they don’t need. 

The relationship between real estate and elasticity is that consumers don’t have to pay one price for housing because there are so many options. Housing is one example of a good with elastic demand. But, what happens to popular suburbs during a down turn? This is a bit complicated and depends on the price bracket and who is losing livelihoods and forced to sell. If one type of housing cost becomes really expensive consumers will typically opt for a different type of housing rather than paying the higher price. In this way, the variable of housing is sensitive to changes in price. Further information about this is available here: https://www.investopedia.com/ask/answers/042315/how-does-price-elasticity-change-relation-supply-and-demand.asp

Conclusion

Supply, demand, and elasticity are the fundamental concepts that make up our economy and they help make sense of fluctuations in the real estate market. Each plays a pivotal role in how the economy grows and shrinks. This also affects the ability of consumers to be successful in finding a property that suits their lifestyle plan. Consider these ideas when examining your investments and the amount of risk you’re willing to undertake.