Economics of the Real Estate Market by Ramon O.

Introduction

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Economics is broadly defined as the study of how individuals and society allocate scarce resources in satisfying their wants and needs, including the production, distribution and consumption of goods and services to meet the needs of various economic units.

Overview

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People utilize resources, capital, technology and expertise to create goods and services. The creation, distribution and ultimate consumption of such goods and services is largely dictated by the forces of supply and demand. Further, the amount of production and its ultimate use by consumers, determines the standard of living enjoyed within a particular society.

Factors of Production

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All economies require four basic elements in order to produce goods and services:

• Land

• Labour
• Capital
• Enterprise

Collectively, these are referred to as the factors of production. The overall effectiveness of the economy is dictated by its basic philosophic orientation.

Economic Principles and Primary Indicators

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Canada's Economy

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Best describes as a mixed economy, consisting of both private economic units, as well as government participation in the direction of economic activity and production of goods/services.

Labour

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Labour indicators not only measure the strength of the economy, but also the efficiency with which manpower is being utilized in addressing consumer demand.

Statistics Canada provides extensive research and statistical data on total employment, employment rates and detailed labour force statistics.

Capital

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Statistics Canada publishes worthwhile information not only on existing capital investment from private and public sectors but also on anticipated allocations of capital dollars by large and small companies. The availability of capital and attractiveness of interest rates charged are directly tied to economic expansion.

Business (Supply)

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National Product
The supply of services and goods in the marketplace is a critical measure of the economic output. Economists have focused on two major indices:

GNP - Gross National Product
GDP - Gross Domestic Product

Manufacturing Activity
Statistics Canada also produces information concerning manufacturer’s new orders, shipments and inventories. This information is necessary when assessing overall demand through the depletion and replenishment of goods.

Utilizing Rates
Although no key indicator exists assessing the effective use of production facilities within the country, economists do rely upon various topical reports from Statistics Canada. These attempt to illustrate whether the economy is operating at its full potential, utilizing the available production factors.

Consumers (Demand)

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Consumer Confidence and Spending
The Conference Board of Canada produces a quarterly report on consumer attitudes that has proven to be a fairly reliable indicator of future economic trends. If attitudes are positive and consumers are aggressive in the marketplace, increased expenditures on goods and services will normally result.

Consumer Disposable Income/Debt
The ability of consumers to expend dollars in the marketplace relates to both the amount of disposable income (used for acquisition of goods and services) and overall household debt load (ability to pay for acquisitions). A rise in disposable income, coupled with high consumer expectations and lowering debt loads, normally result in economic growth.

Consumer Price Index (CPI)
The CPI is a combined measure of both the forces of supply and demand in the marketplace The CPI contains a price index for new houses (labour and material prices only; land value is not included) as well as a rental index. The Consumer Price Index and related sub-indices are valuable indicators as they:

• Quantify family expenditures;
• Provide input on price trends; and
• Reflect current inflationary trends.

Market Bubbles

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The over expansion of a market due primarily to excessive buyer confidence resulting in inflated values. Real estate bubbles, when a burst occurs, can have significant negative impact on the overall economy.

These market bubbles are very problematic and lead to the misdirection of vital economic resources.

Business Cycles

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Recession

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Ultimately, such a market correction inflicts significant economic damage.
E.g. unemployment, large equity (value) losses, oversupply of products and services and financial hardship including foreclosures and powers of sale.

Law of Supply

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In a money economy, goods are exchanged for money and money for goods. The result of these exchanges is a redistribution of goods and money. In the real estate market, the process of exchange results in the production and allocation of properties according to the preferences of users in the marketplace and their financial capabilities. Thus, the real estate market functions to redistribute existing properties, cause an increase in the supply of new properties, determine the use of such properties and establish the value of those properties.

Law of Demand

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When demand is high, numerous building projects are often commenced. If the market changes and demand drops, the projects are completed anyway, adding to the oversupply. Because of the durability of real estate, the supply remains. On the other hand, when a sudden surge in demand occurs, no quick solution is available given the time required to plan, finance, develop and build.

A strong demand for housing typically is associated with periods of prosperity and increased employment. Given strong employment opportunities and rising wages, more new homeowners from the labour force are able to enter the market by buying their first home. In turn, existing homeowners now have the ability to move up by acquiring larger homes.

Scarcity creates demand.

Market Equilibrium

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Buyers should ultimately balance sellers in a perfect marketplace, but countless intervening factors make real estate cycles at best difficult to predict, at worst destructive.

When supply and demand find perfect balance

Interest Rates (Correction)

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Loans are based on the lender’s confidence in the borrower and the security that the borrower offers. Loans made on the security of real estate are no exception. Loans are only made when lenders feel that real estate is a sound investment, that properties acquired will retain their value and that the borrowers will earn sufficient sums to provide for repayment of the loans.

If interest rates are high, the real estate market is usually adversely affected as people tend to stay put in their existing housing accommodations. As debt is frequently a major component in a house purchase, any significant interest increase directly impacts the market. If interest rates are low, then mortgages become more affordable and consumers react accordingly.

Types of Markets

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Real estate markets are typically discussed in terms of three categories reflecting increasing demand, increasing supply or balanced supply/demand characteristics.

Seller's Market
In a seller’s market, the number of buyers wanting properties exceeds the supply. This type of market is characterized by properties that sell quickly, rising prices, many buyers looking and a minimal inventory available for sale. These characteristics have implications for the buyer, who has to make decisions quickly, must pay more and frequently has conditional offers rejected as the seller can demand a firm sale for his or her property. Often, sellers have the luxury of considering several offers and counter-offering for higher prices.

Buyer's Market
In a buyer’s market, the supply of properties on the market exceeds the demand. Characteristics of this market include longer selling periods for properties on the market, fewer buyers compared to properties available, higher inventory and stabilized or declining prices. The implications for the buyers in this type of market are more favourable negotiating leverage, more choice and the luxury of additional time in searching for just the right property.

Balanced Market

In a balanced market, the number of properties on the market equals the demand. The characteristics of this market include properties selling within a reasonable period of time, demand equalling supply, sellers accepting reasonable offers and prices generally stabilized. The atmosphere is usually more relaxed.

1. Bank of Canada Controlling Inflation

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If the total amount of currency circulating increases faster than the total value of goods and services in the economy, each individual piece will be able to buy a smaller portion of those things than before. This is called inflation.

2. Deflation

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On the other hand, if the money supply remained the same while more goods and services were produced, each dollar’s value would increase, in a process known as deflation.

3. Overconsumption

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So which is worse? Too much inflation means that the money in your wallet will be worth less tomorrow, making you want to spend it today. While this stimulates business, it also encourages overconsumption or hoarding commodities like food and fuel, raising their prices and leading to consumer shortages as well as more inflation.

4. Unemployment

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But deflation makes people want to hold on to their money. The decrease in consumer spending reduces business profits, which leads to more unemployment and a further decrease in spending, causing the economy to keep shrinking.

So many economists believe that while too much of either is dangerous, a small consistent amount of inflation is necessary to encourage economic growth.

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Market Correction after a 2016 Real Estate Frenzy

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Conclusion

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The Real Estate Market affects the overall health of the economy as a whole. They are closely related by economic indicators such as GDP, employment rates, manufacturing activity and inflation rates. As a correlation, when the economy is slow, so is the real estate market. Interest rates have a major impact on the market and changes in rates can greatly influence a consumer's ability to purchase a home. The government uses the Canadian Mortgage and Housing Corporation to regulate the market by controlling the Supply and Demand of the real estate market. This padlet introduced some of the higher-level factors that play a significant role in moving the market, but there are also more complex parts that come into play. I hope this comprehensive evaluation gave you an understanding over the key factors that drive real estate and inspire you to look into some potential investments!

- Ramon O'

McGill Bibliography

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Real Estate Council of Ontario, RECO. Real Estate As a Professional Career, ed (Don Mills, Ont.: Ontario Real Estate Association, 2015).

Fallis, G. (1985) Housing Economics, Butterworth, Toronto, 1985.

Levinson, Doug. “What gives a dollar bill its value?”, online: TED-Ed

O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey: Pearson Prentice Hall.

Nguyen, Joseph. “4 Key Factors That Drive the Real Estate Market”, (12 March 2019), online: Investopedia

Smith, Charles Emrys, "Economic Indicators", in Wankel, C. (ed.) Encyclopedia of Business in Today's World (2009). California, USA.