How is a real estate market formed?
A real estate market is formed when multiple people place similar levels of importance on the ‘factors of value’ – utility, desire, scarcity, and effective purchasing power/willingness to pay.
In a previous article and video seen here, it was demonstrated that a buyer needs to see four factors of value (utility, desire, scarcity, and effective purchasing power/willingness to pay) in order for the product or service to have a monetary value.
It therefore stands to reason that a real estate market is formed when multiple people share high levels of utility, desire, scarcity, and effective purchasing power/willingness to pay, for the property. Ultimately, at a property auction, the property is sold to the bidder who places the most importance on the factors of value.
As explained, people place similar levels of importance on the ‘factors of value’ when bidding on a property. However, this doesn’t mean they see the same reasons for wanting it.
As an example, take two bidders at an auction, one bidder sees the property as an investment opportunity. The other sees it as their family home. Both these bidders see different uses (utility), but share similar levels of desire.
The ‘factors of value’ have much to do with supply and demand and what our minds believe and how we’re influenced. This is why understanding a real estate market is such a mixture of art and science.
Why do real estate markets never reach equilibrium?
Real estate markets are inefficient. This is due to many reasons including the following:
- Property is immovable, heterogeneous, illiquid, and has limited essential information available to buyers for markets all over the country.
- Property has many Government restrictions and barriers to entry.
- Property has large timeframes to produce, and ownership is held for years.
For these reasons real estate markets are relatively inefficient and difficult to value. Also, there is an ability to influence price which regularly stops markets from reaching equilibrium, and limits Adam Smiths ‘invisible hand’ theory for free trading markets.
Because of these inefficiencies, real estate markets are imperfect and can favour people who have solid understanding of what’s happening at ground level.
Trading shares is more the opposite, it’s considered an efficient market with all necessary information available to investors.
In consideration of the number of property markets around the country, one way to understand and track these inefficient markets is through data. Data provides a window into what happened, what’s currently happening, and what’s likely to occur in the short term.
What are the demand and supply factors that create monetary value? A product or service must have utility, desire, scarcity, and effective purchasing power to have a monetary...
In part 1 we learned what scarcity is and its relationship with utility. We also learned why scarcity has an influence on both land and the improvements e.g. a house.