Microeconomics 101 for Real Estate

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Basic Concept of Supply and Demand:

One of the most useful classes I took in college and graduate schools was Microeconomics. I love economics theory – so elegant. Economics make sense to me.  At the core of market pricing, there is a concept called supply and demand. How much supply is there in the market place plotted on a graph against price on Y-axis and quantity on the X-axis? How much demand is there in the market place plotted against the same graph? In this theoretical exercise, the Supply curve and the Demand curve intersect and meet within the graph that determines the theoretical price. Simplistically, the following theoretical conclusions can be made:

a)    Supply goes up (Demand remains the same), pricing decreases

b)   Supply goes down (Demand remains the same), pricing increases

c)    Demand rises (Supply remains the same), pricing increases

d)   Demand goes down (Supply remains the same), pricing decreases

TrimTabs Investment Research:

Many years ago, I came across a very interesting investment research and data firm called TrimTabs Investment Research that also runs an ETF and formerly a hedge fund. They have been in existence for over 20 years. Most consumers have never heard of them, yet the largest hedge funds in the world pay 5 to 6 figures annual subscription fee to get access to their specialized research and data which they use to help with their investment strategies. Additionally, several years ago, Goldman Sachs even bought a minority stake in them. The TrimTabs premise is that the stock price movement is as much a function of the supply of float in the market combined with the demand side indicators such as money flows of mutual funds, ETFs and hedge funds, than any other more traditional stock valuation methodologies. Through their proprietary data collection and measurement tools of both the supply side and demand side indicators they conduct data analysis and then put forth bearish or bullish calls for the US market, sectors, and international markets.  See http://trimtabs.com/global/liquiditytheory.htm for more information. Certainly, this isn’t foolproof all the time, but this theory makes sense to me and I certainly believe supply and demand factors contribute to stock market movements.

Real Estate Supply and Demand in the Bay Area:

It appears that the Bay Area (and other key markets around the US) is being impacted by the ‘imbalance’ of supply and demand contributing to the phenomenon of a rapidly appreciating real estate market. Providing some feedback at a rudimentary level:

Demand:

In the mid-Peninsula, in cities which include San Carlos, Belmont, Burlingame, San Mateo, Redwood City, Millbrae, Foster City, Redwood Shores and Menlo Park, you will read about the strength of the economy and how much wealth there is to purchase property and thus driving up price. All of those aspects are directionally true. After a few years of slow demand where people were not feeling as confident about the economy, their job situation, their stock option value, or trend of real estate prices, the last couple years it seems people are feeling good about many of those items. The stock prices have risen precipitously such that there is higher value in stock portfolios or in employee stock option grants. High technology is doing well and lots of start ups abound and growing. Formerly underwater houses have recovered such that equity available for down payments on new houses. But also, as prices have really increased in the past two years, there is now a fear for new homebuyers, investors or move-up buyers that if they don’t lock in and purchase a new house now, that in another year or two, prices will continue to appreciate thus either pricing them out of the market or having to purchase a less desirable property in the near future. Demand appears good.

Supply:

A major driver that seems to be impacting the degree in ramp up of prices is the lower supply of property available in the market. So good demand + lower supply = higher increases in price.  In San Mateo county and Santa Clara county, the heart of Silicon Valley, there is very little land to build new houses/condos. Land is extremely expensive which includes land that currently has an old house on it (“tear down”). New construction appears to be increasing in select pockets, but again, there is limited supply of available land. However, for several years, new construction virtually stopped so there was no new pipeline of new properties in up until recently.

Additionally, supply of homes relies of existing owners selling their current house. Certainly, there are sellers, but it’s clear that buyers outnumber sellers. I have my hypothesis on why sellers have been more hesitant to sell, but I’ll save that for another post.

Open Questions:

In the meantime, what does this mean for current buyers looking to participate in the real estate market? What is your prediction on future demand for property? When do you think the supply side issues will loosen? And how might the recent uptick in interest rates affect supply and demand?

2 thoughts on “Microeconomics 101 for Real Estate

  1. Pingback: Why Belmont Housing is Hot | Tao Silicon Valley

  2. Pingback: Huge 2019 San Francisco IPO Pipeline…. Speculations Abound on Impact to Real Estate Prices! | Tao Silicon Valley Real Estate

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