How House Prices Are Determined (Part 1)

If you are familiar with the factors that affect the price of residential property, you will have an advantage over the typical investor and can proceed to benefit from that knowledge. Also, note that the same force applies in the housing market that influences virtually all of our purchases—the law of supply and demand.

An example to consider
To clarify, think of two kinds of property, such as a small apartment in the Central Business District (CBD) and a house by the sea. While the demand for sea-front property is high, the supply is also somewhat limited, and that forces prices to go up. At the same time, the demand for apartments in the CBD may not be as great, and consequently, rents will go down.

 

Source of the demand
Those who invest in residential property create the demand for it, and that in turn is influenced by the current economic climate, action taken by the government, demographics, the opportunities for capital growth, and the returns consumers realize on their other investments.

Traditionally, interest rates have a tremendous affect on our purchasing decisions. As a rule, when they rise, people are less inclined to invest, and when they go down, they often decide to seize the opportunity and buy a home.

Two apparent contradictions
Toward the end of 2007 through early 2008, interest rates and the prices for residential property were high, but the demand for it held steady. Also, interest rates have declined by about 4% since March of 2008, but housing prices have only fallen slightly, even though the demand for homes has decreased significantly. This is puzzling at first glance, but there is a logical explanation for the apparent paradox.

The last so-called “mini-boom” peaked toward the end of 2007 through early 2008, and although interest rates rose, consumer confidence remained high for several months. Then, interest rates rose again in March, and housing prices are still feeling the effects of that devastating increase.

Action taken by the government
As a counter measure, the Reserve Bank of Australia proceeded to lower the cash rate by 4.25%. At the same time, consumer and commercial confidence declined sharply as a result of the Global Financial Crisis (GFC), and this has had a greater effect on the behaviour of investors than the lowering of interest rates. Once the state of the global economy begins to improve, financial authorities feel that the demand for homes will also increase, and prices will go up once again.

Today’s global economy
If financiers decided to assign grades to world economies right now, every other country would be given a D+, and Australia would squeak by with the C-. There are some indications that things are improving slightly, and Australia seems to be one step ahead of the rest.

Encouraging the purchase of real estate
The need for job creation has the most influence in regard to buying property, and it is having a major negative affect that lowering interest rates cannot offset. The decision to purchase a home is also influenced by what consumers earn and how much disposable income they have. If employee wages go up, they are more inclined to buy property, which increases the demand and causes prices to rise. Also, when consumers have more disposable income, perhaps as the result of tax cuts, they may even consider buying investment and holiday homes.

The demand for residential property is certain to grow again when the unemployment rate peaks, and then begins to fall. This is a key indicator, and you will want to pay attention when unemployment statistics are released, especially if economists report that “the unemployment situation is not expected to improve for several months.”

Continued (Part 2) >>>