Microeconomics and Property Market - Assignment Example

"Microeconomics and Property Market" I. Introduction A. Microeconomics can be applied to all types of markets including property market B. Property market is a system to buy and sell land and buildings C. The real estate or property market is based on local, and, in many cases, micro-local economies II. Body A. Property Market and Microeconomics 1. Market analysis is important for real estate investment 2. Ricardian land rent theory can be used for real estate analysis 3. Understanding the factors affecting supply and demand of property is crucial 4. Buyers and sellers interact to set price of a property 5. Supply of land is often inelastic III. Conclusion A. Microeconomic concepts help in finding a better property B. Demand and supply concepts help in buying a property before a rise in price C. Other factors including some macroeconomic concepts should also be considered for better investment Microeconomics and Property Market Introduction: Microeconomics is all about considering the micro aspects of the economy. It considers questions such as: how is it decided, and how should it be decided, what enterprises should operate; what goods and services should be produced; what techniques of production should be used; at what prices should goods be sold, or on what terms should they be given away; and how should incomes be distributed amongst the members of society (Black, 2002)? This is the basic definition of microeconomics but you can apply it to many types of markets, including the real estate or property market. Property market is basically the system by which land and buildings are bought and sold. There is no central institution for this market, which works through an informal network of estate agents and other specialized intermediaries. The property market is extremely imperfect, as every property is different in location, and properties in close proximity differ in several characteristics. These include: the type of buildings on them and their condition; access to transport facilities; and amenity aspects, such as proximity to either sources of pollution such as rubbish dumps or sources of pleasure such as parks. Also, most individuals move fairly seldom, owing to high costs of movement, and firms move even more seldom. Thus most buyers and sellers have little recent experience of the market, and most properties are not available to be traded at any point in time. Property prices are thus subject to large fluctuations (Black, 2002). As there are several fluctuations involved in property market, it is important to use some sort of a system to predict these changes in prices, supply and demand. That’s exactly the point where microeconomics lends a helping hand. Here, it is worth mentioning that when people speak of the real estate economy, they are using nationally-based statistics. For example, Fortune magazine reported recently that since the early 1960s, average residential real estate values have never had a down year. This statement is true. But while these numbers are measurable, they do not reflect the intricacies of local real estate markets. The stock market is based on the national, even the world economy. The real estate market is based on local, and, in many cases, micro-local economies. Whats happening in Los Angeles does not directly affect whats happening in Toledo (Bronchick). That’s exactly the reason why you can make use of certain microeconomic principles to understand the current condition of the real estate or property market in a particular area. In this assignment, I will talk about those specific microeconomic concepts that are directly related to real estate market. The effects of knowing those concepts will also be discussed in this assignment along with making a conclusion about the use of those theories and factors at the time of investing in a property. Property market and microeconomics: There is nothing to emphasize the importance of analyzing market trends and situations before making an investment. Same thing holds true for property market. In fact the importance of knowing everything about the real estate or property market of a specific area has reached to zenith because of the “bubble” theory of real estate. This theory implies that real estate market is going to burst in near future. Though many experts don’t believe it but you will still be better off conducting a research on your own. Although different types of theories, methods, procedures and strategies can be used to determine the profitability of your investment decision but you should always start from micro level. First off, one of the most important microeconomic theories to keep in mind is about the rent, i.e. Ricardian land rent theory. This theory is all about checking the difference between the productivity of lands. According to this particular theory, the most productive land will have the highest rent. The next productive land will have the rent equals to the most productive land but the amount of investment required to bring this land up to the level of the most productive land has to be deducted from this rent. This theory is still considered to be the most important theory for real estate appraisal. Although you can make use of this theory to get some idea about the value of land around the property that you want to buy but you must keep in mind that this theory is not perfect in the sense that it doesn’t take the importance of location into account. Apart from paying attention to this particular theory, it is also essential to spend some time in understanding the supply and demand of properties. When you will delve more into the details, you will find that prices are determined in local and regional markets, which means that microeconomics has a role to play in determining the demand and supply of property and housing market. Just like other markets, buyers and sellers interact in real estate market while paying attention to the price of properties. But, the value of a property is determined through different demand and supply side factors that have to be considered at the time of making a purchase. It is quite understandable that if there will be a shortage of good properties in any area, the demand will go up. In such circumstances, you will see sellers to lead the market. It is so because excess demand will be there in the market and sellers will prefer waiting before finding a buyer offering a price higher than their minimum selling price. On the other hand, when there will be no shortage of properties in a market, the price will go down because of lower demand and greater supply. In this situation, the buyers will have the upper hand because sellers will prefer selling their properties at a price offered by buyers. Now, it is easy to see that demand and supply can create a huge impact on price but if you will keep an eye on this fluctuation you will always be able to make a better decision about buying a property. For instance, demand for properties will go up if there will be an increase in the population. What it means is that by paying attention to the inflow of people to a specific area you can predict that there will be an increase in demand, resulting in a rise in price of properties. But, it is significant to mention that supply is least elastic, and price appreciation potentially greatest, in metropolitan areas where available land is in worse locations than existing housing. Across US metropolitan areas, home price appreciation between 1980 and 2008 is highly correlated with the within-metropolitan relationship between age of housing stock and land rents, as measured by either hotel room prices in 2008 or apartment rents in 1980. The relationship between this land rent gradient and home price appreciation is stronger where predicted employment growth based on 1980 SIC code shares is greater (Davidoff, 2008). Moreover, the supply is often supposed to be inelastic because the time lags present between the change in price and the availability of new properties. But, when demand shifts outwards and supply is inelastic the result is a large rise in market price and a relatively small expansion of the quantity of houses traded. As supply becomes more elastic over time, assuming the conditions of demand remain unchanged, we expect to see downward pressure on prices and a further increase in the equilibrium quantity of houses bought and sold (Demand and Supply for Housing). Following diagram (from Tutor2u) gives a better idea in this regard. Conclusion: The entire assignment is based on the fact that microeconomic principles and concepts have an impact on property market and if you will implant those concepts in a better way then you will end up making a better buying decision. If you will combine land rent theory to judge the value of neighborhood properties with demand and supply theory, you will surely be able to find a better property to invest in. However, it is crucial to point out that though it is fact that using aforementioned concepts will help you to determine the value of properties in a particular area but you must always bear this in mind that there are many other factors affecting the value and price of a property. For instance, growth of real incomes, consumer confidence, expectations of change in price in near future, change in housing taxes and many other macroeconomic factors can determine the value and the profitability of a property purchased by you. It is fact that many of the richest people in the world have earned their wealth through real estate. Thats why real estate investing is touted as the avenue to riches, but while it is estimated that 80 percent of the worlds wealth is held in real estate it is owned by a very small percentage of the population -- less than 20 percent, according to a new book on real estate (Chongchua, 2006). So, if anyone wants to be amongst them, he needs to pay attention to all important factors to make a rational decision. References: Demand and Supply for Housing. Tutor2u. 1 May. 2009. Website: http://tutor2u.net/economics/content/topics/housing/housing_demand_supply.htm JOHN BLACK. "microeconomics." A Dictionary of Economics. 2002. HighBeam Research. 30 Apr. 2009 . JOHN BLACK. "property market." A Dictionary of Economics. 2002. HighBeam Research. 30 Apr. 2009 . P. Chongchua. Making Millions through Real Estate. 2006. Reality Times. 1 May. 2009. Website: http://realtytimes.com/rtpages/20060313_millions.htm T.Davidoff. Housing Supply is Inelastic Where Location Matters. 2008. Hass School of Business. 1 May. 2009. W. Bronchick. Real Estate Bubble Theory is Full of Hot Air. 1 May. 2009. Website: http://www.creonline.com/articles/art-289.html Read More