Overview of real estate markets
The main participants in real estate markets are:
Owner/User: These people are both owners and tenants. They purchase houses as an investment and also to live in.
Owner: These people are pure investors. They do not consume the real estate that they purchase. Typically they rent out the property to someone else.
Renter: These people are pure consumers.
Developers: These people prepare raw land for building which results in new product for the market.
Renovators: These people supply refurbished buildings to the market.
Facilitators: This includes banks, real estate brokers, lawyers, and others that facilitate the purchase and sale of real estate.
The owner/user, owner, and renter comprise the demand side of the market, while the developers and renovators comprise the supply side. In order to apply simple supply and demand analysis to real estate markets a number of modification need to be made to standard microeconomic assumptions and procedures. In particular, the unique characteristics of the real estate market must be accommodated. These characteristics include:
Durability
Real estate is durable. A building can last for decades or even centuries, and the land underneath it is practically indestructible. Because of this, real estate markets are modeled as a stock/flow market. About 98% of supply consists of the stock of existing houses, while about 2% consists of the flow of new development. The stock of real estate supply in any period, is determined by the existing stock in the previous period, the rate of deterioration of the existing stock, the rate of renovation of the existing stock, and the flow of new development in the current period. The effect of real estate market adjustments tend to be mitigated by the relatively large stock of existing buildings.
Heterogeneous
Every piece of real estate is unique, in terms of its location, in terms of the building, and in terms of its financing. This makes pricing difficult, increases search costs, creates information asymmetry and greatly restricts substitutability. To get around this problem economists (beginning with Muth (1960) define supply in terms of service units, that is, any physical unit can be deconstructed into the services that it provides.
High Transaction Costs
Buying and/or moving into a home cost much more than most types of transactions. These costs include search costs, real estate fees, moving costs, legal fees, land transfer taxes, and deed registration fees. Transaction costs for the seller typically range between 8 - 10 % of the purchase price.
Both an Investment Good and a Consumption Good
Real estate can be purchased with the expectation of attaining a return (an investment good), or with the intention of using it (a consumption good), or both. These functions can be separated (with market participants concentrating on one or the other function) or can be combined (in the case of the person that lives in a house that they own). This dual nature of the good means that it is not uncommon for people to over-invest in real estate, that is, to invest more money in an asset than it is worth on the open market.
Immobility
Real estate is locationaly immobile. Consumers come to the good rather than the good going to the consumer. Because of this, there can be no physical market-place. This spatial fixity means that market adjustment must occur by people moving to dwelling units, rather than the movement of the goods. For example, if tastes change and more people demand suburban houses, people must find housing in the suburbs, because it is impossible to bring their existing house to the suburb.
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