Flashcards in Chapter 15: The Real Estate Market and Analysis Deck (82)
Free enterprise system
The free enterprise system is an economic system that both produces and distributes goods and services by the application of the four factors of production. The four factors of production are land, labor, capital, and entrepreneurial ability. Memory device: “CELL”.
Entrepreneurial ability refers to the risk taking and management component of production. No good or service can be delivered to the market without the application of combination of these four factors.
What are the three questions that must always be answered with regard to the production and distribution of goods or services?
1. What is to be produced?
2. Who will do the producing?
3. Who will get what is produced?
The answer to these questions is found in the relationship between production, distribution, and demand.
The question “What will be produced?” is not easily answered. Resources are limited, while demand is not. The number and variety of products and services that could be offered is virtually unlimited. The decision to produce an item or provide a service often meets with failure as a result.
Those who are willing to risk their time, expertise, and finances in order to assume the risk are the only ones who can answer the question “Who will do the producing?”
The price mechanism answers the question “Who will get what is produced?” The conflict between limited resources and unlimited demand can be solved by the price at which a product or service is offered to the market. As demand continues, price rises at an ever-increasing rate until those unwilling to pay the price withdraw from the market.
Under the free enterprise system, in which real estate is bought and sold, products and services are produced based on the price at which they can be sold profitably. Inefficient suppliers and producers will not be able to compete, and the risk they assumed will not be rewarded.
A market is anywhere a buyer and a seller can interact to conclude a transaction. The prices of items or services create different levels of competition, referred to as stratified demand. Obviously, the seller of a $500,000 home is not in competition with the seller of a $100,000 home.
is the amount that is actually paid for an item. It should be distinguished from an asking price or the cost to produce the item. Neither the asking price nor the cost to produce the item controls the ultimate price that will be paid in the market. It is the buyer that ultimately decides whether or not a sale will occur.
Government- Controlled Economies
The free enterprise system is an open system in which anyone can participate. In contrast to the free enterprise system, some nations operate under a government-controlled system. Land is not privately owned. Government decision makers control the money supply and determine the employment offered to citizens. The government determines what products and services will be produced and who will be able to purchase them.
What do government-controlled systems lack?
Government-controlled systems lack the flexibility that is needed to produce the products that consumers typically demand. In a free society, the entrepreneur replaces the government decision maker that is present in a government-controlled system.
is the quantity of an item that is available, or anticipated to be available, for sale.
Price in the real estate market
is a function of the number of items available in relation to the number of items in demand.
Supply and demand in the real estate market
If the supply for a desired product decreases relative to demand, the price increased. At the higher price, fewer buyers may be willing or able to purchase the product and demand will fall. As demand falls, suppliers may be forced lower prices to attract interested buyers.
Factors affecting supply
1. Availability of skilled labor
2. Availability of land
3. Increased productivity
4. Availability of construction loans & financing
5. Availability of Materials
Availability of skilled labor
a decrease in the availability of skilled labor can increase labor costs and drive up the cost of new construction to the point where new construction prices are prohibitive. Supply would be reduced since builders would be hesitant to build in fear of not being able to sell the finished product.
Availability of land
a shortage in the supply of available land can drive up the cost of acquiring land for new development.
through the application of new technology, builders are able to make more efficient use of labor. Builders can sometimes offset increased costs by better use of materials and labor. Increased productivity can result in an increase in supply.
Availability of construction loans & financing
as interest rates on construction loans rise, the cost of borrowing money escalates and builders’ costs increase. Excessively high interest rates make new construction expensive and the finished product unable to compete for buyers with existing properties.
Availability of Materials
a decrease in the availability of materials can increase the cost of materials, and drive up the builders’ costs. This results in higher finished costs and may make new construction too expensive for buyers who wish to enter the market.
Measurements to track the supply of real estate includes the following:
• The number of vacant properties that are available for sale (vacancy rate)
• The number of properties that are currently under construction, but not completed.
• Properties that have been permitted, but are not under construction.
• Projects that have been announced, but not permitted.
Tracking the number of permits
Tracking the number of permits that are being issued is a rather basic, but effective way to discern trends in market changes as well as changes in supply.
There are both short- and long-term considerations
when measuring supply. Obviously, properties that are currently available for sale represent the supply available today. However, properties that are under construction will become available in the near future. Developers who have obtained permits have already made significant investments and will likely go forward with their projects. These projects will come into the market within a relatively short time and must be considered as part of the supply. Projects that have been announced, but not permitted, may or may not be constructed, but must be considered in light of current and anticipated supply and demand relationships.
Supply may increase or decrease as a result of?
Supply may increase or decrease as a result of new construction, conversion from other uses, or the action of sellers in deciding whether or not to sell. Conversion from other uses is the change of a property from one type of use to another type of use, such as a factory that is converted to apartments.
Change in supply takes time
Changes in supply occur over a relatively long time since construction is a time-consuming process. Even though an individual house may be physically constructed in a few months, the entire process includes a site selection and acquisition, planning, permitting, financing, coordination of labor and materials, and finally, construction. The entire process can take one to two years and even longer for major projects.
Net Household Formations
The basic measure of demand for residential real estate is net household formations, which is the net difference between the number of households expected to be created within a given period-of-time and the number of households expected to be eliminated during the same period of time.
The U.S. Bureau of the Census defines a household as, “a living unit.” A single person who lives alone in an apartment is considered to be a household. Three generations of a family who share a farm home is also considered to be a household. Therefore, net household formation is a measure of living units, not population.
Factors of Demand
5. Consumer Preferences
price is principally the result of the interaction of material and labor costs. Demand will typically decrease as prices rise. Price and demand are inversely related.
as population grows, so does demand. Population and demand are positively related.
as credit becomes more readily available and interest rates go down, demand increases. Credit and demand are positively related. The availability of credit is a key market indicator, and is said to be the barometer of the real estate market.
demand is influenced by income. Effective demand is the combination of a potential buyer’s desire for an item that is coupled with the ability to pay for the item. Demand is not created until both components are present. As income increases, so does demand; income and demand are positively related.