This is a 3 part series blog post on the housing economy. This is the first of the series of articles.
One of my objectives in this blog is to educate my readers on how to read economic indicators to assess a market. I am no economist and certainly not an expert, but I want to get my readers thinking in a certain framework to assess the situation. In this case, a particular market that I have tracked and followed very closely that I believe is a relevant one in personal finance – is the housing economy. A strong word of caution though – there is no such thing as a global or national housing economy. Housing is local – so every local economy has its own drivers. But as I said, I aim to provide you with some understanding so as to help you assess your own local economy or whichever local market you choose. Also, this article really focuses on the residential housing economy.
Why do I care about this?
If you are not asking this question, you should be. Why do I need an Econ 101 lesson on demand and supply on the housing market? Because housing is the single biggest personal investment (whether its your own home or investing in rental properties) that you will make. While I am not advocating timing the market in terms of housing purchases, it is prudent to know the cycles of housing as well as how to think about what drives the housing market so you can make better decisions.
The law of Demand and Supply
Before you start rolling your eyes and start worrying that I am taking you back to your econ classes, bear with me. I want to get some basics straight for everyone. Let’s start with the famous and golden law of demand and supply. This was an economic theory developed by the famous economist Adam Smith back in the day.
Simply put, what this is says is this – when demand goes up, prices increase (because more people are competing for buying the product) and vice-versa. When supply goes up, prices decrease (because there is more supply of the products giving buyers more options), and vice versa. The intersection of demand and supply fundamentally determines the price in the market. Visually, this is how this is represented:
You can read more about basics of demand and supply here in this Investopedia article.
The demand side for housing
Let’s ask the basic question now – what drives demand for housing? Well, that’s a very broad question. There are a whole host of factors. But I like to break it down to a few basic ones. There are longer term factors and short-term factors.
Longer term factors include:
- Demographic trends – is the population of the local market increasing or decreasing? An increasing population in a local area will clearly indicate higher demand. The other is the mix of age of the population. For eg. Across the US, there is an increasing aging population that has given rise to several senior living homes. There is also an increasing number of younger generation looking to buy their first homes now. So there is a strong demand for ‘starter’ homes in the US.
- Diversity of the economy – is the local market tied to a smaller group of employers/industry segments or has a diverse group of employers/industry segments? A major metro area that has a broad group of companies and industries tends to have less risk for demand compared to a smaller town or metro area that is heavily dependent on one or two employers or one segment. Now, higher risk does not mean lower demand – it just means there is an expectation of some level of volatility of demand. For eg. in the US, cities across the ‘rust belt’ that were heavily tied to the automotive, steel, coal industries took a beating when these industries moved offshore or demand reduced over time. The San Francisco Bay Area is home primarily to tech companies and when there is a ‘tech-recession’, the housing market suffers there and of course, the bay areas has been a benficiary for many years to the tech boom and has some of the most expensive and unaffordable homes in the planet today.
Short term factors include:
- Interest rates – the reason interest rates are a big deal because almost everyone typically buys a home through a mortgage and when interest rates go up, mortgages become more expensive and vice versa. During the past decade leading up the pandemic, we had an era of low mortgage rates in most parts of the world making it very cheap to borrow. This has a huge effect on demand. The reason I call this short term is because as we have been observing at the time of writing this article in Mar 2023, within less than 9 months, the Federal Reserve in the US and other central banks around the world have been increasing interest rates causing the demand to cool down a bit. So, this can happen very quickly.
- The broader state of the local economy – overall, the GDP and the unemployment rate at a given point in time will have an impact on the economy and therefore the buying power of the individuals.
So to summarize, you can measure and track the below key economic indicators (for the local market) to assess demand:
- Population growth
- Number of industries and companies in the local market
- Interest rates
- GDP
- Unemployment rate
Btw, these are by no means exhaustive or the only indicators to look for. They are probably the most common and basic indicators. You can go crazy looking at a whole host of indicators but for the average person, just understanding the above is sufficient in my opinion, unless there is something very unique about the specific market you are looking at.
Thank you for reading and please ensure to read the next 2 parts of this article in the coming weeks because the story does not end with the demand side picture.
Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.
