BLOG

As many of you who know me know, I have split my seven year real estate career in half.  In the middle I earned my Bachelor of Commerce from the Peter B. Gustavson School of Business, at the University of Victoria.  Prior to my formal business education, I already found myself fascinated with markets - especially real estate markets.  Looking back, what I find most interesting about my quest to understand markets, is that the more detailed knowledge I obtain, the more I realize that the simple fundamentals are often enough to understand what is happening in your market.    

One of the very first principles that you learn when studying economics and finance is Supply and Demand.  For me, the laws of Supply and Demand are the most useful tools for making sense of real estate markets.  Put simply, when the demand for real estate increases, and the supply of real estate for sales remains unchanged, prices will increase as will the number of units sold.  However, when the supply of real estate for sale increases, and the demand for real estate remains unchanged, prices will decrease as will the number of units sold.  In a nut shell, this is all you need to know about markets, to make sense of your own.  In economics there are nearly an infinite number of variables that effect change - but I would argue that for our purposes we can ignore them and focus only on Supply and Demand.  The reason is that while all these variables do effect the market, they effect it through changes in Supply and Demand.  For example, if interest rates increase how does this affect the market?  Less people will be  able to afford to buy, demand will decrease, and prices will begin drop.   

In real estate markets demand is easy to measure - it is the number of units sold over a period of time.  Supply is equally easy, it is the number of units for sale over the same period of time.  One financial tool that can be used to make sense of the Supply and Demand question is the Inventory Turnover Ratio.  Inventory Turnover Ratio = Sales / Listings.  A low turnover implies poor sales and, therefore, excess inventory.  In other words Supply is high relative to Demand.  A high ratio implies strong sales, or in other words Demand is high relative to Supply .

Another interesting aspect of this discussion is market efficiency.  A perfectly efficient market is one in which price is perfectly represented by the available information.  If demand suddenly increase, price will quickly increase.  I would argue that real estate markets are far from efficient - especially the resale market.  In this case each unit is not identical, and the homeowners often attach emotional value to their properties.  This causes inefficiency.  In this case, if supply suddenly increases, price will not fall immediately (due to emotions effecting business judgement).  You just don't get the same level of emotional involvement in the lettuce market... From my perspective this means that studying Supply and Demand numbers for your own market will be extra beneficial, because the inefficiency creates a time lag between the change in Supply or Demand, and the inevitable change in price.    

As I stated in the beginning.  This topic fascinates me and I could write about it for days.  But, I believe the above information is all YOU need to start YOUR quest towards understanding YOUR market.  Let me know what you think?