Understanding the determinants of house prices is very important for investors in residential real estate. Such an understanding is crucial for assessing the potential impact of changes in local market conditions on house prices.
The determinants of house prices include factors that drive the demand for and supply of housing.
The major drivers of housing demand are:
• Household formation/population- Higher population and number of households results in higher demand for houses.
• Income - Higher income allows individuals living with parents or with roommates to form their own household.
• Interest rates – Higher interest rates increase the cost of financing and discourage house purchase decisions.
• Availability of mortgage financing – Limited availability of mortgage financing prevents many households from purchasing a house.
• Price growth expectations – Expectations of rising house prices motivate households planning to become homeowners to purchase a house earlier than later.
The determinants of house prices on the supply side are equally important. The effect of these factors though on house prices appears with a significant time lag due to the long time that it takes to plan and deliver a completed housing unit or apartment building.
The major drivers of housing supply are:
House prices – All else being equal, higher house prices increase developer profits and motivate them to build more houses.
Construction costs – Higher construction costs reduce developer profits and discourage them from building more houses.
Availability of financing – Reduced availability of financing for housing development projects reduces the supply of new housing.
A very good presentation and detailed discussion of the determinants of house prices and housing market dynamics can be found in the book Urban Economics and Real Estate Markets.
