What May Trigger House Property Value Appreciation?
House property value apprection, within a free economy is caused by the interaction of demand and supply. The important thing to keep in mind is that when the demand-supply balance is disturbed, house rents and prices start moving accordingly in order to bring the market back into balance.
If we assume the market begins from a point at which the number of houses demanded is equal to the number of houses supplied, prices should be stable. Economists describe this situation as the market being at equilibrium. At this point, there is no house property value appreciation in the market since home prices remain stable. If this balance is disturbed, either in favor of demand or in favor of supply, home prices should start moving. In particular, if demand becomes greater than supply (due to non-price factors) then home prices have to rise in order to force enough buyers to drop out of the market and enough suppliers to enter the market so that the number of homes demanded equals the number of homes supplied. These are exactly the market conditions that trigger house property value appreciation. Similarly, if supply decreases while demand remains constant, there will be excess demand, which will again force property values and rents to rise. However, because of the durability of real estate, sudden decreases of an area’s property inventory cannot occur in the normal course of events. An area’s inventory of properties, however, may decline gradually if the amount of space build is smaller than the amount of space that “drops out” of the market due to physical deterioration and functional obsolescence.
If supply increases while demand remains constant, or if demand decreases while supply remains constant, there will be excess supply, which will force house values to fall in order to induce enough suppliers to drop out of the market and enough house buyers to enter the market. Obviously these are not the market conditions that trigger house property value appreciation and, therefore, should be avoided by property investors. Based on this discussion, we can identify the two broad principles of house property value appreciation, assuming that the market is in equilibrium (demand equals supply): 1) An increase in the demand for houses while supply remains constant 2) A decrease in the supply of houses while demand remains constant To better understand the first principle of house property value appreciation, consider a nice residential community, called Paradise, with few vacant housing units and limited development under way, due to zoning con-trols. If, for some reason, demand for housing suddenly increases considerably so that the existing vacant units are far from adequate to cover it, housing rents and prices in Paradise will register strong increases, and therefore trigger house property value appreciation in the market. Demand for housing in Paradise may increase considerably, due to a number of reasons, such as intensive office development in a nearby community, which brings a great number of new white-collar employees to the area. Since there is a tendency for people to seek housing close to their workplace, it is logical to assume that many of these new employees will seek housing in Paradise too. An important characteristic of the supply of real estate, which explains why short-run increases in prices/rents can be very strong in response to a strong increase in demand, is the construction lag, that is, the lag between the time a real estate project is perceived and the time it comes out in the market. This lag, which is due to the time needed to complete necessary studies, design, secure financing, get permits, and build a project, ranges from one to many years, depending on the size and nature of the development. This characteristic is very important, because if demand suddenly increases considerably, supply will not be able to respond immediately, unless lots of new buildings are about to be completed and enter the market. This is not very likely, however, if the demand increase is sudden or considerably greater than usual. As a result of the supply’s inability to respond quickly to changing market conditions, a strong increase in demand will originally create supply shortages, which will force increase in house prices, at least in the short-run. Because of the inertia/rigidity of supply, strong demand increases can trigger strong rent/price increases as long as the market is not oversupplied. However, as new supply starts to come out gradually, rent and price growth should decelerate, unless demand keeps rising faster than supply. As we have seen in the discussion of the cyclical behavior of the real estate market, house property value appreciation takes place only for a few years when the market comes out of the downturn, but after that, rent and price growth decelerates and turns negative eventually, due to a combination of strong supply growth and a slowdown in demand growth.
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