How Does the Housing Market Work?

If you’ve bought or rented a home before, you most likely understand how the housing market works. But this topic is important enough to have a quick refresher on, and if you’ve never taken the time to understand it, now is the perfect time to learn. Today, we will look at a few economic principles and terms and then apply them to the housing market. By the end of this blog, you should have a good understanding of how the housing market fluctuates and how those changes affect you as a homebuyer or seller.

The Law of Supply and Demand

In economics, there’s a principle named the Law of Supply and Demand. Supply refers to the number of products available to buyers, and demand refers to the number of buyers attempting to get a specific product. Suppliers, or those selling the product, typically want to sell their product for the highest price the market will tolerate. Buyers understandably will look for the cheapest option available and may decide that the product's price is too high for the value it would bring them. Because of the seller’s and buyer’s natural tension, the Law of Supply and Demand states that supply and demand are inversely related. So, when supply is high, demand is low, and when supply is low, demand is high. This sounds very technical, so let’s look at an example to illustrate this concept.

Pretend I, the supplier, have a pizza shop that usually sells pizzas (the product) for $10. One day, there’s a cheese shortage, and I can only make half as many pizzas as I normally do. This means I can’t feed all my regular customers, so what should I do when people demand pizza? If I want to limit the number of people wishing for pizza (and therefore make my situation less overwhelming), I should raise my pizza price to $12. Theoretically, the people who love my pizza will still want to buy it, while my less-loyal customers will go elsewhere. As a supplier, however, I need to ensure that I don’t raise my pizza price so much that all my regular customers refuse to buy any of my pizzas.

Of course, there is the opposite scenario I just gave you. If a new pizza place that sells pizzas for $12 opens down the road, the product available to buyers has essentially doubled, meaning that I, as a supplier, will struggle to sell as much pizza as I once did at the same price. Because supply has risen, demand has lowered. And to sell the same amount of pizzas, I’ll need to lower my price so more people come to my shop over the competitor’s.

The Equilibrium Point

Hopefully, those two examples helped explain the Law of Supply and Demand, so here’s one more technical term for you to know. Eventually, supply and demand have to meet at what economists call the Equilibrium Point. At the equilibrium point, demanders want the amount the suppliers will give. To follow the above examples, if the supplier is willing to sell 50 pizzas at $12 and customers are willing to buy 50 pizzas for $12, we have found the equilibrium point in our market. If the supplier can’t convince people to buy 50 pizzas at that price, then supply will be higher than demand. And if people want to buy more than 50 pizzas, then demand has exceeded supply.

It’s important to note that the market would always be at the Equilibrium Point in an ideal world. But since we don’t live in a perfect world, economists are happy to settle for markets that function near the equilibrium point. The closer the market is to the Equilibrium Point, the healthier the market is. In times of uncertainty or following a significant market shift, the market may swing drastically from one type of market to the next. However, the market should adjust closer to the equilibrium point over time.

(Economists often ask themselves whether or not non-market forces, such as a government, should manipulate market forces to return the market to equilibrium. This is a complicated subject that’s beyond the scope of this post, but you should be aware that manipulating the market is standard practice. Furthermore, be mindful that adjusting interest rates is a common method of driving the market that will directly affect you as a homebuyer or seller.)

The Housing Market

Now that we’ve looked at a few basic economic concepts, we can apply them to the housing market. In the real estate industry, we refer to two types of markets: a buyer’s market and a seller’s market. When experiencing a buyer’s market, demand exceeds supply (housing). In a seller’s market, supply exceeds demand. If there doesn’t seem to be a strong preference towards the buyer or the seller, then this is considered a healthy housing market, and it’s a sign that the housing market is near the equilibrium point.

The buyer has the advantage in a buyer’s market because too many people are trying to sell their house. This forces sellers to lower prices and offer more add-ons, while buyers can be more picky in their decisions. Sellers are often frustrated and may feel defeated in this market because it will be difficult to walk away from a deal and feel like they “won.” Sellers can ensure their house is clean and in good condition before buyers view the home to get a better deal.

In a seller’s market, there are too many buyers and not enough houses, forcing the price of homes up even with no visible additional value. Sellers can ask for more money, do fewer repairs, and still receive multiple offers. Buyers may often feel discouraged in a seller’s market because they may need to put offers on multiple houses before ever getting a counteroffer or acceptance. Buyers should look for homes that have been on the market for longer than others or for places that need more TLC for a faster buying process.

While some periods show a significant swing from one market to another, the market tends to even out over time. If you’re selling your home and buying another one in two markets behaving similarly, the advantages and disadvantages of being a buyer or seller will probably even out. Really, the only time you should worry about how the market is leaning is if you’re going from renting to buying or moving into a market behaving opposite from the one you’re currently in.

An unhealthy housing market can scare everyone involved, but knowing a few basic terms and the reasoning behind the market shifts can help equip you for whatever happens next. If you have questions about your specific housing market, I highly recommend talking to a local real estate agent, but if you have general questions or are looking in North Carolina, contact us!