When looking at value in real estate, it’s important to consider these principles of real estate marketability to see how pricing is determined.
A great number of factors establish home prices, including supply and demand, competition, conformity, interest rates, and more.
Principle of Change
Cities, neighborhoods, and developments experience change, whether it be growth or decay. Nothing really stands still.
Economists note that cities and nations alike experience four distinct stages of change, including development, stability, decline, and renaissance.
The stage of the city or nation or development for which the subject property lies will have an effect on the value of the property.
Principle of Competition
When there is strong demand for real estate, profits rise and competition stirs.
With this increased competition and profit comes more home building and development.
Unfortunately, when excessive profits are available, a surplus of competition can create an oversupply of housing, and collapse the market.
Something we’ve seen lately in the United States with the so-called “housing bubble.”
Principle of Conformity
Many housing markets thrive on conformity. If the properties of a given market are all similar in type, size, style, age, quality, etc, the maximum value is a result.
If for example, a non-conforming home, such as 6-bedroom home is situated in a 3-bedroom community, the true value will not be realized.
So in a sense, you can overbuild for an area and not see your return on investment. See obsolescence for more on that.
Principles of Progression and Regression
Related to conformity, the principle of regression tells us that high-valued properties tend to suffer when found in close proximity to lower-valued homes.
While the principle of progression assumes that lower-valued homes will see increased value if found amongst higher-valued properties.
That’s why you always hear people saying, “buy the cheapest property on the block”, as the strength of those around it will make it more valuable.
And this explains why homes in good areas are often in bad shape, because they know the value is there regardless.
Meanwhile, the newest and fanciest homes are often found in less desirable areas as a means to draw in buyers.
Principle of Substitution
When setting a market price for a piece of property, the cost of acquiring or constructing a similar property must be considered.
If the asking price of a home is $500,000, but similar homes in the neighborhood sell for $450,000, chances are the home will not sell for the full asking price.
Comparable sales come to mind here. The same is true if the cost of constructing a new home (along with lot cost) is less than the asking price of $500,000.
A buyer would likely balk at the asking price unless there was something truly unique about the subject property.
Principle of Supply and Demand
When demand is greater than supply, the price of homes and rent go up, and the inverse is true as well.
When demand is strong, home builders should react by increasing development to meet the demand, and keep prices at bay.
However, if the reaction to demand is too strong, overproduction can occur, leaving a surplus of property and weak demand, followed by lower house values.
Unfortunately, building homes takes time, so it’s difficult to keep the supply/demand seesaw in perfect rhythm.
When supply and demand are at a perfect equilibrium, the cost of production (along with the profit) should be reflected in market prices.