The Demand for Real Estate
Question:
Discuss about the International Management for Urban Areas.
Urban areas require real estate market that should be responsive to the changes in supply and demand so s to ensure that there are distortions in the prices of houses within the urban centers. While the real estate markets my show some idiosyncratic behavior and peculiarities in the patterns that they follow, they still obey the basic principles of economics of demand and supply. The real estate demand in Sydney and Melbourne has been strong over a number of years and is affected by the real estate economic principles of demand and supply. The principles that determine prices of the real estate markets in Sydney and Melbourne are the price elasticity of demand, market size, income as well as the short-run aggregate supply and new constructions.
The demand for real estate in terms of quantity can be defined as the demand for units which in turn affects the price. The lower the amount of units that are available, then the prices will go up accordingly. Demand can at the same time be considered as the effective demand which is backed solidly by the purchasing power of the consumer (Bates, Giaccotto and Santerre, 2015). The effective demand in Sydney and Melbourne are affected by the strong purchasing power of the inhabitants of the two cities which are underpinned by the strong economic fundamentals within them. The two cities have relatively strong economies which give the dwellers a strong purchasing power.
The concept of price elasticity is based on the principle that there is a percentage change in the quantity demanded that is affected by 1% increase in the price. For the real estate dynamic in Sydney and Melbourne, the demand is elastic since the price elasticity is greater than one. An increase in prices of houses (Ishijima and Maeda, 20150 induces a large decrease in the units or available in the market. The price elasticity is affected by the availability of substitutes within the real estate market. Since most of the demand is from the middle-income category, the availability of substitutes affects the price elasticity of the houses available in Sydney and Melbourne.
The recent increase in incomes and wealth and also contribute to the high prices of housing in Sydney and Melbourne. The higher incomes means that more households can afford to buy houses which pushes the demand up and the result is higher prices (Zhang and Seiler, 2013).The income is determined by the rate of unemployment which is relatively low for Sydney at 5% and 5.9 for Melbourne (Bleby and Tan, 2016).The infrastructure investment by the state government in transport in Sydney has resulted in a booming and strong economy in Sydney which has reduced joblessness and increased levels of disposable income with which to invest in buying a house.
The market size also contributes to the high prices as the populations of Sydney and Melbourne are high. The population that is employed is also high which means that a high percentage of this population will need houses either for rental or to purchase. The higher population that is competing for limited housing (Pang and Marton, 2013) will put an upward pressure in the prices to go up. There is increased migration of people from other territories due to the booming economies of Sydney (Irvine, 2016) and Melbourne and this increased population has resulted in a higher demand for houses.
Price Elasticity
The short-run aggregate supply refers to the total stock of units that are available at any given time. In the short-run, the supply of stock in real estate is fixed and this constrains the supply accordingly (Uren, 2016). The supply is affected by the lag in the time taken to construct which is typically between 6-12 months within the Sydney and Melbourne Metropolitan areas. The construction lag affects the changes in rent and prices and contributes to the high prices as the short-run supply does not immediately correct the imbalance of demand and supply in the market.
The short-run aggregate is also affected by the wrong housing mix in the two metropolitan areas. The supply of apartments is higher than detached units, which makes a would-be seller unwilling to sell their house, since they may be forced to upgrade to an apartment which is not the ideal for many (Winston-Geideman, Kimberly and Evangepoulos, 2013).This contributes to the low stocks of houses available and which in turn contributes to pushing the prices up. Instead of selling, many owners resort to upgrading their units which lends to maintain low levels of stock in the short-run.
New construction is determined by the stock flow identity. The stock flow identity states that the stock available at a given time is equal to the total stock of the previous time period plus the completed units minus the depreciated stock. The depreciation includes the physical depreciation, economic depreciation and functional depreciation. Properties that are becoming obsolete within the Metropolitan areas of Sydney and Melbourne (Waller, 2013) do not attract developers wishing to redevelop, due to the rule of redevelopment based on the Residual Land Value. (RLV). The Residual Land Value of the new building when compared to the RLV of the existing structure should be greater than the cost of redevelopment. Developers have tended to prefer new developments in Sydney around the new fast train being built, while neglecting the other areas.
One of the ways to reduce the high prices in Sydney would be to raise the bank rate to the ideal of 3.5%. Currently the rate is at 1.5% which is lower than the national rate and does not augur well for its economy which is booming. Reducing the rate would reduce the uptake of loans and mortgages for houses which would result in lowering the demand and ultimately the prices. This would result in houses within Sydney falling by an average of $100,000 and make them more affordable for the residents of the city (Bleby and Tan, 2015). Higher bank rates will reduce the number of potential buyers who traditionally rely on bank-loans to purchase their houses. The new purchasers on the market would be cash buyers who are less when compared to loan/mortgage buyers. This will lead to lower prices in the market.
In Melbourne, the approach by the Metropolitan authorities would be to give incentives for developers to build up (vertically) and not out (horizontally).The recent rezoning by the Victorian government has resulted in the creation of 100,000 new housing lots which are mostly on the periphery of the Metropolitan area. Building new units on the expanded geography of Melbourne city will have cost implications infrastructure development, including water and sewerage. These costs will ultimately impact the price (Brown, 2015) as they will factor into the cost of construction. The ideal is for new developments which are horizontal and use the existing infrastructure in order to contain construction costs. This will result in lower prices which can be passed on to the buyer.
Income and Wealth
For the young professional in Sydney wishing to purchase a house, the best option is to look for a house that is much further away from the CBD as well as looking at the western suburbs where prices are generally much lower (Gillespie, 2016). The demand within the CBD is high while the supply is short and there is no short-run supply to remedy this situation. Houses that are further away from the CBD tend to attract lower prices than houses that are closer to the CBD due to the increased competition from buyers from the few available units. The young professional can also incorporate their spouse when purchasing the unit if on mortgage so as to lessen the burden of repayment on one person.
For the young professional in Melbourne, the best alternative is to make use of positive gearing (Koulizos, 2016) which can be used for a second purchase at a more desirable location. The positive gearing would be from the position of continuing to rent in Melbourne while making a purchase in a region like Geelong or Ballarat and renting in out. The rent from the property should be higher than the current rent paid in Melbourne. The extra savings between the rent and interest should be saved for a future purchase which should be closer to Melbourne. By the time they want to purchase a house in Melbourne, the regional house will have made some considerable capital gains.
In conclusion, the application of the economic concept of demand and supply is practical from the macro and micro economic perspectives when addressing the problem of high prices for houses. The concepts of elasticity have application in the real estate sector and can guide developers and investors when considering investing in housing. The concept of short-run and how it affects the stock of housing is also important in determining how the market will respond to an increase of houses in the short-run. The options available for cities such as Sydney and Melbourne include a mix of both macro and micro considerations in order to reduce the current high prices. The options available for a young professional are also varied and will give options that will help them purchase a house within the two cities.
References
Bates, L.J., Giaccotto, C. & Santerre, R.E. 2015, “Is the Real Estate Sector More Responsive to Economy-Wide or Housing Market Conditions? An Exploratory Analysis”, Journal of Real Estate Finance and Economics, vol. 51, no. 4, pp. 541-554.
Bleby, M., & Tan, S. 2016. Why housing in Sydney is so strong. [online] Available at: https://www.afr.com/real-estate/residential/nsw/why-housing-demand-in-sydney-is-so-strong-20160825-gr0sks Accessed 8 May 2017
Brown, P. 2015. The Real Estate Development Process. In How Real Estate Developers Think: Design, Profits, and Community (pp. 61-93). University of Pennsylvania Press. Retrieved from https://www.jstor.org/stable/j.ctt14btgrt.6
Gillespie, K., 2016. Financial planner told me I can afford a single house in Melbourne and Sydney. [online] Available at: https://www.vice.com/en_au/article/a-financial-planner-told-me-that-i-cant-afford-a-single-house-in-melbourne-malcolm-turnbull Accessed 8 May 2017
Irvine, J., 2016. NWS housing shortage at unprecedented level. [online] Available at: https://www.smh.com.au/business/nsw-housing-shortage-at-unprecedented-level-20160325-gnr37f.html Accessed 8 May 2017
Ishijima, H. & Maeda, A. 2015, “Real Estate Pricing Models: Theory, Evidence, and Implementation”, Asia – Pacific Financial Markets, vol. 22, no. 4, pp. 369-396.
Koulizos, P., 2016. How negative gearing works. [online] Available at: https://www.realestate.com.au/advice/how-negative-gearing-works/ Accessed 8 May 2017
Pang, M., & Marton, F. 2013. Interaction between the learners’ initial grasp of the object of learning and the learning resource afforded. Instructional Science, 41(6), 1065-1082. Retrieved from https://www.jstor.org/stable/43575141
Uren, D., Don’t blame property prices on a housing shortage.[online] Available at : https://www.theaustralian.com.au/business/opinion/david-uren-economics/dont-blame-property-prices-on-a-housing-shortage/news-story/125f39e559f1190b28204a494392c11e Accessed 8 May 2017
Waller, I., 2013. Melbourne’s derelict buildings.[online] Available at: https://thecityjournal.net/news/melbournes-derelict-buildings-2/ Accessed 8 May 2017
Winson-Geideman, K., & Evangelopoulos, N. (2013). Reading Lists for Ph.D. Seminars in Real Estate. Journal of Real Estate Practice and Education, 16(1), 41-82. Retrieved from https://www.jstor.org/stable/24863213
Zhang, H., Zhang, Y., & Seiler, M. 2013. Using Behavioral and Experimental Design Methods to Teach Real Estate: Understanding Asset Pricing Bubbles. Journal of Real Estate Practice and Education, 16(2), 107-118. Retrieved from https://www.jstor.org/stable/24863219
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