What determines house prices – Part 3 a Lottery or science

© Other Media articles — www.propertyplanning.com.au.
Reproduced with permission.

Basically house prices are determined by the demand and supply of housing and in the previous two articles, What determines house prices? and Determining what a house price should be, I highlighted the demand factors. These are interest rates, state of the economy, demographics, government, finance, rents, prospects of capital growth and finally, returns on alternative investments.

In this article, I explore the factors that affect the supply of property.

Supply

It is builders and developers that supply property. Understanding what encourages builders and developers to build dwellings and develop land will give you a greater insight into house prices and property cycles.

There are eight main factors that drive the supply of property – existing supply and demand for housing, expectations of the level of demand, construction costs (materials and labour), infrastructure costs – (for example, water, sewerage and roads), cost and availability of finance, land availability, state of the economy, level of consumer and business confidence.

Existing supply and demand for housing

It makes sense that if the market is already oversupplied with new property, a builder/developer would not choose to bring more onto the market. It’s like eating more when you are already full; it doesn’t make sense. The same goes for the existing demand for property. If there is currently no demand for new property, then there is no need to build more.

Expectations of the level of demand

However, if existing demand was low but builders and developers were anticipating a heightened level of demand in the future, then they would supply more property. It often takes a year or more to go from vacant land to new house so builders/developers need to ‘take a punt’ on what the future holds.

Builders of apartments have to take a greater gamble as the process to turn a vacant site into a multi-storey apartment block can take a number of years. It’s not all guess work, however, as there are a number of leading indicators for the future demand of property. These include vacancy rates, interest rate movements and government grants, to list a few.

Construction costs

If the materials required to build property are too expensive or they are increasing in price dramatically, builders are less likely to build more property. The same can be said for labour costs. If bricklayers, carpenters, etc, are charging too much, builders are less likely to build more property.

The increase in building costs means that the property costs more and unless the market (that is you and me) are willing to pay more for the property, there is no point in building the new properties. If we are willing to pay more for the property, this will obviously increase median prices.

Infrastructure costs

It is often developers who have to pay for the majority of the new infrastructure in a development. This includes the supply and laying of mains water and sewerage pipes, roads, footpaths, kerbing, lighting, etc. These are additional costs that the developer must pass on to the purchaser. In many states, these costs are very high. If these costs are accepted and in the end paid by the consumer, this will increase the price of property.

In a number of states, developer levies and infrastructure costs make supplying more land and/or dwellings not financially viable. Some state governments and city councils/shires are now working with property developers to develop solutions to these high infrastructure costs and therefore encourage the supply of new housing and hopefully decrease property prices.

Cost and availability of finance

In the current economic climate, it is harder to finance property than it was two years ago. Almost gone are the days of ‘no doc’ and ‘low doc’ loans.

Borrowing money for a property development is much more difficult than borrowing money to purchase an existing home. Banks are often looking for 25 to 30 per cent equity. If you want to borrow money to purchase an existing property, 5 to 10 per cent deposit will suffice.

Two years ago, the equity requirements for developers were much lower than this. Many banks are now not allowing builders/developers to capitalise their interest whereas two years ago, this was common place. Interest rates for developing property are also much higher than they were two years ago.

If the builder/developers’ finance costs increase, so do property prices (that is, if we are willing to pay extra for them).

Even if builders and developers are keen to build, without adequate finance from the bank, many of them can’t build/develop.

Land availability

Many developers are complaining that even though they are keen to build, there is just not enough land made available to build on. If you limit the availability of land, you obviously also limit the supply of more housing. The argument is made by developers that if you restrict the supply of land and therefore the supply of homes, you increase the price of property and make it increasingly unaffordable.

State of the economy

Recently, the NSW economy has technically been in recession. As a result of this NSW builders and developers have been reluctant to increase their activity and supply more housing. On the other hand, the Victorian, Queensland and South Australian economies are performing much better. It is no coincidence that there is proportionally more activity in the building and construction industries of Victoria, Queensland and SA as compared to NSW.

If your state is in good economic shape, so is your building industry.

Level of consumer and business confidence

If consumers are lacking confidence, they are less likely to spend money. The same can be said for businesses. If builders and developers are lacking confidence, they are less likely to spend money or purchasing land and building new homes. This in turn restricts the supply of property which can in turn increase the price of property.

Conclusion

If you can understand which factors influence the demand and supply for property and consequently property prices, you are in a better position to capitalise on opportunities that are not obvious to the majority of the market. If you can get into the market before prices start to go up and get out before they come down, you can maximize your profits and minimize (or hopefully eliminate) your losses.

If you know of someone who has sold their shares to buy property or sold property to buy shares, please let me know. I’d be very interested to hear from them.

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