Monday, March 26, 2007

It's a strange (property) world (2)

The previous post looked at the key drivers of demand for residential property. I now turn to the factors that influence supply.

Every piece of land and every property is unique, making the supply side review quite interesting. The main factors are:

1. availability of land: there is a lot of land on which there is no human habitation. In fact there is far more land unused than used on our planet. Quantity of land in general is not a factor affecting supply;

2. availability of land in convenient locations: most people want to live close to someone or something: work, family, friends, the beach etc. When commuting time/distance is taken into account with other factors below, the availability of land and properties in convenient locations means that supply side limitations on quantum play a key role in determining property prices;

3. constraints on land use: there are a variety of constraints on land usage. Some land is physically unsuitable for use as residential land (swamps, mountains). Some land is made less desirable (proximity to certain industries, former rubbish dump etc). Even for the remaining land in convenient locations which is both suitable and desirable, further limitations on usage imposed by town planners and other regulators have the effect of limiting the amount of land available and the uses to which each piece of land can be put. Certain areas will be set aside for parks or other public purposes. There will be restrictions on density of property development. While all these restrictions are well intended, they do play a significant role in restricting the supply of land and property available in many locations.

Since I do not see much prospect of the regulatory constraints changing in a manner which will permit higher density housing in many cities, I feel comfortable that residential property prices (or, more specifically, land values) have the ability to hold up over the longer term even in the face of economic adversity to the economy in general (obviously with the possibility of considerable volatility). Of course, Japan has shown us that the longer term can be very long when it comes to deflating a bubble.

As long as the population and the number of households continue to grow at a rate faster than the supply of new housing in convenient locations, I would expect any price falls to be a case of demand being deferred rather than a long term prospect. Put differently, the supply side of the housing market in many cities has shown itself to be somewhat inelastic which helps to partially explain why prices levels that look expensive in terms of affordability, yield and historical prices show little sign of easing off (and probably will not unless there is a general economic down). Even rising interest rates have failed to have much impact on the rate of house price appreciation in some places (see New Zealand as an extreme example. In spite of interest rates above 9%, house prices are still appreciating).

The above conclusions apply to cities where there are restrictions on the ability of a city to continue to expand or which have the ability to expand but only at the price of a disproportionate increase in the inconvenience factor. London and Sydney come to mind as examples.


Raphael said...


I agree with your comments on appreciating property prices in cities, although I have to say I find it dangerous when property prices grow too far away from rents.

When the rental yields drop, it usually signals a bubble in the market, which innevitably gets correct.

The reason for this, in my view, is that any supply-demand argument made for the price of housing, should also apply to rent. Any growth in housing prices without a corresponding increase in rent is probably only a factor of increased speculation, higher credit availability etc. which usually has dissasterous consequences.

At the end of the day, we're all investors, and if we can get a better return putting our money in savings accounts and renting (which is the case in Australia), then most people will opt to do that.

Just my view anyway ;)

traineeinvestor said...

Rental yields have been dropping steadily in many places for well over a decade (Australia, NZ and UK come to mind). I am not convinced that rental yield alone is indicative of a bubble - if it was it would have suggested selling in a number of places while the bull market was still in its infancy.

The issue is that supply and demand for buying properties is driven by different factors than the supply and demand for rental accomodation. As an example - the availability of credit is a key factor in demand from property buyers but of limited relevance to renters.

I certainly agree that there are times when it is better to rent and invest than to buy. That said, I would never want to be in a position where I did not own a property in the city where I live. The risk of being priced out of the market if it goes up is very real.