What is the single most important factor in determining supply in the real estate market?

A representative image of a small modern house placed on a stack of coins held in an open palm.

Are you thinking about buying or developing an investment property? If you are, then you’re probably contemplating all the variables that can influence the value of real estate. You may wonder why buildings in neighboring zip codes have vastly different prices, or whether or not the location you picked for your project was the best from an economical standpoint. While there are many factors which may raise or sink property values, the most profound ones are:

• physical and environmental characteristics, 

• interest rates, 

• economic conditions, and

• local government policy

Understand how these influences affect the real estate market, and your investment decisions will be more prudent. Read on to find out more. 

1. Physical and environmental characteristics

The geographical location of real estate comes with many variables, all of which play a key role in boosting or slashing property values. 

No one likes long commutes to work, and most people will pay a premium to live close to their jobs. Proximity to the city core lifts real estate values, thanks to the abundance of shops, restaurants, and entertainment venues. Quality schools, as well as access to public transit and arterial roadways, can also make a property more desirable, thus raising its value. Even the most devout urbanites love access to parks, beaches and other waterfronts, which is why areas close to such natural features are guaranteed to have an edge over those where green spaces are lacking. 

Similarly, some factors can cause property values to nosedive. Neighborhoods known for crime, poverty, and homelessness can cling to their bad reputation for generations, even as they undergo gentrification. As an investor, you should be aware of these factors as you contemplate the location of your property.

2. Interest rates 

Interest rates, or the portions of a loan charged by the lender on a mortgage, credit card, and other credit balances, typically use the federal funds rate as a benchmark. 

The Federal Reserve sets the federal funds rate in an attempt to control the flow of credit into the economy. Adjustments to the federal funds rate create a credit cycle, in which consumers’ ability to afford products and services undergoes cyclical changes. Lower interest rates facilitate access to credit and encourage spending, which in turn spurs demand for goods and services, and causes prices to climb. After some time, life becomes less affordable and consumers get overburdened with debt. To keep people living within their means, the Federal Reserve raises the funds rate to limit access to credit; spending declines, as does demand and production. The economy contracts, and as the Fed gets ready to lower rates, the cycle is complete.  

Because real estate affordability relies heavily on access to credit, its value is fundamentally tied to the federal funds rate. When the Federal Reserve raises the funds rate, mortgage rates climb, and properties drift out-of-reach; the demand falls, and sellers lower their asking prices to remain competitive. Conversely, when the Fed slashes the funds rate, mortgages and homes become more affordable, demand surges, and the prices follow suit. 

A sunset panoramic view of a row of houses along the coast interspersed with trees with the sea to the left and a road to the right.

3. Economic conditions

The real estate market is a reflection of local economic conditions. When the economy is expanding, the quantity of new residential construction projects, as well as the number of real estate transactions increases. During a downturn, fewer people build new homes, and as borrowing becomes more difficult, the real estate market sees fewer buyers. The increased inventory of homes eventually lowers the prices.

Many local, regional, national, and global factors contribute to periods of economic growth and contraction. As described above, the economy’s cyclical nature is partly shaped by the monetary policy and the federal funds rate. Governments can also influence the economy through their fiscal policy, which is a means of determining government spending levels and tax rates. During a downturn, governments can turn to rapid deficit spending to stimulate the economy; during periods of growth, governments can cool the economy by raising taxes and running a budget surplus.

Apart from the monetary and fiscal policies, the economy is also impacted by the consumers’ ever-changing demands, and the producers’ under- and over-production, as well as under- and over-investment, that results from the attempts to meet these demand fluctuations.

The health of the economy is typically measured with Gross Domestic Product (GDP), employment data, manufacturing statistics, and the prices of goods. Researching these indicators and knowing which part of the cycle the local economy is currently in, can help you gauge the future value of the real estate in your preferred location. 

4. Local government policy

Another factor to consider is the government policy in the jurisdiction where you wish to build or purchase your investment property. Most local agencies have vast powers to modify state statutes; consequently, laws vary between cities and counties and fluctuate to reflect the current political climate. 

Certain laws affect property values more than others. Locales with stringent building codes and zoning regulations see fewer buildings being constructed due to the increased development costs. If the area in question is desirable from a buyer’s point of view, the short supply and high demand can spur and maintain property values. 

While high property taxes and stringent zoning bylaws may spook some investors away, regulatory overreach may drive property prices up and create attractive investment opportunities. Local governments’ capitulation to the NIMBY lobby has left swathes of urban land in California zoned for single-family homes, causing the latter to reach astronomical prices. With continued economic, employment, and population growth and weak government appetite for liberalizing zoning laws, you can expect residential property values in large metropolitan areas such as Los Angeles, San Diego, and San Francisco to continue climbing. 

Another key policy aspect to consider is the provision of services, such as power, water, sanitation, schools, highways, and other public infrastructure. These services are a reflection of the local political climate, and play a significant role in swaying real estate values.

Researching government policy and understanding the direction in which it is heading can help you capitalize on opportunities and avoid unnecessary risks.

Design Everest Can Help 

If you’re planning to build an investment property, our architects and engineers can guide you through the process from plans to permitting.

*Note: The content published above was made in collaboration with members of Design Everest.

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