How Does the Housing Market Work?

Home buyers and sellers alike often find themselves surprised by the whims of the housing market. They might wait until the market swings in their favor or take advantage of a favorable change in their area, but what causes these situations within the industry? 

Few people outside of the real estate industry really understand how the housing market works. However, this knowledge can significantly help you make wise decisions when buying or selling a home. In this article, we’ll break down how the market works and how to work it in your favor.

Supply and Demand

The basics of the housing market are the same as the basics of economics: supply and demand. The market is driven by how many houses are available for sale and how many people want to buy them. The ratio between these two aspects is what determines the price. If more people are selling than buying, then buyers have the power to dictate how much they’ll pay and vice versa.

Factors That Affect Supply and Demand

Different factors will affect different industries. A few key things that affect supply and demand in the housing market include:

• Interest rates — lower interest rates often encourage buyers because they can get a favorable mortgage and pay less interest over time. Inversely, higher interest rates discourage buyers and are often used to cool the market.
• Long sales cycle — there are many moving parts to buying and selling homes, as noted in this Home Sellers Guide. Due to these steps, it means that selling a house can take a long time which makes the equity of the home illiquid.
• Inventory fluctuation — you can’t always rely on a stable inventory of homes. Things like economic downturns or new housing developments can cause people to leave one area and flock to another, affecting the supply of houses in certain parts of towns or cities.

Home Prices

Although every home sale includes a valuation of the house based on condition, property and other factors, the price of homes is largely dictated by demand. 

For example, imagine there is a small town and the population has been slowly declining over the last few decades. Historically, home prices were low because it was a less desirable area. However, now the cost of living in a nearby city is driving more and more buyers to purchase in that small town. The housing prices in the town will slowly rise as demand grows because people are interested in buying a home there.

To determine the type of market in your area — favoring buyers or sellers — you can look at the median home price. This is the price of homes in the middle of the pack, meaning half of the homes are more expensive and half are less expensive. Note this is not the average price, which would be to combine the price of all homes and divide by the number of houses on the market.

The median home price shows what most houses are realistically selling for. If it’s higher than it has been historically in your area, then that means it’s a seller’s market. There are fewer houses for sale than there are buyers who want to purchase them. If it’s lower than normal, then it’s a buyer’s market. There are more houses for sale than there are buyers, so they have leverage in the negotiations.

Before You Enter the Market

Before you buy or sell your next home, it’s prudent to do some research into your local housing market. You can take a pulse of the supply and demand situation and determine what kind of market you’re entering. This will often tell you if it’s a good time to buy or sell or if you should wait until the market swings the other way.

Remember, the housing market is always changing. So if now isn’t the right time, you just have to wait until the supply and demand balance shifts in your favor.