Why U.S. Home Prices Rely On Supply And Demand

By Martha V. Shelton | March 15, 2012 AAA
Why U.S. Home Prices Rely On Supply And Demand

If you have ever considered buying a home in a different state, you know that home prices can vary significantly depending upon the market in which you are searching. For example, homes in Manhattan are generally much more expensive than homes in suburban Texas, whereas homes in Ohio are typically a fraction of the cost of homes in certain parts of California. What accounts for these differences? Essentially, the laws of supply and demand determine home prices across the country, and the determinants of supply and demand tend to vary across markets. We will look at some of the factors influencing home prices in the United States.

Demand: A Homebuyer Wants to Feel As Though She Can Afford Her Home!
From the demand, or homebuyer's side of the equation, demand for homes is heavily influenced by how confident & comfortable a potential homebuyer feels in their capacity to purchase a home, and service the associated mortgage payment. While it can be difficult to gauge this consumer sentiment, some useful metrics include: consumer confidence, the rate of unemployment, mortgage rates and the ease with which a homebuyer can obtain financing. In short, a potential homebuyer wants to feel like she can purchase a home and meet her mortgage payments.

Supply: A Homebuilder Strives for Profitability
Homebuilders endeavor to construct and sell as many houses as the market is capable of absorbing at any given time. However, homebuilders must consider several relevant, market-specific factors, including: the cost of building materials and labor, the availability of adequately sized lots of land, the number of homes already available for sale in a particular market (by checking home inventories and foreclosures), access to capital financing, and, of course, whether or not there is consumer appetite for homes. Importantly, homebuilders take into consideration their customers' capacity to purchase homes in that they monitor all of the aforementioned drivers of demand.

Bringing Together Supply and Demand
The confluence of supply & demand dictates home prices. Of course, the factors influencing supply & demand vary across markets, which is why home prices differ across markets. We present an example to illustrate this difference. As mentioned above, homes in Manhattan tend to be much more expensive when compared with homes in suburban Texas. From a demand perspective, Manhattan is a densely populated urban center with roughly 12 people per 5,000 square feet, whereas Sugar Land, Texas – a Houston suburb – is less densely populated, with roughly 0.6 people per 5,000 square feet. Indeed, such a dramatic difference in population density affects homebuyer demand, supply and home price! The median home price in 2009, in Sugar Land, Texas is around $250,000 whereas that of Manhattan is around $900,000!

Overview of Home Price Differentials Across the U.S.
For a general overview regarding how home prices vary in different states, have a look at this home price heat map compiled by Trulia.com. As you can see, homes in the Northeast, California, Montana, Wyoming and Colorado tend to be listed at higher prices while Midwestern states generally see lower-priced listings.

The Bottom Line
Ultimately, home prices are dictated by that tried and true economic relationship of supply and demand. Look for factors that influence supply and demand and you might be able to predict which way housing prices will trend.

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