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Is Real Estate a commodity?
By Harriet Cochran Murrray • Cochran Real Estate - January 2010

Years ago when I became a real estate agent, my first mentor was an experienced broker from Tulsa, Oklahoma. We worked at a new residential development on a lake east of Dallas, Texas.  Bob explained to me one day that “Real estate, Harriet, is a commodity like pork bellies. Demand goes up and down. Never forget that.”

I have painfully remembered this simple analogy over the years when real estate cycles reminded me to never forget certain economic principles which apply to all products and consumer behavior. There have been more times than I care to remember that either a client or I fell into the trap of believing that real estate prices would continue to move up, not down.

Real estate is such an important commodity that we begin to believe it is affected by factors more important than price and quantity. We believe that there are inherent qualities in real estate which make it a necessity instead of an option. Is the purchase of resort property or second home in a foreign country a necessity or an option for a particular buyer? 

What economic principles did the US Congress forget when they voted to deregulate banking and lending laws and make it possible for everyone to own their own home? The methods and products created to “change the rules” made it possible for consumers to buy homes they could not afford. We now have global issues of economics ignored.

The law of demand: The higher the price of a good, the lower the quantity demanded. The lower the price, the more the good will be in demand. To create home ownership in the US for the past few years, the price of homes was not the issue as much as the cost of the mortgage and the down payment. Mortgages were priced to appear “cheap” but in fact they were not. Adjustable rates made the monthly payments unaffordable. The purchase price was based on faulty appraisals which backed up the entire system. When the true higher price of the product was discovered by the consumer, the demand fell. The consumer walked away from the property and defaulted on the mortgage.

The law of supply shows the relationship with demand. The higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at higher price increases revenue.  As demand increases, price can increase. As demand for home mortgages increased, bankers and financial wizards put more of their profit into mortgage costs to the buyer. (Excess demand was created which allowed the lenders to charge more in real dollars for their product.)  What appeared to the consumer to be a bargain was instead an overpriced product to give the producer more profit. Supply (mortgages) became a higher cost as demand increased, without the consumer always aware of it.

A tricky fact about the demand and supply relationship is the factor of time. Time is important to supply because suppliers must react quickly to a change in demand or price. It is important to determine whether a price change caused by demand will be temporary or permanent. Lenders didn’t plan on demand to lessen because they didn’t realize or care that adjustable mortgages would cause defaults and foreclosures. Higher interest rates kicked in and buyers walked away from their property. Builders built according to demand, which would not last, therefore; supply increased.

Now there is excess supply. Lenders and financial institutions have to change their product to recreate demand to absorb the excess supply. Are they doing this? A classic method is to lower the prices and make the terms to purchase more attractive to the consumer. However, if the pricing and terms are not based on good economics, the buyers will default and the vicious cycle will begin again. Email to a friend

Harriet C. Murray
E-mail: harriet@casasandvillas.com.

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