No Need for Demand > Supply to Incur Price Rise

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

April 2012

Just more money will do

Whenever real estate prices rise (drop), bet your life that there will always be market commentaries which would account for the increase (decrease) citing demand and supply imbalances, which in turn are caused by either pent-up (a lack of) demand or under (over) supply, or both.

Not that the above bears no factual substance, on the contrary, demand and / or supply do exert significant influence on asset prices at times. However, it is wrong to think that a market price change always requires demand and supply factors for support. It doesn’t. 

Just changes in $ liquidity and / or income would be sufficient to cause price changes in assets, real estate included.

We shall use the following highly simplified and hypothetical example for illustration:

a) Say there is a simple community consisting of only 10 households living in 10 houses = from a residential demand and supply angle, the market (residential need) is balanced.

b) Say each household earns $10K per year and using a house price to income ratio of 5, the typical house price is $10K x 5 = $50K each (note we have skipped all consideration of differences in income and house features, or for that matter, differences in household taxes and the like).

Barring specific and sentimental likings for any particular house by any particular household, the households may buy and sell their respective homes among themselves for around $50K on average. The ratio of 5, by the way, is arbitrarily selected here purely for calculation.

c) Now assume the economy of the community thrives and each household earns $20K per year. Do you think the households will still trade their respective homes for $50K? No.

Why? Because 1) it is quite likely that things in general would have become more expensive including (hypothetical) house rentals and thus home prices i.e. the owners would want higher prices in order to part with their homes; 2) assuming households are still sticking to trade 5 years of income for a home, then the typical house price will now go up to $100K.

This view is also supported by the many observations we have had so far that house prices appear most influenced by income, whether expressed in GDP per capita or income per household, which in turn could be a reflection of liquidity in the economy / market.

Is there a chance that the homes can still be traded for the original price of $50K? Not likely unless one assumes there is a serious oversupply of homes e.g. instead of 10 houses there are now 20 houses for 10 families, a significant decrease in demand e.g. households moving to other communities, communal instability, or the like.

As such, it is rare, if not impossible to find a community whose households would pay the same home price irrespective of income levels. A $20K average household income community will tend to have higher home prices than one with $10K average household income.  

Sometimes, there is just no need to cite demand and supply as reasons.

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