Supply-Side Real Estate Economics

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Most real estate investors understand the law of supply & demand. High demand and low availability of homes lead to increasing prices. Lately we have seen the opposite side of that equation; too many homes and too few buyers have led to greatly reduced prices. Following standard economic theory, those lower prices will eventually lead to increased demand as buyers perceive prices to be a bargain.

External forces can also wreak havoc on that equation. Tight lending standards of late have made it difficult for many buyers to obtain needed financing even though they would like to buy, which lowers demand.  Government has often manipulated the demand side by providing financial stimulus, such as the recently expired tax credit program, in an effort to get the economic engine moving. Manipulating the supply side of the equation is not as easily done.

The Detroit Experiment

One of the regions hit hardest by the so-called Great Recession is Detroit. With the nation’s highest rate of unemployment, it has seen an immense number of foreclosures. Real estate prices may take decades to recover if they ever do at all. The city has undertaken an ambitious plan to stabilize the region – reducing the supply of homes.

This is certainly not the first time a city has razed homes in an effort to improve an area. I clearly recall the City of New York doing just that. In that case they would condemn and demolish abandoned buildings that had become crack houses and squatter’s quarters. Their motivation was not economic so much as social they were trying to reduce urban blight. In this case we were talking about a few buildings here and there. The scale in Detroit is unprecedented – 10,000 homes! (Article)

Reality Bites

Why is Detroit taking such a bold step? They have approximately 90,000 vacant homes. The initial plan calls for the demolition of 3,000 with the mayor pledging to eliminate 10,000 in the first step in his effort to right-size the city. While that would still leave an enormous glut of available properties, it is a start.

The vacant homes are more a symptom of the region’s economic woes than a cause. The real issue here is the need for jobs.  Demand has little chance of working through the available supply if people are not employed. No jobs means there are no workers to buy or rent. Detroit’s population is shrinking as people move to seek out opportunities elsewhere.

The real bad news for the city is that tax revenue has declined sharply. The tax burden must now be spread over fewer and fewer people and the pain is going to continue for a long time to come. Will Detroit end up like an old west ghost town? Time will tell.

He that will not apply new remedies must expect new evils; for time is the greatest innovator.Francis Bacon

Photo Credit: Bob Jagendorf

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