What Is Real Estate and How the Property Market Works

Whether you're interested in buying your first home, growing a business, or investing in real estate for long-term wealth building, you need to understand real estate - and how the property market works. Let's cut the jargon and get to the heart of real estate, and understand the inner workings of the real estate industry.

From a legal and economic perspective, real estate is land and anything that is attached to it - natural or man-made - permanently and in a tangible way. It is not personal property, such as movable items like vehicles, furniture, and jewelry.

The real estate business is split into 5 different segments, each playing a different economic role:

• Residential: Homes intended for one or more people to live in. Single-family homes, apartments, villas, duplexes, and townhouses.

• Commercial: Buildings used by business activities to make a profit. They can be office buildings, shopping centers, medical centers, hotels, etc.

• Industrial: Production/manufacturing facilities, research buildings, logistics facilities. This covers distribution centres, manufacturing plants and warehouses.

• Land: Raw undeveloped land, empty plots and agricultural fields in-use including farms, orchards, and ranches.

• Mixed-Use: Developments with a variety of uses - such as a building where retail store front units are located at street level and residential apartment units are located above.

Unlike stock markets, real estate markets move more slowly and are heavily influenced by local conditions, in comparison to the very quick response time of highly liquid financial markets, where stock shares trade in milliseconds. It has multiple moving components to operate effectively without fouling.

Dynamics of localized supply and demand

The most basic economic answer is that property values are dependent on the supply and demand for property. Real estate is highly location-dependent, as it's not possible to just move a piece of land to another city because there's high demand.

While the national press may herald the housing slump, a certain neighborhood with excellent schools and few empty lots may also be a strong seller's market with rising home prices.

Financial capacity and interest rates

Real estate involves a lot of money, and thus, the real estate market is tightly interwoven with the banking sector. Most transactions are conducted on "leverage," or borrowing (with a mortgage) to make the purchase.

If interest rates decline, it will be easier to borrow money. This increases the buying power, stimulates demand, and increases property value. On the other hand, when interest rates increase, the price of borrowing increases and buyer demand slows down, which has historically resulted in stabilization and/or a downward trend of property values.

Housing markets don't go in a straight line. The real estate market usually moves through different phases over time, driven by other economic indicators such as GNP growth, employment, and population changes. If you know where your market is on this journey, then you can make informed decisions and strategies.

Having an idea of how these four phases work can be beneficial to you when trying to time your investments or purchases:

Phase 1: Recovery

When a recession or market correction is over, the property market goes through a recovery stage. Overall demand is low, prices are at the bottom, and new construction has come to a standstill. During this time, experienced investors who closely follow market trends begin to buy/sell distressed or undervalued real estate before the rest of the community realizes the market.

Phase 2: Expansion

The market goes into expansion once there is a strengthening in the overall economy and an increase in job opportunities. The number of housing units and commercial properties becomes too scarce, and the vacancy numbers decrease while prices start to go up fast. New construction projects increase due to the increased demand by homebuilders and developers.

Phase 3: Hyper-Supply

Over time, the growth of new construction starts to surpass consumer demand. Inventories increase, occupancy rates slowly creep up, and the rate of price appreciation slows down. During this stage, the marketplace is going to be oversaturated.

Phase 4: Downturn

If the supply is higher than the demand in the market, then it will go into a downtrend. Property values are corrected, transactions decline, and developers slow down on new development. It can be a difficult time to sell, but it is a great time to be a long-term buyer since you can get your desired price.

When considering a particular property, there are three basic considerations that ultimately determine its value:

• One of the top real estate principles: Great location for employment, transportation, quality education and lifestyle features always counts.

• Physical Condition and Usability: The level of the building's age, architectural effectiveness, structural integrity and layout functionality.

• Economic Indicators: Local employment rates, wage growth and the natural demographic population inflows that are needed in housing and commercial spaces.

Real estate is a long-term endeavor. In the short-term, a rise and fall of real estate prices may cause anxiety, but overall, it is still an excellent way to create generational wealth. If you become familiar with its basic classifications, monitor interest rates, and know where you're at in your particular market's real estate cycle, you'll be able to engage in real estate with clarity and complete confidence.