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Supply-Demand: Fundamental Aspect For Real Estate Investment

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Supply-Demand: Fundamental Aspect For Real Estate Investment

Last updated: September 13 2014
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  • Supply-Demand: Fundamental Aspect For Real Estate Investment

    Supply-Demand is one aspect of how prices settle in RE. It is technical or in other words, decided by voting machine for the moment. Fundamentals are way different. You have to apply principles that you would apply for other assets for valuation. It is a weighing machine. While it differs from stocks to RE, demand-supply is an ephemeral stuff and not a sustainable measure of what the asset is worth. Using demand-supply to support valuation is much closer to greater fool theory and it is completely disconnected to fundamentals. It may be 'fundamental' to some but that is not the 'fundamental' for an asset.

    Using supply-demand as a way to buy/sell RE is akin to stock trading based on FII money flows or rising volume or declining volume - all of which are non-sustainable data. Where are the fundamentals?

    Chasing demand as a proxy for fundamental has 2 fundamental flaws -
    1. It is momentary and short lived.
    2. One can predict demand in a medium term or longer

    To call 'something' as fundamental, it should be measurable and quantified. No anecdotal guesses. Fundamental should have some determinism. It should stand much longer than few months or a year.

    Disclaimer: As the title unambiguously indicate, we are talking of RE as investment. End-use, pleasure buys, compulsive buying, emotional buying, buying because one can buy, buying because of lack of awareness on other assets, are all exempted as many of the reasoning as it applies to RE as investment do not apply to them.
    Last edited September 7 2014, 03:26 PM.
  • #2

    #2

    Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

    Cross Posting absishek's view on the same topic from another thread:

    Originally posted by abishek
    In our unregulated RE market where supply is artifically manipulated by government through slow approvals, no infrastructure and township planning, with greedy builders coterie who plan which area to pump and create speculation interest and increase price periodically to fool buyers into thinking there is so much demand that they increased price..One has to put extra effort to see whether one is buying at correct price or at forward/future price to be able to estimate the future returns. Buying a good property now doesnt guarentee future returns. Buying a property that will remain a good property in future is the key to protect the property value. Buying in good location is one such way, but when it is unaffordable to the majority of buyers they have to be aware of other strategies and the context where to apply which notion.

    High Prices means High Demand is a wrong notion. It can give confidence to buy now but does not guarentee higher returns. Which is why people look at over-capitalization, rental yield etc to stay away from such properties. For better returns, One has to look for value buy opportunities. Identify gap between potential and pricing, by putting in some effort to identify the various factors that affect property pricing and the trends of buyer sentiments. When one is leveraging to buy or sending money from abroad there are greater factors like interest costs, inflation, arbitrage risks etc to name a few.

    RE pricing has long ago stopped being a function of supply and demand. I have said many times before, In good locations people are paying more because one is paying to outbid the competing buyer not because it promises higher returns. When the target segment shrinks so does its potential for redevelopment/conversion to commercial etc. Peoples expectation keeps changing which also should be factored. Earlier we had local residents who were willing to travel from avadi to siruseri everyday, but now with many from outside chennai coming to work they see more value in buying near the place of work than staying within the city. It doesnt mean city properties have lost potential, it only means suburbs offers more value at lower prices.

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    • #3

      #3

      Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

      What happens when you chase demand?

      What happens when you chase demand or think demand as a fundamental?

      You chase higher highs. Because demand is your fundamental. When in demand, you never get reasonable prices. Demand does not inform you before it wanes. When it falls, prices correct or stagnate. You would not buy because there is no demand. People who follow fundamentals can see beyond the demand-supply aberration and take advantage of it.

      Following demand is a classic herd mentality in investment parlance - more herds, demand gets magnified and more will follow. More demand increases momentum. Momentum begets Momentum. In a way, demand driven investing is momentum chasing and there is no 'investment' thesis in any form.

      Investing on Fundamentals:

      Often quantifiable through some measures and historical data. Provides some sense on where your margin of safety is. Allows you to sit tight even if temporary supply-demand mismatch causes it to be volatile - because you know over time 'fundamentals' will be recognized and realize the value. Markets may not respect fundamentals at times. Yes, Markets can remain irrational longer than you can remain solvent. Does not mean that you throw fundamentals outside the window.
      Last edited September 7 2014, 08:42 AM.

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      • #4

        #4

        Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

        Certainly demand-supply cannot be fundamental for price especially when the asset has not established its credentials. Once it is built certain performance it may generate demand and hence price (example, many chasing the same hot property though seller may view each offers different perspective). This is probably the case of true investment perspective leaving aside emotion etc...but house or apartments for end use typically follows herd mentality and everyone wants to ride the wave assuming that everyone is not a fool. But the real reality (if manipulated) everyone can be made fools like it happened in most of the RE projects in outter parts of Chennai. The real beauty is that even while most of the RE buyers are losing money they are made to feel that RE gives fantastic returns by discounting, capital management cost, tax, inflation, maintenance etc...as they say, the system convinced everyone that "RE lose" never exists!

        Not sure many would go with this theory!

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        • #5

          #5

          Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

          Originally posted by nabishek
          High Prices means High Demand is a wrong notion. It can give confidence to buy now but does not guarentee higher returns.
          Absolutely. If investment is about returns, chasing demand and equating it to a greater return in future need not have a happy ending.

          Example - OMR in 2007-2008 (Navalur-Kelambakkam and beyond). Buyers saw potential on the size of the IT jobs and had a groundswell in demand and buyers piled on. Result is for all of us to see. Potential did exist but demand bid up the prices which was not commensurate with the infrastructure development. Where it ended up is for all of us to see.

          Moral: In high demand situations, its hard for the buyer to separate the true demand, and hype from excessive interest. In several cases, Demand = Hype or feeds from Hype. Caution is warranted.
          Last edited September 7 2014, 02:25 PM.

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          • #6

            #6

            Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

            Originally posted by Ramchi
            ...but house or apartments for end use typically follows herd mentality and everyone wants to ride the wave assuming that everyone is not a fool.
            Above is one instance of how demand can go up - herd mentality. Why those who care about returns should pay heed to the demand? Because your returns are predicated on how long these herds will continue to crowd and keep the demand up - your guess is as good as anybody's. You must be lucky to see your returns. Returns predicated on luck is not an investment.
            Last edited September 7 2014, 03:05 PM.

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            • #7

              #7

              Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

              Technically price is based on demand and supply however in case of India RE is also based on Black money. Today not many can afford a house in India so only time will tell what is going happen however u can safely bet RE price next 60 months is going nowhere in hurry especially apartment market given the unsold stock and inventory overhang as high as 60 months. Will not be surprised this figure touching 100 months soon
              RE overpriced still fancy then 4% yield is must anything less is overpriced

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              • #8

                #8

                Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

                Demand for a property is a culmination of various factors like

                1.Intent to buy
                2.Increased affordability
                3.Attractiveness of the asset
                4.Availability of the asset.

                etc

                Supply is constrained because every land is not occupiable. Land zoning and approvals are held to ransom by cartels with vested interest in collusion with government officials. We are still so much dependent on government to plan infrastructre, create industries, jobs, schools, hospitals, civic amenities etc which is the reason city properties that have the facilities demand a premium. In suburb areas where such facility is missing the builders charge hefty cost to provide namesake community. Who is responsible for such plight is debatable..but the reality is buyers today are forced to pay high price for basic things.

                In such environment where profit is the only motive, one cannot expect operation to continue unhindered when the profit is not realized. We see many complexes not operating swimming pool, clubhouse, school, convenience store promised citing no consumer interest. When cost is high and profit is less, smart money moves away. Many companies keep moving around and setting up, closing shops as they please as and when Real Estate price becomes restrictive. If there is no government support and suitable environment all they hype, demand surrounding the development potential may not be realized. The same herd mentality that contributed to hiking of prices will also contribute to tappering when the interest moves elsewhere.

                When one looks RE as investment then we look around and try to analyze to see if our money can be more productive elsewhere in a different investment/asset. Unlike other assets thats constantly traded, RE is a long term haul where the supply of good properties is severely constrained. When there are several similar comparable properties there will be pressure on the seller to negotiate. This is like the best kept secret that no one talks about. One will find people saying I bought for 50K now I sold for 1C but the hidden truth is the person would have sold for 1 crore when new properties in the locality is trading at at least 25-30% higher. There are many who count their profits but dont talk about their losses. If one keeps a long term view then they dont have much to worry but if buyers get carried away by short term bullish sentiments and want to buy and flip in short term they can get royally screwed. If one is leveraging then holding a negative returns asset is very costly and can lead to fault in repayment and loan default.

                Another thing is the real movers of property value are people who are prepared to occupy the property. Not the people who buy it. Someone who is paying 1.5+ crore in the best location to let out the house for 10K+maintainence is doing praiseworthy social service. Such buyers may just buy because they have surplus money and they dont care splurging few lakhs and crores. The motivation can also be personal preference like gentry, lifestyle etc. A few peoples choice sets a beginning and only when more people are able to follow in a sustainable fashion it creates a trend. Poes garden and boat club also came up that way and so did the slums along the canals.

                If one is keeping demand as fundamental for buying then they also have to keep an exit strategy to eject before the demand wanes. Nowadays its not costly to shift base from one location to another. People change jobs and move between cities and countries on an average of every 3-5 years now. Earlier days change happened in 15-20 years cycles, now its as short as couple of years. I know so many people who dont even go to Marina beach. They are happy visiting Elliots or Thiruvanmiyur beach. For such people buying a 1C property near their comfortable habitat is more value than buying 3C property in mylapore. Each locality is becoming self sustained and such locations only will hold value. The idea of CBD is constantly changing and Being at the right place and right time is sometimes being just plain lucky. More than just looking at demand, it has become very important now to see is the demand sustainable and is there enough backing from government, residents. For buyers its important to look and stick only with value buy opportunites, assess risk correctly and take an informed decision.
                Last edited September 7 2014, 03:53 PM.

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                • #9

                  #9

                  Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

                  Why does Demand Supply is not reliable in RE?

                  Demand Supply driving the price is a conventional wisdom but the theory works when there is a free, competitive market. See the quote below:

                  "Supply-and-demand theory revolves around the proposition that a free, competitive market does in fact successfully generate a powerful tendency toward the market-clearing price."

                  One can see why it is highly misplaced in RE market place in India and often skews the demand disconnected from real demand strength. nabishek has put it nicely in his earlier post:

                  Originally posted by nabishek
                  In our unregulated RE market where supply is artifically manipulated by government through slow approvals, no infrastructure and township planning, with greedy builders coterie who plan which area to pump and create speculation interest and increase price periodically to fool buyers into thinking there is so much demand that they increased price.
                  If the demand is manipulated, it becomes a less reliable untrustworthy indicator. Sudden coverage often skews the demand which robs the returns of the next several years. Once Knight Frank knighted the Medavakkam as the place to watch for, do you think you get a fair or reasonable price after the news is out? Medavakkam was in more demand after KF news, but what about returns?

                  Moral: For good returns, one has to choose a place with potential that can get in to 'demand strength' radar down the line and not now.

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                  • #10

                    #10

                    Re : Supply-Demand: Fundamental Aspect For Real Estate Investment

                    What are the parameters you would look for places that can gain 'demand strength' ?

                    Originally posted by maverick007 View Post
                    Demand Supply driving the price is a conventional wisdom but the theory works when there is a free, competitive market. See the quote below:

                    Moral: For good returns, one has to choose a place with potential that can get in to 'demand strength' radar down the line and not now.

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