What is the economic principle of scarcity and how does it influence property value?

Terms in this set (62)

- Location,
- Climate,
- Topography,
- Utilities,
- Improvements,
- Orientation,
- Size and Shape,
- Soil,
- Assemblage,
- Corner Influence,
- Pedestrian Traffic or Traffic count, Environment,
- Exposure

Physical features that may cause adjustments include age of building, size of lot, landscaping, construction, number of rooms, square feet of living space, interior and exterior condition, presence or absence of a garage, fireplace, or air conditioner, and so forth.

Sets found in the same folder

Scarcity is defined as

"The present or anticipated undersupply of an item relative to the demand for it. Conditions of scarcity contribute to value."

Scarcity usually triggers demand. The more scarce an item is, the more valuable it is likely to be.

Think of sales or auctions of paintings by Rembrandt or Van Gogh or Stradivarius violins. There are only so many of them and more will never be produced.

Many more people want one of those paintings or violins than are available. When one comes on the market, the bidding starts. Apparently this is real demand, as quite a few people are able to afford them.

On the other hand, if there is an unlimited supply of some item, like dandelions, they tend not to have much value. Yes, I know, people sell dandelion greens and dandelion wine. But you pay for the processing, not the availability of the raw product. You could go pick your own - unless it is wintertime.

If it is wintertime in the north, or you live in a desert, dandelions might be scarce. Then they may have some value.

Let's try to relate scarcity to real estate, not dandelions. Real estate fetches premium prices when it is scarce. If you have 50 people wanting (and able) to buy a new house in the county and there are only five available, what will happen? Want to bet the asking prices will get bid up?

Of course, it can go the other way. Imagine you are in a part of the country where condos were significantly overbuilt. What if there were thousands of newly built condos for sale and few buyers in sight? They could go into foreclosure if they could not be sold. The opposite of scarcity is an oversupply. It can strongly depress values, or lead to no sales at all - at any price.

A property's zoning is one of the strongest determinants of its value. I'm sure you understand that a property could have different values depending on whether it was zoned for and permitted only one unit residential use, commercial or retail use, or industrial use. An acre could be worth $20,000 or $200,000, depending upon the allowed usage under zoning.

Of course, some parts of the country do not have zoning at all. In some areas, such as the city of Houston, Texas, land uses are controlled primarily by deed restrictions.

The first citywide zoning regulations were created in New York City in 1916. The purpose of these regulations was to separate the residential areas from commercial areas.

Later regulations in other areas restricted specific items such as setback regulations and story height. Local zoning laws and regulations appeared in most areas in the country in the 1960s and 1970s.

As part of your zoning research on a property, you also need to investigate the procedures for and possibilities of getting a zoning change or exception. Perhaps a property is zoned single-unit residential, but many other properties in the neighborhood have been able to get a variance to construct multi-unit properties.

Zoning regulations will also dictate minimum lot sizes. An area in which zoning permits nothing less than five-acre sites will probably result in different price levels for housing as opposed to an area which permits four houses to an acre.

However, in some areas this type of "exclusionary" zoning will create an imbalance in the marketplace because it will shorten the supply of available land, and it may impact the demand because the larger parcels will be priced too high. There are myriad possibilities.

In some rural areas, the local government offers no public utilities. In more densely populated areas, it is common to find public water and sewer.

The availability of public utilities to a site constitutes another value-influencing factor. If you have a piece of land with no utilities provided, in order to place a dwelling on that property, a well has to be drilled and a septic system installed. This will certainly cost thousands of dollars - sometimes tens of thousands of dollars. In some areas, there is uncertainty as to whether or not adequate systems can be built. If a piece of property can easily be connected to public water and sewer at the street, it should be worth more.

Beyond the availability of utilities, another factor is their cost of use. Some utility companies have rates that are much higher compared with companies in other areas. Even if costs are equal, many times there are differences in the quality of the water supply.

By the way, don't just assume that because utilities are available nearby that you would have the right to automatically connect to them. In some communities, there are shortages of water because of rapid amounts of construction of new structures, and the availability of new hookups is limited. In some cases moratoriums have been put in place for a year or two to halt new construction until the supplies can be increased by modernizing or constructing new facilities.

Public safety encompasses things like electrical codes and fire codes. We want to make sure that buildings are up-to-date and protected from hazards. Are the codes strictly and fairly enforced?

In recent years, public safety has come to encompass other things, such as national security. Since 9/11, many municipalities have undergone extensive training and are well funded and equipped to deal with such eventualities as terrorist attacks. Medical facilities have also prepared disaster plans. Local governments have studied possible evacuation routes, etc.

Other municipalities have been lax in this regard, and their shortcomings have been publicized. It may give pause to potential residents or transferees.

We also have had experiences with natural disasters in recent years including hurricanes, tornadoes, earthquakes, floods, and droughts in many areas of the country. Some people may think twice about retiring to Florida in light of the recent spate of hurricanes.

Some people may be scared off from areas that are particularly prone to earthquakes or tornadoes. Some farmers or ranchers may abandon properties that are no longer profitable for agricultural purposes due to extended drought conditions. Properties in these areas may lose considerable value and may face severe marketability problems.

Weather and climate are external forces beyond our control, but they may translate into a real impact on real estate values. People love to live in San Diego because of the moderate climate. The same goes for Hawaii. It's not a coincidence that those two areas have some of the highest residential housing prices in the country.

Let's take a break here and check your understanding.

The topic of interest rates is rather complex because of the interlocking effects on so many aspects of our economy. Let's start with the obvious. We mentioned that most homeowners need to take out a mortgage in order to buy a home. If interest rates are low, it encourages mortgage borrowing. However, if the interest rates go up, it forces some people out of the market and slows the effective demand for home purchases.

Part of that "slowing" effect is a voluntary reaction where people say things like, "Wow, I'm not going to pay over 6% for a mortgage. That's just too high!" But there is more to that than a simple perception or knee-jerk reaction.

Some buyers will not be able to afford to buy a house because their monthly payments, at the new interest rate, will be too high. When qualifying for a loan, the lending community imposes certain ratios. For example, it is common for lenders to restrict mortgage loans so that the total expenses for your mortgage, including principal, interest, taxes, and insurance do not exceed about 30% of your gross income. If interest rates go up, payments go up. A buyer who is stretched to his or her limits on the monthly payment will not be able to afford as much house if interest rates go up.

The cost of borrowing money can certainly curtail business investments as well. In periods of low interest rates, many companies and corporations will spend to expand their facilities.

But if interest rates are high, it stimulates parts of the economy other than housing. Saving is encouraged when people can put money into a money market fund and get a return of 3%, or buy a CD and get 4%. Currently in the United States, interest rates on savings are very low, and this tends to discourage traditional saving.

Interest rates are just one part of the picture when we discuss mortgage financing. We need to also look at the availability of financing.

In the late 1970s and early 1980s there was a shortage of mortgage money. Inflation was raging, and interest rates were hitting all-time highs. It was at the point in some areas where the cost of money, from the Fed and other sources, was so high that lenders could not get enough of a return from mortgages.

Also, there was a problem in many states with usury laws on the books which prohibited charging interest rates above certain levels. As a result, many lenders just stopped lending for a while and put a moratorium on new loans. People said money was "tight."

At certain points in our economy, there have been times in which mortgage money may be plentiful for residential properties but in short supply for commercial lending, or vice versa.

The loan to value (LTV) ratio is also an important factor. In times of tight supply, you may have to put 20 or 30% down in order to buy a house. This removes many potential purchasers from the market and decreases the effective demand for properties in an area. For example, if a buyer is required to make a 20% down payment when purchasing a $300,000 house, that means the buyer has to come up with $60,000 in cash for the down payment, plus more cash for the closing costs. Not all potential buyers can come up with that kind of money in cash, so higher down payment requirements reduce the pool of potential buyers. Conversely, when an individual can easily qualify for a loan of 95% or 100% of the property's sale price, it greatly expands the pool of people who can buy a house.

These issues were demonstrated during the lending boom of the early 2000s and the resultant crash. During the boom, lenders were so eager to make loans that in many cases they failed to exercise due diligence in underwriting the borrower's capacity to repay. "Stated income", "low-doc" or "no-doc" loans, in which the borrower simply stated how much income he/she made without verification, were common. These types of loans became known as "liar loans" due to the propensity of many borrowers to overstate their income levels. During this time, lenders were also happy to make 90%, 95%, or 100% LTV loans without PMI. These under-collateralized loans were usually the first to go into default, and they resulted in significant losses to lenders when property values began to decline in 2007-2009.

After the well-publicized crash that resulted in the demise of many lenders, the lenders that remained in business suddenly developed an aversion to risk. As a result, many otherwise qualified borrowers, particularly those that were self-employed, suddenly found themselves unable to obtain a mortgage loan. Many industry insiders felt that the tightening of underwriting guidelines resulted in a lack of available financing, which exacerbated the decline of real estate prices even further, creating a vicious cycle.

Wage rates in an area are another item of interest. It can't be much more basic than that. The more you make, the more you can afford.

You'll find a direct correlation between average family earnings in an area and housing prices. A lot of it is related to the multiplier effect I mentioned earlier. If I can afford a mortgage payment up to 30% of my annual income, this means the more I make, the more I can borrow, and therefore the more I can afford to pay for a house.

According to the National Association of REALTORS®, the median sales price for the fourth quarter of 2017 for existing housing was:

Toledo, OH $115,100
Amarillo, TX $153,900
Charleston, SC $272,700
Hartford, CT $223,800
Decatur, IL $100,000
White Plains, NY $372,900
San Jose, CA $1,270,000
Honolulu, HI $760,600

I have to believe there are differences in wage levels in these places!

I won't go into all the details, but you can click here to see average wages for any metropolitan area, region, or state at this website.

Obviously, when valuing residential real property, local employment trends are more important than national trends. An area may be doing very well, for example it may boast an unemployment rate of 3%, bucking the national trend. That area is likely to have a healthy housing market. Or conversely, an area may be really struggling, with an unemployment rate of 12% or more. It is likely that this area would have an oversupply of available housing, and declining property values.

Is the employment in an area permanent or cyclical? In some areas construction work is very busy in the summer and dries up in the winter months. Some areas have job opportunities primarily in the summer season (at a beach or lake) or in the winter season (a ski resort). You might encounter 5% unemployment in the busy season and 10% at other times of the year.

Are some jobs transient? Areas around military bases are subject to fluctuations as thousands of military personnel are shuttled in and out. The service industries nearby may expand and contract accordingly. The workers at the nearby gas stations, pizza parlors and movie theaters may periodically get laid off or hired back.

What are the trends in your area? Are layoffs predicted in some of the basic industries? Or are local employers hiring?

It is a constant effort to keep informed; read the newspapers, utilize appropriate online sources, talk with people in the know; or drop in at the local chamber of commerce or planning agency. And remember - things could change tomorrow.

If unemployment rates are high, it can affect the housing market. People are not going to be buying houses if they are out of work. The market may get flooded with foreclosed houses, and depress prices further. Businesses may suffer as well as a decrease in people's purchasing power.

These next three categories (rental rates, rental vacancies, and expense levels) apply primarily to commercial properties, because these types of properties are often valued based on their income and expenses.

When appraising any type of income producing property, the value is primarily a function of the amount of net income a property is able to produce. This is the total income minus expenses.

Therefore, the rental rates in an area will impact property values. This applies in both residential apartments and in the rental of commercial or industrial space. If I have an apartment building that produces $30,000 annual net income, it certainly should be worth more than one that produces a net income of $20,000.

In residential appraising usually we consider the amount of rent per apartment. In some cases, for purposes of comparison, we break it down into rent per square foot of living area, per month.

Retail space is usually compared on the basis of dollars per square foot per year. Class A office space in an area may rent for $15 to $20 per square foot per year.

A property that is more valuable should be able to attract more rent. A property that can produce more rent should be worth more. Rent and value go hand in glove.

In analyzing a rental market, one of the first measures we look at is the percent of rental vacancies. This is analogous to the unemployment rate, in that lower is better.

It is possible for a rental property to be occupied 100% of the time, or 365 days a year for all units. You may find properties like that in a really hot rental market. When you encounter a property like this in a "typical" or "average" market, it generally means that the current rental rates are too low.

A well-managed property, running under optimal conditions, typically would generate a small vacancy percentage during a given year. Circumstances will change, and tenants will move. Also, management needs a little downtime to get in and make repairs and upgrades between tenants.

A relatively normal and healthy rental vacancy rate might be in the range of 4% to 5%, for a year. The statistics in your local marketplace are harder to track than the unemployment rate. The government is able to keep pretty close track on the unemployment rate because unemployed people apply for benefits.

The rental vacancy rates in an area are sometimes published in your local newspaper. Those kinds of statistics usually emanate from real estate brokers, appraisers, or management companies. You can also do your own checking by calling around to those people as well as other market participants, such as investors or building superintendents.

You no doubt are aware of the influence of the Baby Boomers. That generation has been described as a bulge moving through the system, as a result of a large number of babies born after the veterans returned from the Second World War.

They have had a large influence on the economy and many are now reaching retirement age. How will this affect real estate values and the types of houses that are being built?

In 2001, the first wave of baby boomers turned 55, which was significant because according to the Fair Housing Law, at age 55, a buyer is eligible to live in a legally "age-restricted" community.

The home building industry is feeling the impact of this demographic surge and seeing a growing demand for active adult housing which meets the needs, demands, and lifestyle of this unique generation.

The nation first became aware of the baby boomers as a group with an impact in the late 1960s, and they have been making their impression on the American culture, economy, and lifestyle ever since.

They are wealthy, controlling about 70% of the nation's wealth and 50% of all discretionary income.

In 2011, the oldest members of the Baby Boom generation began to turn 65 years of age. Beginning on January 1, 2011, approximately 10,000 baby boomers will reach age 65 every day for the next 19 years.

In 2010, only 13% of Americans were age 65 or older. By 2030, 18% of the nation will be at least 65 years of age.

Average family size in America has been decreasing steadily over the years. In the 1900s and 1930s people had large families. In the 1950s and 1960s the average family size was lower. The birth rate has been declining ever since.

Around the year 2000, the average U.S. family size dropped below 3.0 persons for the first time ever.

For the last several years, the average U.S. family size has held steady at 2.53 to 2.54.

Family households (defined as married couples or a man or woman living with other relatives) declined from 81% of all households in 1970 to 68% in 2010.
Married couple households with their own children declined from 40% of all households in 1970 to 23.5% in 2010.

In 2010, 25.8% of households were occupied by one person (56% of whom are women)
In 2010, 28.1% of households were occupied by married couples with no children
In 2010, 5.2% of households were occupied by unmarried partners
Add those up and you get the staggering statistic that almost 60% of current households are occupied by one or two people!

One would think this would have resulted in changes in new construction between 2010 and the present. The median sized new house built in 2010 had 2,169 square feet, which is over 100 square feet larger than the median new house in 2000, and over 250 square feet larger than the median new house in 1990.

However, according to the U.S. Census Bureau, the median size of new homes increased annually starting in 2010, peaking at 2,467 square feet in 2015. The median size decreased slightly in 2016 to 2,422 square feet, and for the partial year 2017, it declined even further to 2,388 square feet. It remains to be seen whether this decline is a trend, or just a temporary "correction."

Worth noting is that the 13.7% increase in the average new house size between 2010 and 2015 happened against the backdrop of a nationwide decline in average household size.

The general topography of an area may dictate development patterns or even preclude development in areas of severe slopes. If the topography of an area is generally open and level or moderately sloping, it opens up the possibilities for various kinds of development; either residential, commercial, industrial, agricultural, or recreational.

Hillside areas may prove desirable, gaining privacy and views. On the other hand, sloping land presents more construction problems and additional costs for leveling, terracing etc. It may be prohibitive to develop such land for commercial purposes.

It really is a matter of degree, pun intended. A little bit of slope may be nice but if it is too steep, it may limit land use to little more than growing trees or as a nature preserve.

What is the economic principle of scarcity?

What is the economic principle of value?

What is the relationship between scarcity and value?

Which is an example of the principle of scarcity?