Supply and Demand

The residential home market, much as the oil price is at the vagaries of capitalist supply and demand economics. What do these two have in common?

On the surface it seems simple to explain the oil price: demand exceeds supply and therefore the price increases. A simple explanation except that the northern hemisphere has experienced its mildest winters in decades and most industrial nations have huge stockpiles of the black gold at present yet the high price of this fossil commodity remains above $60 a barrel. OPEC - who supply a large proportion of the world's oil - have also not cut production so we can't attribute a fall in supply to the price.

The cost price of oil is not a factor as production costs have not trebled in the last 12 months - although the perceived future increase in production costs has.

The conclusion that we to come to is that the simple dynamics of supply and demand are not sufficient to explain the rampart prices. Enter perception. Even the idea of a constriction in supply - like a hurricane like Katrina, which actually had almost no effect on production, or the ongoing Bush threats to many middle-eastern countries with non-American aligned economies - causes group panic and purchasing which leads to a self-fulfilling prophesy of increased prices.

Over the last six months, every bomb blast in Baghdad, or anywhere else in the world seems to contribute to a collective fear of a lessening in supply or an increase in demand. The point is that the oil price is so high because people think it should be so high even though in reality these issues are NOT causing the escalation.

The similarity to house prices in South Africa is pertinent. Even though there might be a slowdown in demand in certain sectors of the market, prices remain high because people think that that is what they should be paying for property.

Prices in Cape Town are much higher than elsewhere because people in Cape Town think they should be paying a lot more for property than people in Johannesburg even though the building costs are similar and land prices are not that disparate. People's perception - and willingness to pay - these prices contribute to the existing and sustained bullish market.

The same argument could be made for properties being undervalued in Johannesburg because of group perception of value too. Either way the price or value within a market is determined largely by people's perception of that market and .

The interesting situation is that when value is equated with perception an event that changes perception suddenly will have the same pronounced effect on the market. Let's say South Africans talk about preventing foreigners from buying property in this country and even talk about forcing existing foreign owners to sell.

As the rumour markets go, if enough people buy into this negative group- lemming-like thinking that the effect will be to bring down property prices in Cape Town, property prices will come down in Cape Town. People will suddenly not be willing to pay what they were last year and sellers will be forced to sell - if they're serious sellers - at reduced prices further enforcing the group perception.

Reality is as we perceive it to be.

If, however, only some people buy into this group thinking and not enough momentum is achieved than the market just becomes great for some buyers who suddenly have the pick of properties and huge leverage when negotiating deals.

Interesting times. Happy buying.

Article by: Dave Welmans - www.thepropertygame.co.za