fundamentals of real estate demand
how the market shapes the demand in real estate
My dad used to tell me that basketball is all about fundamentals. It is the same in real estate. A, if not the, most foundational concept in real estate is the concept of fundamental demand, or demand for space users; i.e., actual users of real estate. In other words, the actual users of real estate in any given market fundamentally shape demand for real estate.
house demand
This is why market participants—i.e., real estate brokers, developers, investors, lenders, etc.—are so concerned with the drivers of such demand, namely population, employment and income. Based on these drivers of demand, market participants can forecast changes in demand for real estate. For example, as employment increases there are more users requiring office and industrial space. As employment increases, population increases leading to more demand for housing. Finally, following growth in housing is growth in retail space. I will demonstrate this concept with the industrial market in the Albuquerque MSA and why an understanding of fundamental demand is crucial to understanding the ebbs and flows of the commercial real estate market. In order to proceed, we need estimates of current and future employment, a breakdown of employment by industry and current supply/demand. All of these figures are readily available from government data sources, select commercial brokerages and various data providers.
workforce solutions
According to the New Mexico Department of Workforce Solutions (NMDWS), there are 401,717 employed persons in the Albuquerque MSA, with an estimated 15% (60,258) of these being industrial-related jobs based on my review of employment levels by industry. NMDWS projects annual employment growth of 0.8% for the next 10 years. Further, according to CoStar Group, 49,137,851 square feet of industrial space is occupied. This reveals that there are 815 square feet of industrial space demanded per industrial-related employee. Finally, I’ll estimate that 150,000 square feet of new supply is added per year, consistent with average annual supply added the past five years as reported by CoStar Group. Based on this information, we can forecast industrial demand going forward, as shown in the following table:
Given the data available and assumptions made, this model indicates that industrial demand will increase concurrent with increasing employment; i.e., the estimated vacancy rate will decline over the next five-year period from 3.6% to 1.2%. This type of information can be powerful for decision-making, assuming the assumptions made are credible. With this information, developers can plan future projects hoping to meet the future demand for a particular type of product. Further, bankers can assess risk, investors can make buy/sell decisions, landlords or tenants can project future rental rates and more. Moreover, this type of information has a tendency to ground a market to reality during boom/bust cycles.
real estate factors
While there is a level of subjectivity associated with this type of analysis, which can be applied across property types in various ways, credible assumptions lead to realistic results. Regardless, it has been demonstrated that changes in employment directly relate to changes in demand for real estate. The same relationship could be demonstrated for population change and housing demand or income change and retail demand. While there can be other factors that affect demand for real estate, such as low interest or other forms of government stimuli, real estate markets have historically corrected to levels as dictated by the fundamental forces of demand. The next time you read a real estate-related article discussing employment, population or income or hear a real estate broker talking about the same, you’ll know why. As I said, it’s all about the fundamentals.