Thought Leadership

Supply and Demand in Private Real Estate

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James Domach

Associate

Hearing “supply and demand” likely evokes memories, good or bad, from your high school economics course. As a focal point of basic economic theory, it is a concept that follows us far beyond the classroom. The supply curve depicts how much of a good (product) will be provided at various price points, while the demand curve depicts how much of that good the consumer will desire at those price points. In a competitive market, the price is set where supply and demand are in equilibrium, or where the quantity demanded equals the quantity supplied.

The real estate market is no stranger to the concept of supply and demand. The applications and significance of the concept are perpetual considerations in the analysis and decision-making process for every potential acquisition. Smart real estate investors will analyze the supply and demand equation prior to investing and consider how that relationship persists over the investment horizon.

Supply and Demand Drivers in Real Estate

Before diving into the significance of this economic law in real estate, let’s first consider some of the relevant drivers for both supply and demand. Real estate is relatively illiquid; after all, these transactions are usually not quick, and when owned, one cannot simply produce liquidity without a sale or refinance of the asset. Additionally, it takes significant time to construct new buildings or renovate existing ones. Due to the longer lead times in real estate, it is important to understand that supply cannot adjust as quickly as it can with other goods and services.

Supply side drivers in real estate may include:

  • Material costs and labor costs
    • Recent supply chain disruptions and the tight labor market have increased the costs of goods and labor used in construction, making the building of new housing less feasible.
  • Policies regarding housing and development
    • Zoning, entitlements, low-income requirements, and rent control are all potential policy examples that impact supply in real estate.
  • Capital markets
    • The availability of capital (both debt and equity), and the cost of that capital, can have profound effects on new development supply.
  • Government intervention
    • Government intervention can drive capital in or out of a given market based on how landlord or development-friendly certain municipalities are.

These driving factors are in play on all levels of real estate, from building a single-family home to developing a high-rise apartment building.

Real estate demand drivers may include:

  • Population growth and household formation
    • A growing population needs places to live.
  • Job growth and wage growth
    • More employment opportunities in an area means more people are in search of housing, and wages impact the type of housing, location, and quality that is affordable.
  • Societal trends, such as lifestyle decisions or generational patterns
    • For example, individuals getting married later or young adults living with their parents longer (often related to the dramatic increased costs of single-family housing) are common societal trends.
  • Interest rate environment
    • On the acquisitions side (consumer or institutional), interest rates have a major impact on demand, as cheaper capital can make a purchase or an investment more achievable.

Of course, demand factors will vary slightly across different asset classes and geographical areas, but the same general trends remain important considerations.

Importance of Supply and Demand in Private Real Estate

At MLG Capital, private real estate is all we do. While private real estate may benefit from lower correlation to the public markets, these investments are less liquid, and investors expect a higher return in exchange for that illiquidity. Giving proper attention to the supply and demand equation’s impact on an acquisition is one way to help MLG make informed investment decisions for our series of Private Funds.

Consider the implications of the supply-demand equation being off-balance: in any asset class, consequences, or opportunities, will exist. For example, a market oversaturated with multifamily will put a major strain on other multifamily owners. These owners must adapt, providing some sort of additional competitive advantage when compared to the other supply in the area. The tenant (demand-side) has the market power to drive rental rates lower, benefit from concessions and flexible lease terms, and occupy the most amenity-heavy buildings in the best locations in the market. The owner will inevitably see their bottom line affected, whether it be through higher vacancy, increased concessions, and/or lower rental rates. As a result, investment returns will suffer.

Alternatively, a certain market may have little to no developable land available, or the local municipality makes it difficult to develop. Owning assets in a supply-constrained market gives the owner the market power to increase rental rates and maintain strong occupancy. Appreciation potential is high for owners in these markets.

A savvy investor in private real estate will recognize opportunities where certain conditions are met regarding the supply-demand equation. This investor will consider the current demand drivers and how they project to fare in the given market going forward. After all, real estate is also more likely to appreciate in areas with strong demand for that asset class.

Asking and sufficiently answering questions like the following provides increased insight into potential investments:

  • Will the area grow in population and household formations?
  • How will job growth and projected household income fare?
  • On the supply side, are there new assets planned or under development that will add to the existing supply in the area?
  • Will factors like high construction costs, local government regulation, or lack of developable land limit new supply and create more desirability for the asset?

Based on findings from above, what are the believable and achievable assumptions one can make during the investment hold period?

Conclusion

The balance of supply and demand for any asset class, at both the macro and local level, must be considered and reflected in underwriting assumptions, as this relationship is vital to making informed investment decisions. At MLG Capital, we examine supply and demand drivers at the macro, submarket, and down to a one-mile radius level. Among other practices, we consult market research reports, press articles, and local operators, and we consider the supply and demand drivers of the area during our on-site due diligence to fully comprehend the asset’s story.

In the multifamily sector, which our private funds are more concentrated towards, we pursue unique deals resulting from instances of supply and demand imbalance facing the broader United States housing market and individual markets. Today, in addition to buying in more stabilized markets, we see opportunity in areas with excess short-term supply but strong long-term demand drivers, where we can acquire properties at an attractive basis due to the temporary imbalance. Purchasing high-quality product, below replacement cost, in strong locations relatively insulated from new supply that boast robust demand drivers, is a story we always target. We believe these opportunities exist, and by executing on them, we aim to generate attractive, risk-adjusted returns for our investors. These supply and demand considerations weigh into every investment discussion with the goal of protecting our investors’ interests at the forefront.

If you have a deal that you think would be a great addition to our portfolio, reach out to our deal sourcing team. If you’re interested in our diversified private funds, learn more here.


James Domach is an Associate at MLG Capital, primarily focused on the underwriting and evaluation of acquisition opportunities in the Southeast. He enjoys playing and watching sports, especially University of Wisconsin teams, and spending time with friends and family. 


The author, MLG Capital, its representatives, employees, officer, directors, members, respective partners, agents and its affiliates (“MLG”) do not represent any recipients of this article (“Recipients”) and all statements made by MLG shall not be considered tax, investment or legal advice.  Recipients shall consult with their own tax, investment or legal professional regarding their personal financial and tax situation and its relation to the information presented in this article. This article does not constitute an offer or solicitation in any state or other jurisdiction to subscribe for or purchase limited partnership interests in an offering or a security. An investment into a private offering or other security are subject to various risks, none of which are described herein. Recipients of this article agree that MLG shall have no liability for any misstatement or omission of fact or for any opinion expressed herein.

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