How Supply and Demand Works in Commercial Real Estate

A graph depicts supply and demand.

Investing in commercial real estate requires unique dependence on and understanding of a fluctuating market, as supply and demand constantly shift. As a transactional market, real estate relies on the fixtures, buildings and properties on land which then creates distinct interactions between buyers and sellers.

What is Supply and Demand?

Supply and demand depend on the relationship between a buyer and a seller and is inarguably a fundamental principle of economics. Supply is the concept that a higher price will persuade sellers and producers to increase the number of products or services on the market. When market interest causes the price of an item to go up, sellers invest in producing more of that item to increase their revenue. On the other hand, when supply is low, prices will rise as consumers hurry to purchase the available supply.

Supply and demand are directly related. Demand is the idea that consumers will urge for a lower quantity of a good if it’s set at a high price. This means that as prices rise, fewer consumers will acquire that service or product. However, the opposite occurs when prices are lowered, as consumers flock to purchase the good when it’s cheaper.

Supply and demand work against one another until a product, service or property reaches equilibrium price. This price is the closest estimate of the worth of a tangible material investment property.

Real Estate Supply and Demand

When the demand for housing and commercial properties is high — due to increased popularity in a community or particular market — prices rise. This puts property sellers in the ideal position of accepting bids at or above the asking price which, in turn, raises prices across the market.

However, when the supply of real estate properties is high, the demand drops, forcing prices to lower cross-market and putting sellers in the position to accept lower bids for properties on the market. In real estate, this decrease in demand is often a reaction to a previous increase that created a housing market many buyers cannot afford. When buyers aren’t bidding, the seller is forced to drop prices again and invest in increasing supply in new investments, which keeps the real estate market ever fluctuating. Since real estate is hard to buy and sell quickly, the market is susceptible to illiquidity, lower interest rates and borrowing costs.

Commercial real estate is just as susceptible to supply and demand as residential real estate. Scarcity can be both a detriment and a benefit to commercial property transactions, as low supply can increase prices and induce higher supply. However, high demand in commercial land development is often tied to property scarcity as well.

The financial crisis in the mid-2000s was a result of the influx of supply and demand in the real estate market. An oversupply of housing after a particular uptick in demand in 2007 led to several investors, buyers and sellers pulling out of real estate transactions, resulting in the Great Recession from late 2007 to 2009.

Real estate supply is dependent on the amount of housing, buildings and properties available for transaction. This industry relies on tangible material assets — something dependent on the physical construction and ownership of property. As commercial real estate prices rise and fall with the market, supply and demand continue to flux.

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