Why Home Prices Rise - or Fall

A home is primarily a place to live, but truth be told, most homeowners hope to make a profit, known as a "capital gain," when they eventually sell their home. Sometimes, those hopes are realized; other times, homes are sold at a loss or perhaps just at break-even after the transaction costs are paid.

What determines house prices?
House prices fall under the principles of supply and demand. The value of an individual home depends on the location and condition of that home and how desirable it is to local buyers. Yet other factors, such as population growth, construction of new housing, the local job market, the relative affordability of rental housing, mortgage interest rates, household incomes and property taxes, all play a big role in home values. Savvy buyers and sellers know these factors can make a big difference in the price of a home and whether or not the home is sold for a financial gain or loss.

Population and job growth boost demand for housing
Population growth generally translates into higher home prices since more people create more demand for housing. An influx of new residents and increased household formation (when young people move out on their own) are two examples of factors that increase demand. Many coastal cities have experienced strong population growth and higher home prices in recent years.

Cities that have relatively high unemployment or a net loss of jobs over time may experience weak housing markets and lower home prices while cities that have a growing job market, high-paying jobs and rising salaries and bonuses tend to have higher home prices. The presence of major employers who relocate large numbers of workers into the area can contribute to higher home prices as well. Detroit is an example of a city where loss of jobs has depressed home prices.

Construction of large tracts of new homes also can impair the prices of existing homes since those new residences add to the supply of available housing. Cities such as San Francisco and Boston where the supply of vacant land is limited and empty lots are expensive tend to have higher home prices as a result.

Strong markets mean fatter gains
For buyers, market factors may influence whether they opt to purchase or rent a home and, if they decide to buy, how much money they'll need to spend. For homeowners, these factors may affect the timing of when they decide to sell their home and whether they'll then purchase another home or become renters.

The bottom line is that a profitable home sale is more likely in a locale where market factors are positive for housing. Population growth, strong employment and a limited supply of land all increase the chances of home price appreciation.