The Economics of Real Estate: 13 Factors that Affect Home Values

How much your home is worth depends on what’s happening in the real estate market. Home values are also influenced by various economic, demographic and property-specific factors. Sellers can use this information to set an appropriate sale price. Meanwhile, buyers may consider these factors to make a competitive offer. 

The local and broader economy can impact the real estate market and home values. This is measured by key economic indicators, including interest rates, inflation and employment data. 

Generally speaking, lower interest rates, lower inflation, and higher employment rates mean more people can afford to purchase a home. With more buyers in the market, demand and, thereby, property values increase. If the economy slows down, it can affect affordability.

Mortgage interest rates greatly impact mortgage affordability. The higher the interest rate, the more a borrower typically pays in interest over the loan term. While a lower interest rate means it costs less to borrow money, it can also impact home prices.

According to the Federal Reserve Bank of Richmond, homebuying demand will rise in the near term with lower interest rates, leading to an increase in home prices. Higher home prices also raise the income required to qualify for a mortgage.

“Lower rates increase affordability, driving demand and home prices higher,” says Christopher Brown, principal/broker at NEXT New Homes Group in California. “High rates tend to dampen prices.”

Inflation refers to the rise in the price of goods and services over a period of time. As long as income rises with inflation, the impact on housing prices is minimal. If inflation rises faster than income, it reduces consumers’ purchasing power and the cost of living increases more noticeably. 

Higher inflation also means pricier building materials and rising mortgage rates. This results in higher home prices and lower housing affordability. When the cost of building materials goes up, it’s generally more expensive to build new homes. When interest rates increase, so does the monthly housing cost for people who take out a mortgage.

At the same time, inflation can soften demand. This is particularly true if the economy suffers job losses that push prices down.

The stability of the job market can influence the demand for housing, and consequently, home values. 

According to the National Association of Realtors (NAR), rising incomes enable people to afford to purchase a home, increasing demand. Housing demand is typically stronger in areas where income rises faster than the national level. 

“Strong job markets and rising incomes increase buyer power, boosting home values,” Brown says. 

In an analysis conducted by Freddie Mac, per capita income has the largest impact on house prices. A 1% increase in per capita incomes typically results in a 1.5% increase in home prices.

But a wavering or poor job market has the opposite effect. “Economic downturns or unemployment reduce demand,” Brown adds. 

Data from the Bureau of Labor Statistics shows that the national unemployment rate went from 5.0% in December 2007 to 10.0% in October 2009 during the 2008 recession. During this time, demand for housing fell, and households lost over $16 trillion in net worth. Home prices fell by 33% during the recession, but have since rebounded, according to a report by CoreLogic.

Even local industries and businesses help drive home demand. A robust local economy often fuels job creation and increases the average income in an area. That can result in an increased demand for housing. During times of economic stability, people may be more willing to make large investments, including purchasing homes.

“The local economy is always going to have some impact on local home prices,” says Aaron Luttrull, president at Schuler Bauer Real Estate Services in Indiana. According to Luttrull, home prices generally increase if the economy is growing, jobs are being created, people are moving to the area and demand increases on an existing inventory. “Supply and demand dictate that the higher the demand goes, the higher the prices are going to be affected by that,” Luttrull adds.

If there are job losses and people are moving away from the area, it’ll have the opposite effect. “I remember in Kokomo, Indiana, at one point in time when they had an automobile manufacturing plant that closed down and a lot of jobs were lost,” Luttrull recalls.  “The home values were obviously impacted in a negative way at that time.”

Demographic factors include information on the size, growth, age and household formation of the local population. These factors all have a direct influence on the housing market.

As more people move into an area, so too does housing demand. “Growing populations, especially in desirable areas, drive demand and increase home values,” Brown explains. 

Freddie Mac found that for every 1% increase in population, home prices increase by 0.03%.

“Influxes of people moving to certain areas (e.g., from cities to suburbs) can boost local demand and push prices upward,” Brown says. “We saw this during the post-COVID era as many people could work from home and we saw large migration across the country to more desirable or affordable markets.”

On the other hand, when the population declines, home values decrease as demand wanes. A lower population means there’s less demand, more available housing and less competition. The same analysis found that a 1% increase in per capita housing stock (housing stock/population) reduces prices by 0.83%.

People often have different housing preferences based on their age and current stage of life. “Areas with a younger population often see demand for starter homes, while regions with retirees may see higher demand for downsized or luxury homes,” Brown says.

In areas with a younger population, housing preferences may lean towards rental properties and starter homes.

Household formation is the change in the number of households in a given area over a period of time. New household formation can drive demand for single or multi-family housing, impact the housing supply and drive up housing prices.

Factors like marriage, divorce and cohabitation also affect household formation. 

Marriage and cohabitation create new households, while divorce often separates households to create new ones. Marriage and cohabitation can often increase purchasing power and demand for housing, potentially raising home prices. 

Conversely, divorce may form new households, but it can potentially reduce purchasing power and put downward pressure on home prices.

Local market conditions and property-specific factors, including location, condition, local school districts and neighborhood amenities, all impact a home’s value. 

Real estate agents can use this information to conduct a comparative market analysis (CMA). Agents look at comparables, which are similar homes in the area that have recently sold, to help sellers price their homes or give buyers a competitive edge. 

“We evaluate these against our subject property and make adjustments up or down for various

differences in square footage, lot size, age, updates, appearance, etc,” Brown explains. “Once we have this list of adjusted comparables we can see where our subject property should be priced in the market.”

The saying “location, location, location,” is well-known in real estate for a reason. Location is one of the most important elements that people consider when purchasing a home.

During a home appraisal, an appraiser may consider the following factors when determining home valuation:

• Neighborhood safety
• School districts
• Proximity to amenities
• Walkability
• Cleanliness and maintenance
• Local economic factors
• Historical significance
• Environmental factors

Buyers may pay more for a home if it’s in a good school district or close to desirable amenities. Meanwhile, a busy road or a nearby airport could hurt a property’s value.
Local zoning laws and land use regulations can also directly affect property values. Zoning and land use laws govern how property can and cannot be used in certain areas. Local governments can also change these laws, which can impact current home values. However, strict single-family zoning regulations can reduce the housing supply and artificially inflate housing prices, according to the National Association of Housing and Redevelopment Officials.

The property’s square footage, age and condition can affect how much buyers are willing to pay. “The condition and age of the home determine how much work a new buyer has to put in,” Brown states. “Well-maintained or newly renovated homes command higher prices. Homes needing repairs or outdated features lower value.”

Brown also says that the size and layout of the home are important. Larger homes or those with modern, functional layouts, such as open floor plans or an energy-efficient design, tend to sell for more.

This is where a homeowner can make a direct impact on their home’s value. Regular maintenance and upgrades can increase its value, but some renovations are worth more than others.

NAR’s 2024 Home Buyers and Sellers Generational Trends Report found that 30% of all buyers had children under the age of 18 living at home. Additionally, 18% of all buyers said the quality of the school district was a factor influencing their neighborhood choice. Only 2% of buyers compromised on the distance from school when selecting a home.

“School districts are always going to be one of the things that families with children are going to take a look at to try to determine where they want to live,” Luttrull says.

Families with children often prefer to live in an area with a highly-rated school district and will pay a premium to live in these desirable areas. In response, sellers also consider the local school district when pricing their home and putting it on the market.

A well-planned community with access to desirable amenities, such as parks, shopping centers and transportation options, is more likely to increase in property value over time.

“Proximity to schools, jobs, shopping and amenities significantly impacts home value,” says Brown. “Homes in desirable neighborhoods often see higher appreciation.”

There are additional factors that affect home values. The supply and demand of available housing and certain government policies impact the housing market. 

In a balanced market, there are an equal number of buyers and sellers, and the market typically has five to six months' worth of homes for sale. This means that it would take five or six months to sell all of the home inventory in that market at the current sales pace.

When demand for housing is high, but supply is low, sellers can command a higher price for their homes. Conversely, if there’s a high supply of homes, but low demand, homeowners may lower their prices to entice buyers.

Local tax policies and property regulations can impact a home’s affordability.

Homeowners pay property taxes based on their home’s value and the tax rates for the county or city. Tax rates are calculated by multiplying the millage rate by the property’s assessed value. If property taxes are high, homeowners pay more for housing costs. This can dissuade prospective buyers from certain areas and bring prices down.

On the flip side, local governments may offer tax incentives to attract buyers or encourage development. This can potentially increase demand and property values, based on data from the Tax Policy Center.

Government-backed housing programs are another factor that can stimulate housing demand and increase home values. These initiatives offer lower interest rates, more favorable terms, low down payment options, and more lenient credit requirements. The impact of these programs makes homeownership more attainable for low-income and first-time buyers.

“A home’s value is based on simple things like beds, baths, square footage, the neighborhood, interest rates, market trends, etc,” says Brown. “But the true value of a home comes down to the emotional connection a homebuyer makes with it and the value they put on that connection.”

Determining what a home might be worth is important, regardless of whether you’re buying a home or selling a home. To get a home value estimate, consider searching the property address on Homes.com. Each home listed includes an estimated property value, which is determined through an analysis of four valuation models.

By understanding these elements, homebuyers and investors can make informed decisions when navigating the real estate market.