We've all heard the real estate mantra, "It's all about location, location, location." It hangs around because it's true, at least within the confines of human behavior. But, it's not the only factor in home prices, though arguably the most important. Let's take a look at the three factors I believe have the greatest influence on home prices.
Location
There is no arguing with the fact that some locations are far more desirable and in demand than others. For some it's the proximity to the ocean or a lake, for others it's the upbeat and vibrant community, or the predominance of a certain age and interest group. These are all evident in communities on the coasts, technology dominated cities, and core downtown areas with lots of nightlife.
People who want to live in a certain location will obviously pay more to do so if they can afford it. In California areas like La Jolla and San Francisco, prices are considerably higher and they've always been that way. So, location is the primary factor in what you'll have to pay for a home. However, there are other less obvious factors that can be important as well.
Competition
Competition follows population growth. I'm talking about developers and contractors who see opportunity and move in to take advantage. While location and human desires can drive prices upward, competition can help to hold the line or drive prices downward. The geographical size and limitations of highly desired areas can put a real damper on competition though. In some vacation/resort areas, there are too few contractors building homes, and higher prices to get building materials to the site are common.
In larger urban areas, the competitive factor can help though. More builders and concentrated subdivision activity bring an economy of scale into play. A builder loves the ability to have multiple jobs in progress close to each other, as supervision, quality control, and bulk materials purchase and delivery work in their favor. When their costs decrease, the price of the homes they sell do as well.
Regulation
The more people in a growing area, the more regulation of property usage and development there seems to be. Some of it is necessary, and some may be about "closing the door behind" them. People want to preserve the features and characteristics that brought them to the area in the first place. We all want to keep growing populations from destroying natural beauty and nobody wants a paved world.
As regulations are put into place, they always have a cost of compliance, and this contributes to home prices. Many regulations are also about which materials are approved, both for safety and quality reasons. It's difficult to measure the cumulative effect of regulations on home prices in an area, but if you ask contractors, you'll find that they definitely do.
It's a cumulative effect beyond location alone.
Supply and demand is where competition can help to hold home prices down or slow their growth. Location is always going to be the top price contributor. Regulation is a follow-up to growth and contributes to price appreciation. Once we own a home, we all want it to grow in value, so all of these factors work together to spur home price inflation over time.
If you own a home, all of this improves your long term investment outlook. If you want to buy one, it makes it more difficult as time passes, unless your wages are growing proportionally. Unlike some advertising tells us, it's not always a great time to buy a home. But, over the long haul it's always been a good investment if you can hold it long enough. Zillow.com's Breakeven Horizon Analysis is showing that increasing rents are definitely making owning a better idea in many areas, though it's very location-specific.
Unfortunately, no matter how great the buy-vs-rent numbers look, you still need a down payment, good credit, and the ability to make those monthly payments. Economic and job growth are necessary to change the ratio of home formation from rental to ownership.