Jun. 26, 2009

Real estate prices mystery solved

Have you ever thought about the reasons for the changes in property prices? In the following article, I will try explain the main factors behind the property prices’ shifts. This knowledge has been gained from over two decades working as a Toronto realtor.

Following the trend
How to calculate the next price move? How does one determine when it is best to invest? What majority buyers do is they simply watch for the previous direction of prices. In other words, their expectations are mostly affected by the previous movement. If the prices rise they expect the growth to continue, and vice versa. Although such a strategy does not consider the real factors that have an impact on the price, it is applied. Relying on this method alone can produce very painful experiences, just as we saw not too long ago. (picture by kevinzhengli)

Fundamental economic factors

What economic factors have the most significant impact on how prices are formed?
- Economic growth
- Nominal interest rates (before inflation) and structure of mortgage products
- Inflation
Let’s look at these factors in more detail.

Economic growth

The stronger the state of economics, the better it is for business as well as for real estate. One of the reasons is that when economics is stronger it raises property prices because the buyer gets reassured that there will be a rise in the demand for housing, and a rise in the value of his property which will enable him to sell it again for a profit. In accordance with BIS Quarterly Review, 1% of GNP increase is connected with 1% to 4% property price rise after 3 years.

Nominal interest rates and structure of mortgage products

In order that property prices grow, the very first thing needed is eager buyers. One implication of the fact that house lones have to be made when anyone wants to buy property, is that there will be many buyers who will go rather for houses with interesting mortgage products that includes low nominal rates. According to the mentioned source, a 1% drop in the nominal interest rate can be linked with 1/2% to 1% rise in property prices after 1 year. Equally, the buyers seem to be very sensitive to even a slight rise of nominal interest rates, causing the property prices to settle. But there are exceptions to the rule. For instance - a credit crunch occurs when official interest rates become of less importance and the loan market gets driven by different factors. Likewise is the real estate market.

Inflation

Property prices are strongly impacted by the rate of interest while changes in interest rates are influced by inflation. High inflation has a varied impact in different countries. Some countries see investing into property as balancing inflation in which case higher inflation will result in a rise of property prices (for instance Germany). Such countries may be characterized with fixed interest rate loans with no equity withdrawal. Although, high inflation will have a bad impact on property prices in countries where interest rates are floating, as in the UK, or with equity withdrawal as in the USA.

Conclusion

As with most rules there are exceptions and numbers and values do not always have to apply to your area. It is realtor's business to see the exceptions and differences. However, it is important to note that a general system is used by means of which real estate prices are created on the market. Don't let shallow attitude get thebetter of you. Think about every aspect of the market.

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