Introduction
In a recent article in the Washington Post (28th November, 2011) by Elizabeth Norton, the real estate market still remains strong despite the harsh economic conditions. There has been continued investment in real estate especially in quality high end apartments. But the general demand has reduced due to high interest rates imposed by several banks and financial institutions.
According to the article, Real estate is one of the biggest portions of wealth among Americans, especially home owners. Washington State has nearly a third of its wealth in form of real estate. As of 2003, the Washington recorded about 1.7 million homes. The state also recorded about 157,000 homes resale grossing about 36.4 billion US dollars. In the same year 33,000 new homes were constructed at a cost about 7.5 billion US dollars (Norton, 1). This according to an investment agency in the state is a significant rate in terms of economic activity.
However, after the credit crunch that began around 2007 through to 2010, the real estate sector has since curtailed in activity. The country suffered a recessive economy in which people lost their jobs and homes to financial institutions. At this time, Real Capital Analytics estimated that nearly one half of the real estate sector was in financial trouble . On a lighter note, the sector has been improving as the economy tries to emerge from the turmoil of the crunch. Jobs have started to improve as the economy shifts from a recession towards progress.
As we go into the future, factors affecting the real estate market in the state of Washington are going to be quite varied. Traditionally, sales in real estate and especially home sales have relied on four major aspects. One of the key factors that have influenced real estate sales is the neighborhood and its lifestyle. Experts refer to this as the demographics of the location. Secondly, the economic state of the country, in comparison with the state will also determine how the sector performs. For instance, the ability for individuals to get jobs and get value for their money will be an incentive to buy homes. The third factor that affects home sales is government policy and subsidies which help boost the demand for homes. Finally and probably the most significant of factors is the interest rates.
Interest Rates and its Impacts on Real Estate
In Washington State, real estate development is mainly undertaken through credit funds. Assets in the US are financed through credit sources since it has proved to a cheap method for financing. Home owners therefore take such options to acquire assets and furnish payments for the loans together with the interest appended. It is only reasonable for investors to take up homes if they can manage to pay for the interest (Norton, 2)
Cash Flows
Norton illustrates that when interest rates increase, the cost of borrowing capital greatly increases which has a direct impact on the supply and demand of assets such as real estate. This is because as the demand for assets dampens, investors of such assets stop investing. This makes financial institutions to stop borrowing funds from peers and the Federal
Reserve. Banks and institutions borrow funds from peers and the Federal Reserve so as to advance loans to investors. In a situation where the Federal Reserve is not in a position to move bonds in the market due to high interest rates, the country will have a total breakdown in cash flow. Such a situation creates a chain of event leading to the poor sales in the housing sector Norton, 1)
The federal government has since shifted its monetary policy from regulation of financial institution to managing consistent interest rates in the market. However, in the recent past China, America’s biggest financier has been adjusting its currency rates putting the interest paid for loans to China rather unpredictable.
Valuation Methods
One of the major impacts of interest rates on the real estate market is valuation of assets. While several companies could argue that market forces of demand and supply determine the cost of an assets, scholars and current investors use a rather different technique known as the income valuation technique (Norton, 2).
In this method, a forecast on the future income of the property is performed and compared to future costs associated to that asset. For instance in case of leasing or mortgaging a property, the owner of the asset would have to include financing cost for building the asset in computing the mortgage or lease rate. Due to high interest rates this amount will increase reducing demand for the real estate asset.
In conclusion, interest rates will be leading determinant of the real estate sector in the future. Interest rate is also a major determinant in other economic sectors. The Federal Reserve has done well to shift focus to managing the cost of capital (Norton, 3)
Work Cited
Norton, Elizabeth. Real estate professionals say Washington remains strong, but federal cuts loom. 28 Nov 2011. 30 Nov 2011
