The Business Of Real Estate
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Chapter 2
The Business of Real Estate
1
Chapter 2: The Business of Real Estate
Overview Real estate markets and the mortgage industry are interrelated: • Real estate can be affected positively or negatively by interest rates • Interest rates depend on supply and demand for money • Loan activity depends on availability of money • Property values depend on the health of the economy 2
Chapter 2: The Business of Real Estate
Overview Chapter 2 covers: • Four broad forces influencing real estate cycles (P E G S) • Government influences on real estate finance − Fiscal policy and taxation, monetary policy, and four tools the Fed uses • How actions of the Fed affect interest rates
3
Chapter 2: The Business of Real Estate
Key Terms • • • •
Business Cycles Discount Rate Economic Base Fed Funds Rate
• Federal Open Market Committee (FOMC) • Federal Reserve Board (the Fed) • Fiscal Policy
4
Chapter 2: The Business of Real Estate
Key Terms • • • • •
Inflation Interest Rate Monetary Policy Moral Suasion Open Market Operations
• Real Estate Cycles • Reserve Requirements • Supply and Demand
5
Chapter 2: The Business of Real Estate
Business Cycles • General general swings in business resulting in expanding and contracting activity during different phases of the cycle. • The 4 phases of the business cycle are: 1. Expansion 2. Peak 3. Contraction 4. Trough (remember "EPCoT") 6
Chapter 2: The Business of Real Estate
Cycle Influences Business and real estate cycles are influenced by many factors and respond to: • Supply and demand • Inflation • Interest rates
7
Chapter 2: The Business of Real Estate
Cycle Influences • Law of supply and demand: For all products, goods, and services, when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise • Inflation: Increase in cost of goods or services • Interest rates: Additional percentage fees a borrower pays to use a lender’s money
8
Chapter 2: The Business of Real Estate
Real Estate Cycles • General swings in real estate activity resulting in increasing or decreasing activity and property values during different phases of the cycle • Factors that separate the housing market from other supply and demand models: 1. Lag time in response to changes in supply and demand 2. Limited supply of land in any given area 9
Chapter 2: The Business of Real Estate
Causes of Real Estate Cycles
• • • • • •
Supply of land Inflation Cost of money Availability of credit Construction costs Health of the economy
10
Chapter 2: The Business of Real Estate
Other Influences on Real Estate Cycles • • • •
Demographics Population shifts Growth Monetary policies
11
Chapter 2: The Business of Real Estate
Broad Forces The four broad forces that affect real estate (remember P E G S): 1. Physical 2. Economic 3. Governmental 4. Social
12
Chapter 2: The Business of Real Estate
Physical Forces Can include location and popularity • • • • •
Jobs Climate Land availability Land desirability Environment (e.g., waterways, pollution)
13
Chapter 2: The Business of Real Estate
Economic Forces • Economic base of an area is the main business or industry a community uses to support and sustain itself • Economic forces can include: – Inflation – Cost of money (interest rates) – Availability of credit
14
Chapter 2: The Business of Real Estate
Government Forces • National government influences: – Taxation – Secondary markets – Fiscal and monetary policies – Government financing programs – Federal regulations • Local government activities are also having a greater effect on the real estate market
15
Chapter 2: The Business of Real Estate
The Business of Real Estate
• Social factors include: – Demographics – Migrations – Family size
Population shifts Growth Age
• As populations grow and change, so do their housing needs
16
Chapter 2: The Business of Real Estate
Government Fiscal Policy
• The government's plan for spending, taxation, and debt management • Ultimate goals of fiscal and monetary policies: – economic growth – full employment – international balance of payments • Deficit spending and taxation: Two policy tools Treasury Department uses to implement fiscal policy 17
Chapter 2: The Business of Real Estate
Deficit Spending • Occurs when government spends more money than it takes in from tax revenue • If the government spends too much money, then there’s less money available for people to borrow, which could increase interest rates
18
Chapter 2: The Business of Real Estate
Taxes • Directly impact spending habits and abilities of businesses and individuals • Can also have secondary effects on real estate and mortgage financing • Tax provisions: – Raise revenue, – Implement social policies by encouraging or discouraging certain behaviors or activities
19
Chapter 2: The Business of Real Estate
Tax Provisions* that Affected Real Estate
• Tax Reform Act of 1986 • Taxpayer Relief Act of 1997 • American Recovery and Reinvestment Act of 2009 * While it’s a good idea to stay current on fiscal policy and tax laws, you should NEVER give tax advice to anyone. Refer people to tax professionals because tax laws are complicated and change frequently. 20
Chapter 2: The Business of Real Estate
Government Monetary Policy
• Government’s mechanism to exert control over supply and cost of money
• Goals: – Economic growth – full employment – international balance of payments
• Tries to maintain stability in prices, interest rates, and financial markets 21
Chapter 2: The Business of Real Estate
Federal Reserve Board (the Fed)
• Responsible for U.S. monetary policy, maintaining economic stability, and regulating commercial banks • Fed's structure spreads power three different ways: 1. Geographically 2. Between private and government sectors 3. Among bankers, businesses, and the public
22
Chapter 2: The Business of Real Estate
The Fed is Comprised of • Board of Governors (Federal Reserve Board) – 7-member committee that controls the Federal Reserve System
• Federal Open Market Committee (FOMC) – Controls the Fed’s open market operations: Sale and purchase of government securities
• Federal Reserve Banks – Provide services to financial institutions. 23
Chapter 2: The Business of Real Estate
The Fed is Comprised of • The Federal Advisory Council – Meets quarterly with the Board of Governors to discuss business conditions and make policy recommendations
• More than 5,000 member banks – Have some input into the Fed's policies via the election of six directors to its district Federal Reserve Bank
24
Chapter 2: The Business of Real Estate
Federal Housing Financing Agency (FHFA) • Created under the Housing and Economic Recovery Act of 2008 • Will oversee Fannie Mae, Freddie Mac, and the Federal Home Loan Banks • With its initial creation, it was not clear whether there will be any changes to the organization of the Federal Reserve System 25
Chapter 2: The Business of Real Estate
The Fed and Monetary Policy
• Through monetary policy, the Fed can make more or less money available for banks to lend – in effect raising or lowering interest rates for the banks' customers
• Tools used by the Fed to implement monetary policy (D O R M): 1. Discount rates 2. Open market operations 3. Reserve requirements 4. Moral Suasion 26
Chapter 2: The Business of Real Estate
DORM • Discount rates or federal discount rates are interest rates charged by Federal Reserve Banks on loans to member commercial banks. • Open market operations are when the Fed sells or buys government securities (bonds) as a means of controlling the supply of, and demand for, money. 27
Chapter 2: The Business of Real Estate
DORM • Reserve requirements are the percentage of deposits commercial banks are required to keep on deposit—either at the bank or in the bank's own accounts • Moral suasion is using persuasive influences on the public and financial markets so they will perceive credit in a specific way 28
Chapter 2: The Business of Real Estate
Adjusting Interest Rates • Manages growth of money supply to allow adequate growth of the economy at reasonable interest rates. • The Fed now tries to anticipate future economic conditions rather than simply react to them
29
Chapter 2: The Business of Real Estate
Summary 1. Business cycles are general swings in business activity. Four phases are expansion, peak, contraction, and trough. Real estate lags behind business cycles. The law of supply and demand says that for all products, goods, and services when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise.
30
Chapter 2: The Business of Real Estate
Summary 2. Inflation is an increase in the cost of goods or services; also called cost inflation because manufacturers pass along increased costs. Inflation is also too much money chasing too few goods; also called demand inflation because too many people with money want to buy the same thing. Interest rates are extra fees people or businesses must pay to use another’s money for their own purposes. Inflation pushes interest rates higher or lower. Interest rates are a primary factor in determining demand for real estate.
31
Chapter 2: The Business of Real Estate
Summary 3. Real estate cycles are the response of real estate and mortgage markets to the forces of supply and demand. Two things separate the housing markets from other supply and demand models: The lag time for construction industry response and limited supply of land.
32
Chapter 2: The Business of Real Estate
Summary 4.
Physical, economic, government, and social forces (P E G S) affect real estate cycles. Physical: Location, popularity, climate, environment; internal or external. Economic: Economic base of an area (critical for home values), cost of money. Federal government: Fiscal policy (taxes), monetary policy (interest rates), regulation; State/local government: Revenue-generating (taxes) and regulating (Police power: Land use controls, zoning, environment, eminent domain, escheat). Social factors: Demographics, migration, family size, population shift, growth, age. 33
Chapter 2: The Business of Real Estate
Summary 5.
Fiscal policy is the government’s plan for spending, taxing, and managing debt. The Treasury Department carries out fiscal policy by issuing checks, collecting taxes, and issuing notes to cover deficits. Tools of fiscal policy are deficit spending and taxation. Deficit spending occurs when expenditures exceed revenues. Taxation is a way to collect revenue and implement social policies, such as giving tax deductions for mortgage interest to promote home ownership.
34
Chapter 2: The Business of Real Estate
Summary 6.
Monetary policy is government’s way to control supply and cost of money. The Federal Reserve Board (the Fed) is responsible for monetary policy, maintaining economic stability, and regulating commercial banks. Policy tools (D O R M): Discount rate (interest rate charged to member banks on overnight loans); open market operation (Fed sells/buys bonds to adjust money supply and demand); reserve requirement (banks must keep money on deposit—can’t lend it out); moral suasion (using persuasive influences on public and financial markets).
35
Chapter 2: The Business of Real Estate
Quiz 1. The cost of money a. does not affect demand for real estate. b. greatly influences a homebuyer’s decision. a. has no influence on a homebuyer’s decision. b. is not the same as interest rates.
36
Chapter 2: The Business of Real Estate
Quiz 2. The economic base of an area a. creates buyer’s markets but not seller’s markets. b. does not influence the local housing market. c. gives stability to a region, supports real estate values, and determines housing supply in an area. d. is responsible for government money coming in to support an area. 37
Chapter 2: The Business of Real Estate
Quiz 3. In a healthy economy, supply a. fluctuates significantly. b. is in balance with demand. c. is less than demand. d. significantly outweighs demand.
38
Chapter 2: The Business of Real Estate
Quiz 4. The law of supply and demand says that a. for all products, goods, and services when demand exceeds supply, prices will fall and when supply exceeds demand, prices will rise. b. for all products, goods, and services when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise. c. real estate doesn’t respond at all. d. there will always be a shortage of houses due to population growth. 39
Chapter 2: The Business of Real Estate
Quiz 5. The United State Treasury a. gets most of its funds from federal income taxes. b. is considered the nation’s fiscal manager. c. manages the government’s finances. d. all of the above
40
Chapter 2: The Business of Real Estate
Quiz 6. The interest rate charged by the Fed to member banks that borrow money against their deposits is called the a. b. c. d.
deposit insurance. discount rate. prime rate. reserve requirement.
41
Chapter 2: The Business of Real Estate
Quiz 7. The percentage of deposits that banks are required to maintain on deposit with the Federal Reserve System is called the a. b. c. d.
deposit insurance. discount rate. prime rate. reserve requirement.
42
Chapter 2: The Business of Real Estate
Quiz 8. Excessively high levels of government borrowing could lead to a. excess funds for real estate investment. b. government securities disappearing from the open marketplace. c. high interest rates. d. low interest rates.
43
Chapter 2: The Business of Real Estate
Quiz 9. The agency responsible for supervising the growth of the nation’s money and credit supply and regulating banks is the a. b. c. d.
FDIC. Federal Reserve Board. Office of Thrift Supervision. U.S. Treasury.
44
Chapter 2: The Business of Real Estate
Quiz 10. The Federal Reserve Board influences interest rates with a. b. c. d.
federal discount rates. open market operations. reserve requirements. all of the above
45
The Business of Real Estate
1
Chapter 2: The Business of Real Estate
Overview Real estate markets and the mortgage industry are interrelated: • Real estate can be affected positively or negatively by interest rates • Interest rates depend on supply and demand for money • Loan activity depends on availability of money • Property values depend on the health of the economy 2
Chapter 2: The Business of Real Estate
Overview Chapter 2 covers: • Four broad forces influencing real estate cycles (P E G S) • Government influences on real estate finance − Fiscal policy and taxation, monetary policy, and four tools the Fed uses • How actions of the Fed affect interest rates
3
Chapter 2: The Business of Real Estate
Key Terms • • • •
Business Cycles Discount Rate Economic Base Fed Funds Rate
• Federal Open Market Committee (FOMC) • Federal Reserve Board (the Fed) • Fiscal Policy
4
Chapter 2: The Business of Real Estate
Key Terms • • • • •
Inflation Interest Rate Monetary Policy Moral Suasion Open Market Operations
• Real Estate Cycles • Reserve Requirements • Supply and Demand
5
Chapter 2: The Business of Real Estate
Business Cycles • General general swings in business resulting in expanding and contracting activity during different phases of the cycle. • The 4 phases of the business cycle are: 1. Expansion 2. Peak 3. Contraction 4. Trough (remember "EPCoT") 6
Chapter 2: The Business of Real Estate
Cycle Influences Business and real estate cycles are influenced by many factors and respond to: • Supply and demand • Inflation • Interest rates
7
Chapter 2: The Business of Real Estate
Cycle Influences • Law of supply and demand: For all products, goods, and services, when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise • Inflation: Increase in cost of goods or services • Interest rates: Additional percentage fees a borrower pays to use a lender’s money
8
Chapter 2: The Business of Real Estate
Real Estate Cycles • General swings in real estate activity resulting in increasing or decreasing activity and property values during different phases of the cycle • Factors that separate the housing market from other supply and demand models: 1. Lag time in response to changes in supply and demand 2. Limited supply of land in any given area 9
Chapter 2: The Business of Real Estate
Causes of Real Estate Cycles
• • • • • •
Supply of land Inflation Cost of money Availability of credit Construction costs Health of the economy
10
Chapter 2: The Business of Real Estate
Other Influences on Real Estate Cycles • • • •
Demographics Population shifts Growth Monetary policies
11
Chapter 2: The Business of Real Estate
Broad Forces The four broad forces that affect real estate (remember P E G S): 1. Physical 2. Economic 3. Governmental 4. Social
12
Chapter 2: The Business of Real Estate
Physical Forces Can include location and popularity • • • • •
Jobs Climate Land availability Land desirability Environment (e.g., waterways, pollution)
13
Chapter 2: The Business of Real Estate
Economic Forces • Economic base of an area is the main business or industry a community uses to support and sustain itself • Economic forces can include: – Inflation – Cost of money (interest rates) – Availability of credit
14
Chapter 2: The Business of Real Estate
Government Forces • National government influences: – Taxation – Secondary markets – Fiscal and monetary policies – Government financing programs – Federal regulations • Local government activities are also having a greater effect on the real estate market
15
Chapter 2: The Business of Real Estate
The Business of Real Estate
• Social factors include: – Demographics – Migrations – Family size
Population shifts Growth Age
• As populations grow and change, so do their housing needs
16
Chapter 2: The Business of Real Estate
Government Fiscal Policy
• The government's plan for spending, taxation, and debt management • Ultimate goals of fiscal and monetary policies: – economic growth – full employment – international balance of payments • Deficit spending and taxation: Two policy tools Treasury Department uses to implement fiscal policy 17
Chapter 2: The Business of Real Estate
Deficit Spending • Occurs when government spends more money than it takes in from tax revenue • If the government spends too much money, then there’s less money available for people to borrow, which could increase interest rates
18
Chapter 2: The Business of Real Estate
Taxes • Directly impact spending habits and abilities of businesses and individuals • Can also have secondary effects on real estate and mortgage financing • Tax provisions: – Raise revenue, – Implement social policies by encouraging or discouraging certain behaviors or activities
19
Chapter 2: The Business of Real Estate
Tax Provisions* that Affected Real Estate
• Tax Reform Act of 1986 • Taxpayer Relief Act of 1997 • American Recovery and Reinvestment Act of 2009 * While it’s a good idea to stay current on fiscal policy and tax laws, you should NEVER give tax advice to anyone. Refer people to tax professionals because tax laws are complicated and change frequently. 20
Chapter 2: The Business of Real Estate
Government Monetary Policy
• Government’s mechanism to exert control over supply and cost of money
• Goals: – Economic growth – full employment – international balance of payments
• Tries to maintain stability in prices, interest rates, and financial markets 21
Chapter 2: The Business of Real Estate
Federal Reserve Board (the Fed)
• Responsible for U.S. monetary policy, maintaining economic stability, and regulating commercial banks • Fed's structure spreads power three different ways: 1. Geographically 2. Between private and government sectors 3. Among bankers, businesses, and the public
22
Chapter 2: The Business of Real Estate
The Fed is Comprised of • Board of Governors (Federal Reserve Board) – 7-member committee that controls the Federal Reserve System
• Federal Open Market Committee (FOMC) – Controls the Fed’s open market operations: Sale and purchase of government securities
• Federal Reserve Banks – Provide services to financial institutions. 23
Chapter 2: The Business of Real Estate
The Fed is Comprised of • The Federal Advisory Council – Meets quarterly with the Board of Governors to discuss business conditions and make policy recommendations
• More than 5,000 member banks – Have some input into the Fed's policies via the election of six directors to its district Federal Reserve Bank
24
Chapter 2: The Business of Real Estate
Federal Housing Financing Agency (FHFA) • Created under the Housing and Economic Recovery Act of 2008 • Will oversee Fannie Mae, Freddie Mac, and the Federal Home Loan Banks • With its initial creation, it was not clear whether there will be any changes to the organization of the Federal Reserve System 25
Chapter 2: The Business of Real Estate
The Fed and Monetary Policy
• Through monetary policy, the Fed can make more or less money available for banks to lend – in effect raising or lowering interest rates for the banks' customers
• Tools used by the Fed to implement monetary policy (D O R M): 1. Discount rates 2. Open market operations 3. Reserve requirements 4. Moral Suasion 26
Chapter 2: The Business of Real Estate
DORM • Discount rates or federal discount rates are interest rates charged by Federal Reserve Banks on loans to member commercial banks. • Open market operations are when the Fed sells or buys government securities (bonds) as a means of controlling the supply of, and demand for, money. 27
Chapter 2: The Business of Real Estate
DORM • Reserve requirements are the percentage of deposits commercial banks are required to keep on deposit—either at the bank or in the bank's own accounts • Moral suasion is using persuasive influences on the public and financial markets so they will perceive credit in a specific way 28
Chapter 2: The Business of Real Estate
Adjusting Interest Rates • Manages growth of money supply to allow adequate growth of the economy at reasonable interest rates. • The Fed now tries to anticipate future economic conditions rather than simply react to them
29
Chapter 2: The Business of Real Estate
Summary 1. Business cycles are general swings in business activity. Four phases are expansion, peak, contraction, and trough. Real estate lags behind business cycles. The law of supply and demand says that for all products, goods, and services when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise.
30
Chapter 2: The Business of Real Estate
Summary 2. Inflation is an increase in the cost of goods or services; also called cost inflation because manufacturers pass along increased costs. Inflation is also too much money chasing too few goods; also called demand inflation because too many people with money want to buy the same thing. Interest rates are extra fees people or businesses must pay to use another’s money for their own purposes. Inflation pushes interest rates higher or lower. Interest rates are a primary factor in determining demand for real estate.
31
Chapter 2: The Business of Real Estate
Summary 3. Real estate cycles are the response of real estate and mortgage markets to the forces of supply and demand. Two things separate the housing markets from other supply and demand models: The lag time for construction industry response and limited supply of land.
32
Chapter 2: The Business of Real Estate
Summary 4.
Physical, economic, government, and social forces (P E G S) affect real estate cycles. Physical: Location, popularity, climate, environment; internal or external. Economic: Economic base of an area (critical for home values), cost of money. Federal government: Fiscal policy (taxes), monetary policy (interest rates), regulation; State/local government: Revenue-generating (taxes) and regulating (Police power: Land use controls, zoning, environment, eminent domain, escheat). Social factors: Demographics, migration, family size, population shift, growth, age. 33
Chapter 2: The Business of Real Estate
Summary 5.
Fiscal policy is the government’s plan for spending, taxing, and managing debt. The Treasury Department carries out fiscal policy by issuing checks, collecting taxes, and issuing notes to cover deficits. Tools of fiscal policy are deficit spending and taxation. Deficit spending occurs when expenditures exceed revenues. Taxation is a way to collect revenue and implement social policies, such as giving tax deductions for mortgage interest to promote home ownership.
34
Chapter 2: The Business of Real Estate
Summary 6.
Monetary policy is government’s way to control supply and cost of money. The Federal Reserve Board (the Fed) is responsible for monetary policy, maintaining economic stability, and regulating commercial banks. Policy tools (D O R M): Discount rate (interest rate charged to member banks on overnight loans); open market operation (Fed sells/buys bonds to adjust money supply and demand); reserve requirement (banks must keep money on deposit—can’t lend it out); moral suasion (using persuasive influences on public and financial markets).
35
Chapter 2: The Business of Real Estate
Quiz 1. The cost of money a. does not affect demand for real estate. b. greatly influences a homebuyer’s decision. a. has no influence on a homebuyer’s decision. b. is not the same as interest rates.
36
Chapter 2: The Business of Real Estate
Quiz 2. The economic base of an area a. creates buyer’s markets but not seller’s markets. b. does not influence the local housing market. c. gives stability to a region, supports real estate values, and determines housing supply in an area. d. is responsible for government money coming in to support an area. 37
Chapter 2: The Business of Real Estate
Quiz 3. In a healthy economy, supply a. fluctuates significantly. b. is in balance with demand. c. is less than demand. d. significantly outweighs demand.
38
Chapter 2: The Business of Real Estate
Quiz 4. The law of supply and demand says that a. for all products, goods, and services when demand exceeds supply, prices will fall and when supply exceeds demand, prices will rise. b. for all products, goods, and services when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise. c. real estate doesn’t respond at all. d. there will always be a shortage of houses due to population growth. 39
Chapter 2: The Business of Real Estate
Quiz 5. The United State Treasury a. gets most of its funds from federal income taxes. b. is considered the nation’s fiscal manager. c. manages the government’s finances. d. all of the above
40
Chapter 2: The Business of Real Estate
Quiz 6. The interest rate charged by the Fed to member banks that borrow money against their deposits is called the a. b. c. d.
deposit insurance. discount rate. prime rate. reserve requirement.
41
Chapter 2: The Business of Real Estate
Quiz 7. The percentage of deposits that banks are required to maintain on deposit with the Federal Reserve System is called the a. b. c. d.
deposit insurance. discount rate. prime rate. reserve requirement.
42
Chapter 2: The Business of Real Estate
Quiz 8. Excessively high levels of government borrowing could lead to a. excess funds for real estate investment. b. government securities disappearing from the open marketplace. c. high interest rates. d. low interest rates.
43
Chapter 2: The Business of Real Estate
Quiz 9. The agency responsible for supervising the growth of the nation’s money and credit supply and regulating banks is the a. b. c. d.
FDIC. Federal Reserve Board. Office of Thrift Supervision. U.S. Treasury.
44
Chapter 2: The Business of Real Estate
Quiz 10. The Federal Reserve Board influences interest rates with a. b. c. d.
federal discount rates. open market operations. reserve requirements. all of the above
45
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