Real Estate Prices Explained

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By Elli Davis, June 26, 2009

Canada price index by Global Property Guide

Have you ever wondered 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.

Following the trend

Is it possible to calculate the next market move? How to determine when is the best time for an investment? What almost all buyers do is they simply watch for the previous direction of prices. In other words - what buyers expect is mostly affected by the previous movement. Once prices grow, it will be their expectation to see such growth continue, as well as the other way round. Sadly, this method has not much to do with all the important factors that determine the price, but yet it is often practised. When one relies too heavily on such a method, the result may be seriously disappointing, as could be seen not too long ago.

Fundamental economic factors

You most likely instinctively know that the property price is heavily influenced by some fundamental economic factors. True. But which ones? Here are the top three.

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 economy, the better it is for business as well as for real estate. One reason is that strong economics will positively push up the prices of property as it reassures buyers that the demand for housing will keep on growing, their property will increase in value and they will be able to make profit when passing it on again. When considering the BIS Quartely Review, it indicates that a 1% rise of GNP is linked with 1% to 4% rise of property price after 3 years.

Nominal interest rates and structure of mortgage products

For the property prices to grow you first need plenty of eager buyers. Since today the majority of people cannot afford to buy property without some kind of a bank loan, there are more buyers eager to buy houses when more attractive mortgage products with a lower nominal interest rates are available. According to the same source, only 1% decrease in nominal interest rate are connected with 1/2% to 1% of property prices growth 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. However 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. It applies to the real estate market as well.

Inflation

While the level of interest rates has a very strong impact on the property prices, the changes in the inflation rate have a strong influence in changes of interest rates. High inflation has a varied impact in different countries. In some countries, where investing in property is perceived as balancing the inflation, higher inflation in fact pushed property prices up (Germany would be a good example). Such countries are characterized by fixed interest rate loans. However, high inflation will have a negative impact on property prices in countries where interest rates are floating, as in the UK or the US.

Conclusion

As with the majority of rules there are exceptions. The big picture can affect individual areas differently. As a realtor I am follow the exceptions and differences closely. If you wondering what is coming up next for your neighbourhood just ask.