LESSON 1: NATURE AND CYCLE OF REAL ESTATE FINANCE Flashcards
Why is real estate considered a major economic engine?
Real estate significantly impacts the economy by driving investment, employment, and financial markets.
What are the key aspects covered in real estate finance?
Borrower and property qualification, financing types, closing sales, federal legislation impact, and monetary systems.
Why must lenders assess a borrower’s financial qualifications?
To reduce lending risk by evaluating income, credit, debt, funds source, and net worth.
What is the primary risk lenders face when lending money?
The risk that the loan may not be repaid.
How do lenders mitigate risk in real estate financing?
By requiring collateral, setting credit standards, and using underwriting guidelines.
Why do government-backed loans have lower interest rates?
They are insured (FHA) or guaranteed (VA) by the government, reducing risk.
What is the relationship between risk and interest rates in lending?
Higher risk loans (e.g., sub-prime loans) have higher interest rates to compensate for the risk.
What are the key mortgage lending activities?
Qualifying loan applicants, property valuation, handling defaults, foreclosure prevention, and offering various loan types.
What are the four phases of the real estate cycle?
Recovery, Expansion, Hyper Supply, and Recession.
What economic factors impact real estate markets?
Population growth, job growth, housing supply, social influences, and government regulations.
How does government policy influence real estate finance?
Through monetary policy (Federal Reserve) and housing policy (HUD).
What is the Housing Affordability Index?
A measure indicating whether a median-income family can afford a median-priced home with an 80% loan.
How do market areas go through life cycles?
Growth, Stability, Decline, and Revitalization phases.
What is the role of the secondary lending market?
It affects the primary lending market by influencing liquidity and lending practices.
How does inflation impact home affordability?
Higher inflation and interest rates lower affordability, making it harder for median-income families to qualify for loans.
What is inflation?
Inflation is a general rise in prices, leading to a decrease in the dollar’s purchasing power.
How is inflation measured?
Inflation is measured using indexes such as the Consumer Price Index (CPI) and the Producer Price Indexes (PPI).
How does inflation affect real estate finance?
It impacts the ability to predict rising or falling prices, influencing mortgage rates, property values, and investment decisions.
What role does government play in inflation?
Government actions like increasing the money supply can influence inflation rates.
What is monetarism?
Monetarism is a theory that explains the relationship between inflation and the money supply of an economy.
What historical example illustrates inflation due to increased money supply?
After the Spanish conquest of the Aztec and Inca empires, the influx of gold and silver led to rising prices.
What is the opposite of inflation?
Deflation, which is a general decline in prices when the inflation rate falls below 0%.
How does inflation impact consumer behavior?
Higher inflation can lead to increased spending as people buy before prices rise, while lower inflation can encourage saving.
What is the Cantillon effect?
The Cantillon effect describes how inflation causes sequential changes in purchasing power and distorts relative prices.
How can inflation benefit exporters?
If inflation causes a nation’s currency to decline, its exports become cheaper for foreign buyers.
How can inflation harm savers?
Inflation erodes the real value of savings, reducing future spending or investment power.
What are the major inflation indicators?
The Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCEPI).
What is the significance of the exchange rate in inflation?
A depreciating currency signals a high inflation risk and affects purchasing power in foreign markets.
How does exchange rate fluctuation impact real estate investment?
A weaker home currency raises costs for foreign investors, while a stronger home currency lowers costs.
How does GDP relate to inflation?
Strong GDP growth can signal rising inflation due to increased aggregate demand.
What is per capita GDP?
It is the GDP divided by the total population, representing the average standard of living.
What is the Phillips curve?
It describes the inverse relationship between unemployment and inflation.
What is NAIRU?
The Non-Accelerating Inflation Rate of Unemployment, where inflation and deflation pressures balance.
Why is real estate considered a hedge against inflation?
Real estate investments are less likely than other investments to suffer from rising inflation, though they are not completely immune. Increased demand during high inflation can drive prices higher.
How does inflation impact consumers and investors?
Inflation increases the prices of goods and services, making it harder for consumers to afford necessities. Investors and landlords are also affected by inflation’s impact on housing supply and demand.
How does inflation affect the cost of building a home?
The cost of building a home increases due to rising wages and the higher cost of materials and supplies.
How can an asset manager benefit from inflation predictions?
Accurate inflation predictions can help asset managers anticipate lower vacancy rates and future property value increases.
What happens to interest rates during high inflation?
Interest rates tend to rise alongside inflation, making borrowing more expensive and potentially deterring investors from purchasing real estate.
How can investors still benefit from real estate during inflation?
Despite high mortgage rates, rental properties tend to do well as demand increases. Landlords can adjust rental rates based on location, amenities, and inflation trends.
What is an assumable loan, and how does it relate to inflation?
An assumable loan allows a buyer to take over an existing loan with a lower interest rate. This can make a property more attractive during times of high inflation when market interest rates are high.
How does inflation affect rental prices?
Inflation increases demand for rental homes, allowing landlords to raise rental prices, which can contribute to an affordable housing crisis.
How do government-imposed taxes influence the real estate market?
Taxes can increase the price of goods and decrease consumer purchasing power, while tax incentives can stimulate demand and supply in real estate.
What are property tax incentives?
Property tax incentives include exemptions, deductions, and credits that reduce taxable property value, thereby lowering taxes owed.
What is a homestead exemption?
A homestead exemption reduces the taxable value of a property occupied as a primary residence. The amount varies by state.
What are common property tax exemptions?
Common exemptions include homestead exemptions, disability exemptions, and senior citizen exemptions.
How do disability exemptions work in real estate taxation?
Some states provide tax exemptions for disabled individuals, sometimes with additional benefits for those with military-related disabilities.
What is a senior citizen exemption?
Some states offer property tax exemptions for seniors, typically those aged 63-66 or older. Texas, for example, provides a $10,000 senior exemption plus a freeze on school taxes.
What are income tax incentives for real estate?
Income tax incentives include deductions and credits that lower taxable income and tax liabilities, such as mortgage interest and real estate tax deductions.
What is the difference between a tax deduction and a tax credit?
A tax deduction reduces taxable income, while a tax credit directly reduces the amount of tax owed.
How do capital gains tax exemptions work for homeowners?
Married couples can exclude up to $500,000 in capital gains from selling their primary residence, while single homeowners can exclude up to $250,000.
What is the most common type of homestead exemption in Texas?
A $25,000 reduction in the taxable value of a property, as outlined in section 11.13(b) of the state tax code.
How does the Texas homestead exemption work?
It allows homeowners to reduce the taxable value of their property by $25,000. For example, a home valued at $200,000 would be taxed as if it were worth $175,000.
When can a homeowner file for a homestead exemption in Texas?
As of January 1, 2022, homeowners may file immediately upon closing, as long as an exemption has not been filed for that tax year.
What is a key requirement for a homestead exemption?
The property must be the homeowner’s primary residence, and only one homestead exemption is allowed per person.
What is a cash sale in real estate?
A transaction where the buyer purchases a property entirely with their own funds, without lender involvement.
Why are cash sales simpler than financed transactions?
They do not require lender scrutiny, such as appraisals, title searches, or surveys.
What responsibility do real estate brokers have in cash sales?
They must safeguard their client’s interests by carefully reviewing the appraisal, title commitment, and survey.
What is a potential issue with cash contracts when buyers intend to finance later?
If the buyer’s financing is rejected and no escape clause is included, they may be forced to complete the purchase with cash.
How did real estate financing change after the 1980s?
The rise in interest rates led to Savings & Loan failures, prompting the creation of the secondary mortgage market for liquidity.
What is the impact of the secondary mortgage market?
It ensures that money is always available for mortgages but also subjects rates to competition with other financial instruments, causing fluctuations.
What must real estate professionals understand about financing?
Down payments, closing costs, seller contributions, payment structuring, loan types, underwriting guidelines, and qualification standards.
What is an assumption in real estate financing?
A buyer pays for the seller’s equity and takes over their existing mortgage.
Are FHA and VA loans assumable?
Yes, but the new buyer must qualify for the loan and occupy the property as their primary residence.
What clause prevents most conventional loans from being assumable?
The “due on sale” clause, which allows lenders to demand full repayment upon transfer.
What is a seller’s potential risk in an assumption?
If the new buyer does not qualify, the original borrower may remain liable for the loan.
What was the credit crisis of 2008?
A financial meltdown caused by excessive subprime lending, high-interest mortgage-backed securities, and borrower defaults.
How did subprime loans contribute to the crisis?
Many borrowers were given loans they could not afford, leading to mass defaults and a collapse in home values.
What was a major consequence of the credit crisis?
The U.S. economy suffered trillions of dollars in losses, leading to over 30 new laws regulating real estate financing.
What is the economic impact of real estate?
It contributes significantly to GDP, employment, and wealth-building, making it a crucial sector of the economy.
How does real estate affect GDP?
Through Residential Fixed Investment (new housing, broker commissions, improvements) and Housing Services (rent, household expenses).
What is the average length of a real estate cycle?
18 years, though cycles vary in length.
How does supply and demand affect real estate prices?
When demand exceeds supply, prices rise; when supply exceeds demand, prices fall.
What factors influence real estate demand?
Price, construction costs, financing costs, property taxes, personal income, and economic expectations.
What factors influence real estate supply?
Selling price, loan interest rates, construction costs, land prices, and seller expectations.
What is the role of the Federal Reserve in real estate?
It controls the money supply and interest rates, influencing loan availability and housing demand.
How does the availability of financing affect real estate demand?
More available financing increases demand and prices, while less financing reduces demand and prices.
What led to recent proposed policy changes in US housing markets?
The intertwined housing and financial market crises in the US.
How do policymakers approach new housing policy directions?
By learning from both domestic and foreign government approaches.
What does the paper describe regarding government intervention?
Different ways governments intervene in housing finance markets, providing alternatives to the US system.
What argument exists regarding private markets in the US?
Some argue private markets could allocate credit more efficiently than government-sponsored enterprises like Fannie Mae and Freddie Mac.
Why is careful consideration needed before privatizing housing markets?
To avoid unintended negative consequences and to study alternative successful models from other countries.
What distinguishes European housing markets from the US?
European countries had similar housing booms and busts but avoided the high default rates seen in the US.
What role do housing market booms and busts play in financial stability?
Housing-linked recessions tend to be more severe and prolonged, but not all housing busts cause wider financial crises.
What contributed to the recent housing boom and bust cycle?
Lax lending standards, high leverage, and weak solvency buffers.
How did housing prices trend in the US from 2001 to 2005?
Prices increased steadily until 2005, then sharply declined.
How did housing price trends in the US compare to Europe?
Europe saw similar trends, but the overall price increase was less sharp than in the US.
Why did governments intervene in housing markets?
To stabilize markets and restore investor confidence after the housing market correction.
How is housing finance provided in the US and other advanced economies?
Mainly through banks, with a significant past role played by mortgage brokers in the US.
What change occurred in mortgage brokerage between 2004 and 2010?
The share of mortgages processed through brokers in the US dropped from 68% to 10%.
What types of government intervention exist in housing finance markets?
Subsidies, guarantees, tax deductibility of mortgage interest, and capital gains tax deductibility.
How do US housing subsidies differ from other countries?
The US provides subsidies mainly to low and middle-income groups, whereas other countries offer broader subsidies.
What is an example of a government intervention for financial stability?
The US placed Fannie Mae and Freddie Mac in conservatorship and purchased mortgage-backed securities.
How did the Obama administration respond to the housing crisis?
By proposing and enacting a homebuyer tax credit to spur demand.
What are some government interventions for borrowers facing payment problems?
Mortgage modifications, loss mitigation, deferred interest schemes, and mortgage rescues.
How does the UK’s mortgage rescue policy work?
Certain borrowers at risk of default can become social tenants while staying in their privately bought homes.
What financial measures have the US and UK used to ease housing markets?
Rate cuts, credit guarantee schemes, and quantitative easing policies.
How do governments use guarantees to stabilize housing markets?
By providing lenders with protection against mortgage defaults, ensuring market stability.
What risk is associated with government guarantees on mortgage defaults?
Moral hazard, as it may incentivize risky lending practices.
How do US and Canadian mortgage insurance policies differ?
Canada has tighter government-backed insurance conditions than the US.
What is the impact of mortgage interest tax deductibility?
It lowers the after-tax cost of mortgage debt, potentially increasing loan-to-value ratios and contributing to housing booms.
How does mortgage interest tax deductibility vary across countries?
The US allows full deductibility, while most EU countries (except the UK, France, and Germany) provide some tax relief.
What effect has Italy’s mortgage interest deduction had on housing prices?
It has contributed to an 8% annual price increase since 2000, potentially leading to a boom-bust cycle.
Where does mortgage lending begin?
Mortgage lending begins with savings, which are loaned to borrowers.
How do banks earn money from lending?
Banks earn money from the “spread,” the difference between the interest paid by borrowers and the interest paid to members.
What is an example of a mortgage lending transaction?
Fred borrows $100,000 at 5% interest; the bank pays 2% to members and retains 3% for expenses.
What is the Primary Market in mortgage lending?
The Primary Market consists of institutions that lend money directly to borrowers.
What is the Secondary Market in mortgage lending?
The Secondary Market includes government-sponsored enterprises, private investors, and federal/international banks that buy loans from the Primary Market.
What happens when you get a mortgage?
The lender provides money for a home purchase, and the borrower repays it with interest over time. The lender retains rights to the home until the loan is paid off.
What is Mortgage Debt Outstanding?
It is the total amount of outstanding mortgage loans at a given time, tracked by the Federal Reserve Bank.
How do economic reports help in real estate?
Reports such as GDP, unemployment, and inflation help investors and policymakers assess economic health and trends.
What is the Leading Economic Index (LEI)?
A monthly report from the Conference Board that tracks turning points in the economy using 10 key components.
How do local economic factors affect real estate?
New businesses or developments can impact local, state, and national economies by creating or replacing jobs.
What is BiggerPockets?
A real estate investment community that provides education, tools, and networking for investors.
What is the mission of BiggerPockets?
To help members build wealth through real estate by providing resources, education, and networking.
What is the American Real Estate Society (ARES)?
An organization promoting real estate research, education, and communication between academics and professionals.
What are the main activities of ARES?
Publishing real estate journals, hosting an annual meeting, and developing best practices in real estate education.
What does The Real Estate Finance Journal focus on?
Financing, liability, investments, taxes, and asset management in real estate.
What is the Real Estate Center at Texas A&M?
A research center providing reports and education on Texas real estate and economic trends.
What are key reports published by the Texas Real Estate Center?
Texas Housing Insight, Outlook for the Texas Economy, and the Monthly Review of the Texas Economy.
How is the Texas Real Estate Research Center funded?
It is publicly funded through real estate license fees paid by professionals.
What significant real estate event happened in 1971?
The Texas Real Estate Research Center was established to conduct studies related to real estate and economics.
