Wüestacademy Flashcards
What are the key drivers of real estate prices?
- interest rates
- supply & demand
- construction cost etc.
What drives interest rates?
- supply and demand
- inflation
- monetary policy
What is the role of interest rates for real estate prices?
Interest rates affect supply and demand which affect real estate prices: low interest rates -> higher demand -> higher prices
Average yearly price change 2008-2022 (condominiums, SFH, MFH, rents)
Condominiums, SFH, MFH: 3.5+%
Rents: 0.5%
When was the first interest rate hike since 2007?
June 2022
How was the Swiss policy rate in the last years?
It was negative for 7 years
How does the real estate market react compared to stock market?
With circa 1 year delay
4 submarkets in real estate
- Asset market
- Property market
- Construction market
- Building stock
Asset market
- transactions
- interest rate development
- real estate specific risk
- returns
- regulation, mortgage lending, Lex Koller
Property market
- households
- population and employment
- immigration
- surface consumption
- purchasing power, willingness to pay
Construction market
- construction & refurbishment
- availability of land
- regulation, spatial planning
- construction cost
Building stock
- maintenance cost
- depreciation
Summary of DiPasquale / Wheaton model
- modeling interaction between property market, asset market, construction market
- determination of long run equilibrium
- elegant graphical representation
- allows to perform comparative statics (effect of shock on market equilibrium)
Property market:
Rent results from…
…supply and demand for residential space
Asset market:
Price results from…
…willingness to pay for rental income
Define cap rate
The cap rate is the percentage rate used to calculate the income value from rental income.
The cap rate is formed from a base interest rate and surcharges, it is the percentage rate used to calculate the income value from rental income.
Income value =
net income (x100) / net cap rate %
Decisive for investments in real estate are…
… the attractiveness of alternative investments (bonds, stocks) and expectations of future developments.
When bond yields rise, real estate…
… less attractive in relative terms.
Construction activity depends on…
… construction cost and price.
Construction investments are low despite high demand, because…
… of supply bottlenecks and construction price surge.
Building stock depends on…
… new construction and depreciation rate
When interest rates drop, longrun rent…
… decreases less than in short run
When interest rates drop, transaction prices of MFH
…increase
When interest rates drop, apartment construction activity…
… increases
When interest rates drop, stock of apartments…
… increases
When interest rates drop, rental prices of apartments at times of interest rate cut…
… stay the same
When interest rates drop, rental prices of apartments after the lowering of interest rates (short-term adjustment)…
… decrease
When interest rates drop, rental prices of apartments in the new equilibrium (long-term adjustment)…
… decrease
How many years does adjustment process take (after drop of interest rates)?
7 years
If a 10-year Swiss government bond yield rises by 100 basis points, in what chronological order would the individual segments react?
- discount rates
- prices for investment properties
- construction market
- supply on property market
- reference interest rate
- demand in property markets
What happens (with rent) when population growth increases?
Rent increase in longrun is less than initially -> expansion along longrun supply
Advantages of the DiPasquale / Wheaton model
- model shows interaction of user market, capital and construction market
- suitable for determining long-term market equilibrium
- allows to analyse effects of shocks (interest rates, immigration, construction cost, depreciation)
- simple framework can explain various real world developments
Reasons for high RE prices in last years
High population growth, high demand, low interest rates
Disadvantages of DiPasquale /Wheaton model
- classical model does not allow analysis of short-term adjustments
- capitalization rate is exogenous
- no role for vacancy rates or market expectations
- no distinction between rental and owner-occupied housing
- no modeling of the search and matching process between suppliers and demanders
-> various extensions address these issues at the cost of simplicity
What is interest?
Interest is the consideration paid by a debtor to his creditor for granting a loan, it compensates for the borrower‘s default risk, inflation risk and the time value of money
High interest rates increase the willingness to…
… save because future returns are higher
Low interest rates increase the willingness to…
… make investments, as financing is favorable
Determinants of interest rates:
- inflation: high inflation -> high interest rates to compensate loss of purchasing power
- economy: strong GDP growth -> high interest rates
- demographics: increase in life expectancy -> lower rates -> desire to save
- monetary policy: price stability -> high interest rates slow down investment and thus economic development and inflationary pressure
SNB policy rate
Indicates the conditions under which credit institutions can borrow money from the SNB
SARON
Swiss Average Rate Overnight:
overnight interest rate between banks, moves closely to policy rate
What drives government bond yields?
- expected inflation
- policy rate
- financial market: investment pressure, risk aversion, savings vs. investments
- other premiums, e.g. illiquidity
Types of mortgage rates
- SARON mortgage: term of 3 years with variable SARON as base rate with +0.9 bp margin
- 10-year fixed rate mortgage
Importance of interest rates for real estate prices
- interest rates determine borrowing costs and thus influence demand for ownership property
- interest rates influence the discount rate and thus the property value for owners
- in an inflationary environment with rising wages and interest rates, rents typically rise as well
What happens in the event of an inflation shock?
- yields on bonds rise
- policy rate rises
- prices of investment properties fall
- existing rents rise
Bond yields follow…
… inflation movement
Why have interest rates decreased
a) in general over the last 10 years
b) in 2020?
a) the SNB first imposed a negative interest rate of -0.75% in 2015 when it was forced to abandon a policy of defending the Swiss franc with a peg to the euro
b) because of the slowing economic growth related to Covid-19
