The Business of Real Estate

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
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
Key Terms
• Business Cycles • Federal Open

• Discount Rate Market Committee
• (FOMC)
Economic Base
• Federal Reserve
• Fed Funds Rate
Board (the Fed)
• Fiscal Policy
4
Key Terms
• Inflation • Real Estate Cycles

• Interest Rate • Reserve
• Monetary Policy Requirements
• Moral Suasion • Supply and
• Open Market Demand
Operations
5
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
Cycle Influences
Business and real estate cycles are

influenced by many factors and
respond to:
• Supply and demand
• Inflation
• Interest rates
7
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
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
Causes of Real
Estate Cycles
• Supply of land
• Inflation
• Cost of money
• Availability of credit
• Construction costs
• Health of the economy
10
Other Influences on
Real Estate Cycles
• Demographics
• Population shifts
• Growth
• Monetary policies
11
Broad Forces
The four broad forces that affect real

estate (remember P E G S):
1. Physical
2. Economic
3. Governmental
4. Social
12
Physical Forces
Can include location and popularity

• Jobs
• Climate
• Land availability
• Land desirability
• Environment (e.g., waterways, pollution)
13
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
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
The Business
of Real Estate
• Social factors include:
– Demographics  Population shifts
– Migrations  Growth
– Family size  Age
• As populations grow and change, so do
their housing needs
16
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
Quiz
6. The interest rate charged by the Fed to

member banks that borrow money
against their deposits is called the
a. deposit insurance.
b. discount rate.
c. prime rate.
d. reserve requirement.
41
Quiz
7. The percentage of deposits that banks

are required to maintain on deposit
with the Federal Reserve System is
called the
a. deposit insurance.
b. discount rate.
c. prime rate.
d. reserve requirement.
42
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
Quiz
9. The agency responsible for

supervising the growth of the nation’s
money and credit supply and
regulating banks is the
a. FDIC.
b. Federal Reserve Board.
c. Office of Thrift Supervision.
d. U.S. Treasury.
44
Quiz
10. The Federal Reserve Board influences

interest rates with
a. federal discount rates.
b. open market operations.
c. reserve requirements.
d. all of the above
45

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Chapter 2

• Business Cycles • Federal Open

• Inflation • Real Estate Cycles

• General general swings in business resulting in

Business and real estate cycles are

• Law of supply and demand: For all products,

Real Estate Cycles

• General swings in real estate activity

The four broad forces that affect real

Can include location and popularity

• Economic base of an area is the main

• National government influences:

• Occurs when government spends more

• Directly impact spending habits and

Tax Provisions* that

The Fed is Comprised of

• Board of Governors (Federal Reserve

The Fed is Comprised of

• The Federal Advisory Council

• Created under the Housing and Economic

The Fed and

• Discount rates or federal discount rates

• Reserve requirements are the percentage

Adjusting Interest Rates

• Manages growth of money supply to allow

1. Business cycles are general swings in business

3. Real estate cycles are the response of

5. Fiscal policy is the government’s plan for

1. The cost of money

2. The economic base of an area

3. In a healthy economy, supply

4. The law of supply and demand says that

5. The United State Treasury

6. The interest rate charged by the Fed to

7. The percentage of deposits that banks

8. Excessively high levels of government

9. The agency responsible for

10. The Federal Reserve Board influences

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