Real estate market and Interest Rates

Housing prices can go up under two main scenarios:

  1. One is when the fundamental economy of a given location has undergone a change. This means that there is somehow a better standard of living or more employment available in that area making it imperative for more people to stay there.


  2. Or else, there could be a speculative bubble wherein investors buy at a high price today to be able to sell at an even higher price tomorrow.

Interest rates have been the common factor in every boom and bust scenario that we have witnessed in the property market. Whether or not, they are the direct cause is a question of debate. However, they are definitely amongst one of the causes.

All the property market booms, be it in Japan, United States, China or India, have been perpetuated in an atmosphere of low interest rates. This is because low interest rates lead to excess money supply and a scenario wherein the buyers are suddenly flush with excess cash and queuing up to buy homes.

The converse of this is also true. All the downfalls in the property market have also been created by a sudden and unexpected increase in interest rates. All the crises right from the subprime mortgage crises to the “lost decade” all have their roots in the rising interest rates.

As an investor, one should therefore stay away from any markets where the rise in property prices seems to be fuelled by a dropping interest rate. This is because, in most scenarios, this is likely to be a property bubble.

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