The amount of money in the system directly correlates with the amount that gets into the real estate market. Real estate is the preferred investment class in the world. It is considered a haven and one of the best hedges against inflation.
But, only a few people realize that real estate can create more money supply. Because of how the modern fractional reserve banking system operates, this is possible. The higher the money supply, the more real estate will be created. This article explains the recursive relation between real estate supply and money supply and how they propel one another higher.
Self-perpetuating money supply
Real estate investment has created a system where real estate can increase the money supply. The increased money supply is then channeled back into the real-estate sector. The constant back-and-forth between the real estate sector and the banking system creates the environment for rising real estate prices.
The economic fundamentals, i.e., The fundamentals of the economy, i.e., income levels, are not changing, so these rising prices are often a sign of a real estate boom. The bubble bursts, causing prices to drop for a brief time. Real estate investments, by their very nature, boost the money supply and create an amplifying and self-enforcing loop.
Mortgages are a way to make money.
Around 80% of house purchases in developed countries are made with borrowed money. “house purchase” is often used interchangeably with “mortgage.” This may seem familiar until you consider how modern banking works.
The banks don’t lend money out of existing capital. Instead, they create new money by making loans. Banks make mortgage loans that generate cash and pump it into the system. The system will have more money if there are more mortgages. This can be empirically proven by comparing mortgage loan growth in the banking sector to the economic money supply. These two charts move almost simultaneously.
High Inflation is Caused by Money
The problem with creating more money is that it revolves around the existing system. It is a derivative of other money that has less value. When mortgage markets boomed, there was a lot of inflation in countries like the United States. High inflation combined with low wage growth leads to a situation where workers are losing their real wages.
Inflation Causes High Prices
The mortgages have created a lot of money, which has been reinvested in the real estate industry. Because of the rising demand for real estate, prices are higher, and buyers queue up to purchase what appears to be profitable investments.
Excess money and excess demand lead to an increase in real estate prices. This increases investor confidence in real estate as a profitable investment. Real estate prices that initially seemed disproportionately high given economic fundamentals remain that way, and the illusion becomes a reality. Inflation in real estate prices is the new norm.
More mortgages are created by speculation
Speculators are often inspired by their peers who have made much money speculating in real estate. They decide to try and join the party. Excess cash and excessive demand meet speculative intent, further putting upward pressure on real estate.
This is the ideal recipe for a bubble. Through self-reinforcing feedback loops, speculators push the prices skywards. In the past, higher prices have been justified by future costs. This period also sees a rapid rise in housing and mortgage prices.
The Bust Phase
Finally, the bubble bursts at an unpredicted time. Unsustainable economic conditions in the economy are the primary reasons for the bust. Many borrowers find themselves unable to pay their banks at this time. The bank must foreclose these properties and write off the losses. But, only some people realize that banks erase the money when they write down these losses. Because mortgages are what created the money, the money ceases to exist when these mortgages are canceled. The total money supply is decreased, and prices have dropped.
Mortgages and actual property prices influence the money supply. The real estate market significantly impacts the economy because the money supply is an essential economic parameter.
Analyze the Basic Ratios for Real Estate Investment
Real estate investment is a complex business. Many investors are skilled at using sophisticated techniques to do their research. Ratio analysis is one such advanced technique. This technique is similar to the ratio analysis of publicly traded corporations’ financial statements. This ratio analysis also includes specific terms and idioms only applicable to real estate investments. This article will explain the ratio analysis for real estate investments from an individual’s perspective. What should a person consider when buying a rental property? These are the most common ratios.
Ratio Loan to Value
The loan-to-value ratio (LTV) is a critical number that both investors and banks will be looking at. These two parties look at the same number but for very different reasons.
The bank may consider the loan-to-value ratio to ensure its investment security. For example, let’s say a property has a loan-to-value ratio of 90%. If the property’s value is $100, the bank will have financed $90 and a claim on it. The bank’s investment remains secure if the property’s value falls by 10%. The bank will offer better interest rates and terms when the loan-to-value ratio is lower.
Individuals also consider the loan-to-value ratio to determine how much leverage they use to purchase a property. Higher loan-to-value ratios are a sign of a risky investment, as even small movements in property prices could cause the investment to go into the red.