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Index and Country's Financial Stability (Benefits to Users)

Fundamentally, the price of any property is equal to the present discounted value of all future services (i.e. housing, renting, commercial purpose etc) that will be provided by that property while it is owned by its current owner, plus the present discounted value of the price at which the owner will be able to sell the property in the future.
To take this a step further, the "market price" of any property at a given time can be defined as the highest price at which the owner would be able to find exactly one willing buyer for that property at that time. This market-clearing price, however, may fluctuate sharply over time due to changes in the supply demand equation.

Property markets and real estate prices are inherently subject to booms and busts. One reason for this is construction lags: if a surge in demand pushes the price of existing property above its replacement cost, then developers have an incentive to build more properties. But new properties may take years to complete, and until the new supply is forthcoming, market prices will remain high. In the presence of construction lags, then, price increases efficiently reflect the current scarcity of housing services. Nonetheless, this increase in market prices will tend to be followed by a drop once the new supply is forthcoming.

A second reason for cyclicality in asset values is the absence of short selling in real estate markets. Myopic buyers tend to extrapolate price increases into the future, even when sustained price increases are not justified by market fundamentals. In an efficient market, such price rises would be countered by non-myopic investors selling short. But, due to the underlying heterogeneity of properties, there are no futures or options markets for individual property sales.

Banks and individual managers, have little data on which to base careful analysis of future real estate prices. The property value appraisal process is based on observing the prices of comparable properties to estimate the market value of properties (and therefore LTV ratios). While lending decisions would ideally be made on the basis of long-term expectations about the market value of the property throughout the life of the loan, the observed transaction prices of comparable properties are market prices, subject to bubbles and other sources of short-term fluctuation.

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* Contributed by: -
Rahul Abrol & Rahul Gulati,
MBA - IInd Year,
Institute of Management Technology, Ghaziabad.