Question

Trends in Real Estate Credit are considerable pressure has been placed on interest rate margins

And greater emphasis on fee income. Explain this statement and enumerate its reasons.

^ This is exactly how the question is written in my assignment.

Answer 1

In real estate people’s income consist of different thing depending on what side of the transaction they are. If they are the buyer of real estate then their income would consist of rental income and price appreciation of property. If you are financing the purchase of the real estate, say from a banks perspective your income would consist of the fee income from the transaction and the interest that you will earn from the loan you are providing. Now there can also be a third situation in which a buyer a bought a property and financed the property at say 10% interest rate but after a certain point the interest rate has fallen to say 8% and now he wants to refinance the loan to reduce its payment of loan, here the interest rate margin are important as to what interest rate he is able to refinance the loan and the fee income comes into the picture because there are sometime prepayment penalty on loan or loan closing cost of the loan so if he is going to refinance the loan at say 8% then the net benefit has to be positive after paying the prepayment penalty and closing cost of the loan or the refinancing of loan really does not benefit him. This interest rate margins and fee income has become important because many real estate buyer when they buy the property do not buy with the intention to stay in the property for long term, they simply want to buy it and if the price appreciates they will sell it and gain capital appreciation in price. Also, if the interest rate falls, they would refinance the loan making prepayment and the margin of interest rate is important because it should benefit them after considering all the closing cost associated with the loan.