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A real estate capital market consists of individuals and institutional investors that invest money either directly or indirectly into real estate. Construction firms are heavily reliant on cash infusions from the capital market to finance work on new and existing buildings. Since real estate investments are secured by property or mortgages, the real estate capital market normally exposes investors to lower levels of risk than investments in unsecured capital markets.
Direct investments in the capital market often involve real estate investment trusts (REITs). When investors buy shares in a REIT, the share sale proceeds are used to buy commercial or residential real estate. Normally, a single REIT owns a wide variety of property located in different locations so as to protect investors in the event that real estate prices decline in a particular market. Investors receive dividends that are comprised of rental income or the profits generated by property sales. REITs help to drive the real estate market because construction companies can sell properties to these funds and use the sale proceeds to fund the construction of new developments.
Aside from buying real estate, some REITs invest in commercial or residential mortgages. The interest payments on the underlying loans are passed on to the REIT's shareholders as dividend payments. In most instances, REITs buy large pools of mortgages from investment companies and these firms use the sale proceeds to finance more loans. Real estate purchases tend to increase when financing is readily available which means that REITs indirectly bolster the real estate capital market.
While REITs only invest in real estate and mortgages, many mutual funds and hedge fund companies invest in a wide variety of different securities that may include real estate and loans. Fund managers regard these types of investments as relatively stable when compared with equity investments and many firms maintain a fixed percentage of real estate related assets in many types of investment funds. Therefore, construction companies and lenders have to keep building properties and writing loans to satisfy the demand for real estate related securities.
Many finance companies only write loans for creditworthy borrowers, while construction companies typically verify the assets of individuals before accepting bids on new homes. This means that people with poor credit or minimal income are often unable to buy real estate or obtain loans. Some players in the real estate capital market assist these people by offering to finance high-risk loans and real estate developments. These fund companies mitigate the risks involved by charging higher interest rates than conventional lenders. Additionally, many companies sell some of these high-risk securities onto other investors.
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