Interest rates can significantly affect the cost of financing and mortgage rates, which in turn affects property-level costs and thus influences values. However, supply and demand for capital and competing investments have the greatest impact on required rates of return (RROR) and investment values
As interbank exchange rates decrease, the cost of funds is reduced and funds flow into the system; conversely, when rates rise, the availability of funds decreases. As for real estate, the changes in interbank lending rates either add or reduce the amount of capital available for investment. The amount of capital and the cost of capital affect demand but also supply, capital available for real estate purchases and development. For example, when capital availability is tight, capital providers tend to lend less as a percentage of intrinsic value, or not as far up the "capital stack." This means that loans are made at lower loan to value ratios, thus reducing leveraged cash flows and property values.
These changes in capital flows can also have a direct impact on the supply and demand dynamics for property. The cost of capital and capital availability affect supply by providing additional capital for property development, and also affect the population of potential purchasers seeking deals. These two factors work together to determine property values.
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