Real Estate Lending: A Year 1999 and 2000 Forecast as a Function of the 30-year Treasury Rate and the Consumer Price Index from a Simple Aggregate Expenditures Perspective
 
BYRON McCLURE and KELLY CRAWFORD
College of Business
Western Carolina University
 
Abstract
 
U.S. Real Estate Lending is forecast to grow 4.27% in the year 1999 and an additional 4.37% in 2000. This forecast is based on a Keynesian aggregate expenditures model which assumed fixed interest rates, consumption spending, government spending, and net exports. The Consumer Price Index (CPI), is monthly data taken from 1992.1-1998.12 and the 30 year Treasury Rate (R), is taken from 1992.1-1998.12. Real estate lending will continue to grow steadily over the next two years, due to favorable interest rates and low inflation as indicated by the CPI. The Federal Reserve should attempt to stabilize these low interest rates to encourage investment in such areas as real estate. (JEL: G21, R21, R31)
 
Part 1. Introduction
 
This paper forecasts U.S. real estate lending for the years 1999 and 2000. The explanatory variables are the Consumer Price Index (CPI) and the 30-year Treasury bond rate. The approach is based on the Keynesian aggregate expenditures model. The Keynesian approach is simple and recognizes the role of interest rates as a true impetus for investment.

Real estate lending forecasts are a great way to measure economic health and confidence. Real estate lending will continue to increase if economic indicators, such as a stable CPI, continue to be favorable. Price stability and low inflation encourage consumption and investment. A slowing of real estate investment would possibly indicate consumer anxiety with current economic conditions. The forecast horizon of two years will allows an examination of the effects of present economic conditions and interest rates.

The rest of this paper is organized as follows: Part 2. presents the data used to forecast real estate lending as a function of CPI and the 30-year Treasury rate; Part 3. presents the theoretical basis for the approach adopted in forecasting real estate lending; Part 4. presents forecasts of real estate lending for 1999 and 2000; Part 5. evaluates the importance of the forecast for the economy; and Part 6. discusses conclusions for economic policy.
 

Part 2. Data
 
All variables are taken from the Federal Reserve Bank of St. Louis Federal Reserve Economic Data (FRED). The measures of Real Estate Lending and Consumer Price Index are FRED variables RL and CPI and are given in billions of dollars. The interest rate data is the 30-year Treasury rate given in FRED variable TR30. The sample period for the data is the first month of 1992 until the end of 1998. The forecast horizon is two years into the future.

Real estate lending was used as an indicator of consumer willingness to invest. Alternative measures were considered for this forecast, such as mortgage lending; however, appropriate data were not available. Real estate lending gives an idea of how willing to enter the current market private and non-private investors are. The real estate lending data also gives a more encompassing view of investor activity than mortgage lending alone. The 30-year Treasury rate was selected as the most relevant interest rate, as it corresponds to the usual term of real estate loans. The CPI is used to show the rate of inflation. The CPI shows the price changes consumers incur in the market. The results of this forecast and current real estate lending data give an indication of how comfortable and adaptive the investor is with the current high level of price stability. The 30-year Treasury rate and CPI represent influences which affect investor willingness to seek real estate loans.

Nominal real estate lending data, from January 1992 through December 1998, are adjusted for inflation with the CPI. The real level of real estate lending, in billions of 1982-84 dollars, is computed as:

 
Real RL = (Nominal RL x 100) / CPI.
 
Part 3. Economic Theory: The Aggregate Investment Function
as a Forecasting Instrument
 
The Keynesian aggregate investment function (Keynes, 1936, pp. 135-146) may be written as:
 
It = f(rt),
 
where r is the nominal interest rate. Although the real interest rate is often assumed to be a constant, any change in real interest should trigger a change in investment.

Inflation is defined as the percent change in the Consumer Price Index:
 

Inflation = %D CPI =(CPI t CPI t-1 ) / CPI t-1.
 
The Fisher Equation defines the real interest rate. Real interest rates are a function of nominal interest rates and inflation. The Beta coefficient in the following equation is the impact of inflation and the coefficient helps to give weight to the effect of inflation on real interest rates. However, since there is no determination of inflationary changes no focus will be put on the Beta coefficient (Thomas 101-103). Where r equals the real interest rate, i equals the nominal interest rate, t equals the marginal tax rate, and pe equals the expected inflation rate, the Fisher Equation is written as:
 
r = i(1-t) - ß(pe)

Recognizing the impact that price changes may have on the investment market, the Keynesian aggregate investment function is augmented with the CPI, and becomes:

 
It = f(CPIt,rt).

Real estate lending is used as a measure of investment spending. The right-hand-side variables are lagged two years to permit the investment function to be estimated as a forecasting equation.
 

Part 4. Forecast Real Estate Lending
 
The regression equation was estimated with CPI and 30 year Treasury rate from the first month of 1992 through the first month 1994. The forecasting equation forecasts billions of 1982-84 dollars of real estate lending: B equal billions of 1982-84 dollars of current real estate lending, R equals the 30-year Treasury bond rate, and CPI is the Consumer Price Index. Subscript t indicates the variable value at a given time. A two-year lag is indicated by t-2.
 
B t = -1431 + 17.9 (CPI t-2) - 14.7 (R t-2).

A regression estimate of this forecast equation is presented in Table 1.

 
Table 1
Forecast Billions of 1982-1984 Dollars of Real Estate Lending, 1999.1-2000.12
 
Yearly/Monthly Forecast Periods % D per Month  Billions $ Real Estate Lending
1999.1
January
72.48275
1314.875
1999.2
February
71.49297
1322.295
1999.3
March
69.5687
1320.542
1999.4
April
69.05798
1321.754
1999.5
May
69.49061
1325.752
1999.6
June
70.54699
1333.615
1999.7
July
72.1878
1341.019
1999.8
August
71.80411
1345.344
1999.9
September
72.55702
1353.665
1999.10
October
73.42967
1361.529
1999.11
November
71.76165
1368.343
1999.12
December
70.64443
1371.898
2000.1
January
4.538648
1374.552
2000.2
February
3.9978
1375.158
2000.3
March
4.06887
1374.274
2000.4
         April
4.547261
1381.858
2000.5
          May
4.894334
1390.638
2000.6
June
4.664037
1395.815
2000.7
July
4.507557
1401.466
2000.8
August
4.723216
1408.887
2000.9
September
4.449758
1413.9
2000.10
October
4.57686
1423.844
2000.11
November
4.188894
1425.662
2000.12
December
4.383422
1432.034
 
Part 5. Forecast Implications: Steady Growth in the Short Term
 
The results of this forecast will be encouraging to anyone involved in the real estate market, whether it be buyers, sellers, or pure investors. This forecast of real estate lending encompasses not only the private individual seeking primary housing and investment, but the commercial investor as well. This also gives an idea of the willingness of consumers and lenders to supply loanable funds. This forecast suggests little possibility of the market slowing down.
 
Part 6. Too Much of a Good Thing?
 
Real estate lending is forecast to rise approximately 4.27% in 1999, compared to 1998 compiled data. Year 2000 figures are forecast to rise another 4.37% over forecast 1999 figures.

Assuming this forecast turns out to be correct, the continuance of a healthy economy should be expected. A healthy economy is ultimately a function of confident consumers willing to buy and sell. The real estate market is not only a good indication of consumer confidence and willingness to invest, it is also a market with the potential to create employment. Jobs are created not only in the direct sales of real estate, but the potential employment of people in construction and other fields related to real estate development.

Continued expansion of real estate lending may result in higher interest rates and inflationary pressure. America has rarely experienced such a prolonged period of economic growth and expansion. Since interest rates are currently low, investors demand high quantities of loanable funds. Inflationary pressures will ultimately result in consumer grief if the supply of loanable funds does not keep up with the demand, causing higher interest rates.
 

References
Federal Reserve Bank of St. Louis, Federal Reserve Economic Data (FRED), http://www.stls.frb.org/fred/

Keynes, John Maynard, The General Theory of Employment Interest and Money, New York: Harcourt Brace & World, 1936.

Thomas, Lloyd B., Money, Banking, and Financial Markets, New York: McGraw-Hill, 1997.