Find an upper bound for the one year forward price

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Reference no: EM131243530

Real estate forwards

A house in Boston is offered for sale at $1 million. Interest-only mortgage rates are 4% (annual compounding) and the house can be rented out for $5,000 per month. Real estate taxes to be paid by the owner are $10,000 per annum.

(a) Find an upper bound for the one-year forward price for the house. State any assumptions you are making.

(b) Can you establish a lower bound on the one-year forward price? Consider briefly the cases where:
(i) you own the house and live in it

(ii) you own the house and rent it out

(iii) you own a house in Boston and are prepared to move

(iv) you own no real estate.

(c) There is in fact a nascent market in real estate forwards, largely for institutional real estate investors. At the height of the financial crisis, the difference between the theoretical upper bound and the actual forward price increased significantly. Discuss briefly why this might have occurred.

Reference no: EM131243530

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