Exchange rates are the relative price of one currency to another. For example, how many US dollars are equivalent to a British Pound? For example, on August 8, 2021, 1.38 United States Dollars was worth one British Pound.
Exchange rates in real estate are a vital factor to consider when buying property abroad. If the exchange rates are rapidly changing, it can cause price fluctuations. Also, properties in countries with a strong currency are more likely to appreciate over time and withstand inflation than properties in countries with weaker currencies.
- An exchange rate is the relative value of one currency to another
- A currency’s exchange rate can be fixed or floating
- Exchange rates are dynamic and can sometimes change from day to day or even many times in the same day
Types of Exchange Rates: Floating vs. Fixed
There are two main types of exchange rates: fixed and floating.
Floating Exchange Rates
A floating exchange rate is achieved when a currency’s relative value is determined by market forces (demand and supply). Most exchange rates are primarily free-floating, which means they are determined by private markets.
Fixed Exchange Rate
A fixed pegged exchange rate is achieved when the government through its central bank determines and fixes the value of its currency. In this case, the government can decide to set its currency’s value relative to a major global currency (usually the US Dollar). Fixing a currency will require a high amount of foreign reserves to pay off any demand of the major currency it has pegged its currency to. Failure to do so will create a black market and hyperinflation.
In reality, all currencies have a degree of fixing and floating. In floating exchanges, the central bank can intervene to ensure a stable exchange rate and prevent inflation. In fixed exchanges, a higher level of demand than supply can put pressure on the currency and cause the central bank to adjust the fixed rates accordingly.
Exchange Rates and Commercial Real Estate
A pegged exchange rate is favorable for commercial real estate transactions because the value is relatively stable. However, a fixed rate may signify the presence of economic weakness.
A floating exchange is more dynamic, but countries that use a floating exchange typically have a more robust economy, versatile capital markets, and strong financial regulatory systems.
Exchange rates can radically change the value of a real estate investment for better or for worse. Any foreign property investments must account for the exchange rate and the financial indices supporting it.
Factors that Impact Exchange Rates
The primary factor that affects the exchange rate between currencies is demand and supply. Other factors that can also play a role are trade, foreign investments, inflation, insecurity, foreign relations, monetary policies, and the strength of its financial institutions.