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Chapter 2:Chapter 2:
The Real Estate System
The Real Estate SystemThe Real Estate System
1. The development industry
2. Overview of the R.E. “system”
3. The “4-Quadrant” model (4QM)
4. Using the 4QM to understand “boom & bust” cycles in R.E.
2.1 The Commercial Property 2.1 The Commercial Property Development IndustryDevelopment Industry
FinancialResources
PhysicalResources
NewBuilt
Space
DevelopmentIndustry
The Development IndustryThe Development Industry
Development is a creative, entrepreneurial process characterized by…
VisionGreed
CooperationRisk
(All the most entertaining features of American
capitalism.)
Development (cont.)…Development (cont.)…
Cooperation: Between public & private sectors; Between developers & financiers.
Risk: Even an economy in recession needs an existing stock of built space. New space (need for development) results only from economic growth &/or change.
Development (cont.)…Development (cont.)…
R.E. Development is therefore dealing with the dynamic “cutting edge” of the physical built environment. This makes development the most cyclical branch of the real estate industry…
Exhibit 2- 1 US commercial property construction Exhibit 2- 1 US commercial property construction starts by property type as percent of existing stock…starts by property type as percent of existing stock…
2.2 The Real Estate System2.2 The Real Estate System
Exhibit 2-2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development IndustryExhibit 2-2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development Industry SPACE MARKET
SUPPLY (Landlords)
DEMAND (Tenants)
RENTS &
OCCUPANCY
LOCAL &
NATIONAL ECONOMY
FORECAST FUTURE
ASSET MARKET
SUPPLY
(Owners
Selling)
D EMAND
(Investors
Buying)
CASH
FLOW
MKT
REQ’D
CAP
RATE
PROPERTY
MARKET
VALUE
DEVELOPMENT INDUSTRY
IS DEVELPT
PROFITABLE ?
CONSTR
COST INCLU LAND
IF YES
ADDS NEW
CAPITAL MKTS
= Causal flows.
= Information gathering & use.
““Negative feedback Negative feedback loops”…loops”…
Mechanisms within a system that tend to dampen the changes in the system, helping to keep it in control, preventing it from spiraling out of control.
ExampleExample: : A thermostat puts a negative feedback loop into a heating
and cooling (HVAC) system in a building. When the temperature in the building gets too low, the thermostat triggers the heater. When the temperature in the building gets too high, the thermostat triggers the air conditioning. The result is that the building temperature remains “under control”, within a comfortable temperature range.
Concept check:Concept check:
How do the development industry and the real estate asset market work together to provide a (long-run) negative feedback loop in the Real Estate System?…
How can “forward-looking” behavior (good forecasting of the space market) in the development industry and R.E. asset market (capital market) improve this negative feedback loop?…
2.3 The “4-Quadrant Model” (4QM)…2.3 The “4-Quadrant Model” (4QM)…
Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…
Rent $
Stock (SF)Price $
Construction (SF)
Space Market:Stock Adjustment
Asset Market:Construction
Space Market:Rent Determination
Asset Market:Valuation
Q*
R*
P*
C*
D
D
2.4 Using the 4QM to help understand “boom & 2.4 Using the 4QM to help understand “boom & bust” cycles…bust” cycles…
69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
Price Level Index U.S. Institutional Real Estate
REITs
REIT bust,Recession
ERISA: MPT=>P.F. demand
inflation fears
Boom, Tax incentivesS&L Dereg
Overbuilding Tax reform
Disinflation
Recession
S&L Crisis: FIRREA
Securitizatn: - REITs - CMBS
EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .PRICES OVER THE LAST QUARTER-CENTURY . . .
Rent $
Stock (SF)Price $
Construction (SF)
Space Market:Stock Adjustment
Asset Market:Construction
Space Market:Rent Determination
Asset Market:Valuation
Q*
R*
P*
C*
D0D1
Exhibit 2-4a: Effect of Exhibit 2-4a: Effect of Demand GrowthDemand Growth in Space Market: in Space Market:
Rent $
Stock (SF)Price $
Construction (SF)
Space Market:Stock Adjustment
Asset Market:Construction
Space Market:Rent Determination
Asset Market:Valuation
Q*
R*
P*
C*
D0D1
R1
P1
Exhibit 2-4a: Effect of Demand Growth in Space Market: Exhibit 2-4a: Effect of Demand Growth in Space Market: First phase…First phase…
Can this be a long-run equilibrium result?…
Doesn’t form a rectangle.
Rent $
Stock (SF)Price $
Construction (SF)
Space Market:Stock Adjustment
Asset Market:Construction
Space Market:Rent Determination
Asset Market:Valuation
Q*
R*
P*
C*
D0D1
R1
P1
Exhibit 2-4a: Effect of Demand Growth in Space Market: Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium…LR Equilibrium…
R**
P**
C**
Q**
Rent $
Stock (SF)Price $
Construction (SF)
Space Market:Stock Adjustment
Asset Market:Construction
Space Market:Rent Determination
Asset Market:Valuation
Q*
R*
P*
C*
D0D1
R**
P**
C**
R1
P1
Exhibit 2-4a: Effect of Demand Growth in Space Market: Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium…LR Equilibrium…
Rent $
Stock (SF)Price $
Construction (SF)
Space Market:Stock Adjustment
Asset Market:Construction
Space Market:Rent Determination
Asset Market:Valuation
Q*
R*
P*
C*
11% OAR
8% OAR
D0
D1
P1
P**
R**
Q**
C**
SR
LR
Exhibit 2-4a: Effect of Demand Growth in Exhibit 2-4a: Effect of Demand Growth in AssetAsset Market… Market…
69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
Price Level Index U.S. Institutional Real Estate
REITs
REIT bust,Recession
ERISA: MPT=>P.F. demand
inflation fears
Boom, Tax incentivesS&L Dereg
Overbuilding Tax reform
Disinflation
Recession
S&L Crisis: FIRREA
Securitizatn: - REITs - CMBS
EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .PRICES OVER THE LAST QUARTER-CENTURY . . .
1. What does the 4Q Model reveal about the interaction of the space market, the asset market, and the development industry in causing “boom & bust” cycles?
2. How can the an understanding of the 4Q Model help participants in the asset market and development industry to avoid “boom & bust” cycles? [Hint: Can the 4Q Model help with “forward-looking” decision-making?…]
Concept check…Concept check…