REAL ESTATE MARKETS

LEARNING OBJECTIVES

Examine the implications of fixed location on the behavior of real estate markets and how firms, households, and cities find desirable locations.

Examine the relationship between the current vacancy rate and the long-run vacancy rate.

Examine how competition in the capital asset market influences discount rates and real estate.

REAL ESTATE MARKETS

LEARNING OBJECTIVES

Examine the relationship between asset values and the replacements costs.

Identify fundamental economic factors that influence movements in real estate market prices.

LOCATION MAKES MARKETS ’INTERESTING, INTERESTING’

Competitive market conditions include:product homogeneitymarket freedom--low external controlsknowledgeable participantsmany buyers and sellers who, individually, cannot

influence market pricesproducts that are divisible and mobile

Real Estate Market Price Behavior

Market imperfections may cause transaction prices to deviate from fundamental market values. Imperfections include:imperfect knowledgehigh transaction costslimited number of buyers or sellersshort-run demand / supply imbalances due to

location, regulation, or political constraints.

Location Theory

Classical Location Theoryrent differences result from the accessibility of

land to markets and usersNeoclassical Location Theory

recognizes land as a factor of production, along with labor, capital, and entrepreneurial effort

The Bid-Rent Curve

Location Theory

Location Decision Factors of Households:

users seek to avoid transportation costs, thus having incentives to locate close to economic centers

the price of land decreases with distance from the economic activity centers within urban areas, and buyers substitute land quantity for location

Location TheoryLocation Decision Factors of Firms:

transportation costsproximity to customersproximity to suppliersproximity to work force

land requirementstype of service or product

high-density / low-density demandweight-gaining / weight-losing production

HOW SPACE MARKETS OPERATE

Physical and Financial Asset MarketsFunctions of Space Markets:

to allocate existing spaceto expand or contract space to meet conditionsto determine new uses for land

Demand and Supply Model With VacancyVa = S-Dnatural vacancy

HOW SPACE MARKETS OPERATE

Demand and Supply Model With VacancyVa = S-D

Natural VacancyRents

equilibrium rentnet contract renteffective contract rent

Housing Demand and Supply Factors

Housing factors of demand include:new household formations, age composition

of new households, household income, and mortgage credit conditions.

Housing factors of supply include:prices of factors of production, productivity

factors, number of builders in the market, and credit conditions.

Retail Demand and Supply Factors

Retail factors of demand include:number of consumers, customer income, consumer

tastes and preferences, prices of substitute products, and credit conditions.

Retail factors of supply include:prices and productivity of factors of production,

number of developers, developer expectations, and credit conditions.

Office Demand and Supply Factors

Office factors of demand include:number of local firms, types of business of

local firms, growth in local firms, and office space square feet per employee.

Office factors of supply include:similar to retail market supply factors.

THE ASSET MARKET

Real estate values vary according to their physical characteristics, their locations, and the economic conditions of the market.

Real estate values depend on income expectations and its relative riskiness.

THE ASSET MARKET

Prices and ValuePrice = PV of the expected cash flows

Prices vary according to conditions in the capital market—this affects the discount rate, E(Rj).

E(Rj) = Rf + RPj

RPf, denotes the required risk-free rateRPj, denotes the required risk premium

THE ASSET MARKETTobin’s Q

Q (real estate) = Price (or value) Replacement Cost

If Q > 1, opportunity exists to develop competing properties and sell them for abnormal profits.

If Q < 1, properties are inexpensive relative to their replacement cost.

‘Noisy’ PricesInteraction with Securitized Market

Space and Asset Market Interaction

The Economic Fundamentals MatterEvents in space markets that determine rents and

variations in rents are fundamentally linked to values in the asset market.

Events in capital markets that affect interest rates and the relative attractiveness of all types of assets as investments affect real estate values.

Space and Asset Market Interaction

Government InfluencesDo the Individuals Matter?

The reservation price is the price the seller is willing to accept in negotiating a transaction.

The offer price is the price the buyer is willing to accept in negotiating a transaction.

Speculative Bubbles and Cycles