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Chapter 5
REAL ESTATE ECONOMICS AND VALUE
CHAPTER TERMS AND CONCEPTS
Agents of production
Over-improvement
Amenities
Physical forces
Demand
Political forces
Demography
Principle of anticipation
Economic forces
Principle of change
Fiscal policy
Principle of competition
Gross domestic product (GDP)
Principle of conformity
Monetary policy
Principle of increasing and
Monetary theory
decreasing returns
2
CHAPTER TERMS AND CONCEPTS
Principle of progression and
Purchasing power
principle of regression
Real estate cycle
Principle of substitution
Scarcity
Principle of supply and demand
Secondary market
Principles of highest and best use
Social forces
and consistent use
Principles of surplus
Supply
Surplus of productivity
productivity, balance, and
Transferability
contribution
Utility
3
LEARNING OUTCOMES
1. List the four basic elements of value.
2. List and give examples of the broad forces
that affect value.
3. Define real estate cycles.
4. Name the major supply and demand factors
that cause economic changes affecting real
estate.
5. Describe the federal government’s role in the
economy.
6. Explain how the principles of value relate to
the marketing and productivity of real estate.
THE REAL ESTATE VALUE INFLUENCES
Real Estate has no Intrinsic Value
Value is Derived from Rights and Benefits
that Come from:
Ownership
o Possession and
o Use
o
FOUR ESSENTIALS OF VALUE
Utility
 Usefulness; the ability to create a desire for
possession
Scarcity
 In relatively short supply; a lack of abundance
Demand
 The desire to possess plus the ability to buy;
effective purchasing power
Transferability
 The ability to change the owner or
use; marketable title
= Market Value
BROAD FORCES INFLUENCING VALUE
• Physical Forces
• Social Forces
• Economic Forces
• Political Forces
PHYSICAL FORCES
Natural Resources
Developed Resources
SOCIAL FORCES
1.
2.
3.
4.
5.
6.
7.
Demographics
Neighborhood Stability
Population
Life Styles
Attitudes; Behavior
Attitudes; Development
Attitudes; Public Education
ECONOMIC FORCES
1. Income Levels
2. Employment
3. Wages and Jobs
4. Money and Credit
5. Price Levels
6. Personal Savings
7. General Business Activity
8. Supply and Demand for Housing
9. Production of Goods and Services
POLITICAL FORCES
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Zoning and Land Use
Building and Safety
Environmental Laws
Endangered Species Act
Police, Fire, and Health
Crime Prevention
Public Works
Fiscal Policy
Monetary Policy
Government Sponsored Programs
Government Regulations
HOW ECONOMIC TRENDS AFFECT REAL ESTATE
 Economic Trends and the Business Cycle
 Real Estate Supply Factors
 Real Estate Demand Factors
 Federal Government Activity
ECONOMIC TRENDS AND THE BUSINESS CYCLE
 An Economic Trend is a Pattern of
Changes
 Cycles
Business
Real
cycles
Estate Cycles
 The
Cycle of Construction
 New Home Sales
 Volume of Sales
Used by Permission of Alma Dizon: www.riverside-real-estate.us
REAL ESTATE SUPPLY FACTORS
• Housing Supply
• New Construction
• Supply of Vacant Land
REAL ESTATE DEMAND FACTORS
 Population
 Purchasing Power
FEDERAL GOVERNMENT ACTIVITY
• Housing and Urban Development
Programs
o
FNMA


o
Federal National Mortgage Association
Secondary Market
FHA
 Federal Housing Administration
Figure 5.5:
Government Housing Project
under Construction
FEDERAL GOVERNMENT PROGRAMS
• Energy and the Environment
o EPA

Environmental Protection Agency
o FEMA

Flood Maps
• Governmental Banking and Monetary
Policy
o Federal

Reserve
Monetary Policy Actions
THE ECONOMIC PRINCIPLES OF VALUATION







Principle of Substitution
Principle of Conformity
Principle of Progression
Principle of regression
Principle of Change
Principle of Supply and Demand
Principle of Competition
PRINCIPLE OF SUBSTITUTION
• When a Property Easily can be Replaced by
Another, the Value of Such a Property Tends to
be Set by the Cost of Acquiring an Equally
Desirable Substitute
• The Principle of Substitution is a Basic
Concept Behind Each of the Three Approaches
to Value
PRINCIPLE OF CONFORMITY
Maximum Value
 Properties are similar
o
Size
o
Style
o
Quality
o
Amenities/Utility
Over-improvement
 5 bedroom in a 3 bedroom neighborhood
PRINCIPLES OF REGRESSION & PROGRESSION
• Progression
o
Lower value properties benefit from being close to high
value properties
• Regression
o
Higher value properties tend to decrease in value when
close to lower value properties.
• Is This an Illustration of Progression or
Regression?
PRINCIPLE OF CHANGE
Change is Eternal
o Physical
o Social
o Economic
o Political
conditions
Neighborhood Change
o Development
(growth)
o Stability
o Decline
o Renaissance
(rebirth)
PRINCIPLE OF SUPPLY AND DEMAND
• Price Goes Up with an Increase in Demand
or Decrease in Supply
• Price Goes Down with a Decrease in
Demand or Increase in Supply
• Theoretically, when Supply and Demand
are in Balance, Market Prices Reflect the
Cost of Production with Reasonable Profit
Supply
P
r
i
c
e
Deman
d
Quantity
Principle of Competition
 Market Demand Generates Profits
 Profits Generate Competition
 Excess Profits Usually Generate Ruinous
Competition
PRINCIPLES OF REAL ESTATE PRODUCTIVITY
1. Agents of Production
2. Principles of:
a) Surplus Productivity
b) Balance
c) Contribution
3. Principle of Increasing and
Decreasing Returns
4. Principle of Highest and Best Use
5. Principle of Consistent Use
6. Principle of Anticipation
AGENTS OF PRODUCTION
o Labor
o Coordination
o Capitol
o Land
PRINCIPLE OF SURPLUS PRODUCTIVITY
• The Net Income or Other Benefits that
Remain after the Cost of Labor,
Coordination, and Capital have been
satisfied have been described as the
“Residual” Returns to Land.

Surplus of Productivity
• Dollar Amount of Surplus becomes
Basis of Land Value
PRINCIPLE OF BALANCE
• Proper Balance in the Agents of
Production is Required if the Maximum
Value is to Result from the Costs
Invested.

Consistent with Principle of Conformity
PRINCIPLE OF CONTRIBUTION
• The Benefit of An Agent of Production
Depends Not on Cost But How Much it
Contributes to Value

A pool may cost $25,000 but only contribute
$10,000 of value.
• Principle of Surplus Productivity is the
basis for the Principle of increasing
and decreasing returns and the
principle of highest and best use.
INCREASING & DECREASING RETURNS
• Fertilizer Principle!
o
Added increments of fertilizer and labor do not result
in equal increases in crop yield
o
This principle helps property owners make decisions
about adding improvements or remodeling
 What to add and to what degree
PRINCIPLE OF HIGHEST AND BEST USE
• Highest and Best Use Means the Most
Profitable Use
• Theoretical Balance Between Land and
Improvements

Helps in estimating land value
• Highest and Best Use as:


Vacant
Improved
PRINCIPLE OF CONSISTENT USE
• Corollary to the Principle of Highest
and Best Use

Must appraise land and improvements on the basis
of the same use.

This photo shows that the improvements (house)
are a detriment to development of town homes.
PRINCIPLE OF ANTICIPATION
• Value is the Present Worth of Future
Benefits
• The Principle of Anticipation Underlies the
Income Approach to Value.
SUMMARY
Real estate is a basic and fundamental form of wealth, it
has no intrinsic value. Its market value is a measure of
the rights that the owners control, valued at prices set in
the market. But in order to enter the market, the rights
must have the four elements of utility, scarcity, demand,
and transferability.
We know that real estate is affected by changing
business conditions, such as employment, income and
price levels, production volumes, and building
construction costs. Thus, it is possible to analyze and
better understand real estate by observing key supply
and demand factors in the general economy.