Download Basic Real Estate Appraisal - Lecture Outline for Chapter 05

Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
CHAPTER 5
REAL ESTATE ECONOMICS AND VALUE
STUDENT LEARNING OUTCOMES
This unit will cover the following topics:
5.1
5.2
5.3
The Real Estate Value Influences
How Economic Trends Affect Real Estate
The Economic Principles of Valuation
Class Activities
[Instructor: Complete as needed.]
Lecture [ ] Discussion [ ] Breakout Groups [ ] Other _____________[ ]
5.1 THE REAL ESTATE VALUE INFLUENCES
For any object to have value, certain essential elements must be present.
Four Essential Elements of Value
In the context of the market, there are only four basic elements that create the value of an object.
1.
2.
3.
4.
Utility: usefulness; the ability to arouse a desire for possession
Scarcity: in relatively short supply; lack of abundance
Demand: desire to possess, plus the ability to buy; effective purchasing power
Transferability: ability to change ownership or use; marketable title
Broad Forces Influencing Value
Physical Forces
1.
2.
Natural resources: the land, topography, soil, access and location; climate, air, water, and mineral
resources; plant and animal life; and scenic beauty and ecological balance.
Developed resources: subdivided land; structures for human occupancy, commerce, and indusrty;
public utilities, and health and safety facilities; street, road, highway and public transportation
improvements; and recreation, education, and cultural facilities.
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
Social Forces
1.
2.
3.
4.
5.
6.
7.
Demographics: family sizes, income and education levels, and age-groups in neighborhoods and
communities
Neighborhood stability: attitudes about property use and maintenance
Population: growth, decline, or shifts
Life-styles and living standards
Attitudes: behavior, law, government, and individual responsibility
Attitudes: development, growth, environmental protection and ecology
Attitudes: public education
Economic Forces
1.
2.
3.
4.
5.
6.
7.
8.
9.
Income level of neighborhood and community residents
Employment opportunities and trends
Levels of wages and types of jobs
Availability of money and credit, and interest rate levels
Price levels and property insurance and tax burdens
Personal savings levels and investment returns
General business activity
Supply of and demand for housing
Production of goods and services
Political Forces
1.
2.
3.
4.
5.
6.
7.
8.
Zoning and land-use regulations
Building and safety regulations
Environmental protection laws
Endangered species acts
Police, fire, and health services
Crime prevention, education, and recreation services
Public works: power, water, sewers, flood control, and transportation
Fiscal policy and taxation
9.
Monetary policy and controls
10. Urban redevelopment & housing finance programs
11. Regulation of industry and business
5.2 HOW ECONOMIC TRENDS AFFECT REAL ESTATE
Economic trends are an important part of the real estate climate.
Economic Trends and the Business Cycle
An economic trend is a pattern of related continuing changes in some aspect of the economy. The most
important economic issues are noted here:
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
1.
National: The balance of foreign trade, commodity price levels, and change in the annual gross
domestic product (defined below under Real Estate Demand Factors).
Local: Plant production, employment, construction activity, deed recordings, and the general
volume of business.
2.
Statistical information on the economy is available from a number of sources, most now on the Internet.
Cycles
1.
Many important changes in the economy are cyclical in nature. For example, business prosperity
often increases, stabilizes, then declines to a recession. Recovery leads to a period of growing
prosperity, starting the cycle again.
2.
Some economic changes repeat in a seasonal pattern caused by weather or social
customs.
3.
The real estate cycle may be evidenced in the changes in the number of new subdivision lots,
amount of new construction, and volume of real estate sales.
Short-four-year real estate cycles seem to relate to the cost and availability of money.
Long real estate cycles seem to have more complex origins (i.e. real estate collapse of 2007).
4.
5.
Real Estate Supply Factors
Some of the more important supply factors in real estate are listed here.
Housing Supply
The national supply of 130 million housing units (2009) is constantly affected by:
1.
2.
Decrease from disaster, abandonment, demolition, and conversion to other uses.
Increases from new construction, conversion and remodeling.
Protecting the condition of the existing supply is a major issue.
New Construction Activity
1.
2.
3.
The volume of new construction usually follows the business cycle. It is a good index of the
health of the real estate industry.
Increase in construction costs generally reduces construction activity.
Product substitution (e.g., the trend toward replacing wood framing material with less costly
materials) helps keep costs under control.
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
The Supply of Vacant Land
1.
2.
3.
Political and social changes influence the availability and cost of vacant land.
Impacted by environmental protection, “no-growth”, and subdivision reform laws.
Affected by increased costs for public approval and development.
Real Estate Demand Factors
Population
Population increases usually mean higher real estate values. Important demographic issues include:
1.
2.
3.
4.
5.
6.
7.
Increase or decrease in population at a given location
Composition or make-up of households
Birth rates
Age and sex groups
Occupations
Income levels
Migration patterns
Purchasing Power
Purchasing power studies tend to concentrate on several factors:
1.
a.
The size of the national labor force. Annual change predictions are made by the Bureau of Labor
Statistics, using census information on:
Birth rates
b.
Mortality rates
c.
Migration
d.
Worker participation rates
2.
Changes in the Gross Domestic Product (GDP). Representing the value of all domestic goods and
services produced in the country, the GDP is a gauge of the strength of our economy.
3.
Estimates of “disposable income.” This means per-capita income after taxes. Disposable income
projections can indicate potential demand for real estate. The projections are usually based on:
a.
b.
c.
d.
4.
a.
Employment
Level of wages
Family income
Rate of taxes
Consumer prices, growth, and inflation:
Consumer price index changes and city and industrial growth trends
b.
Inflation vs. growth in disposable income
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
5.
a.
Availability of mortgage financing, usually a function of:
Personal savings levels
b.
General prosperity
c.
The monetary and fiscal policies of government
Federal Government Activity
The government makes use of programs involving real estate to pursue many of its social and economic
goals.
Housing and Urban Development Programs
Agencies that encourage low-rent housing, new construction, and urban renewal include:
1.
2.
3.
Department of Housing and Urban Development (HUD)
The Federal National Mortgage Association (FNMA or Fannie Mae)
The Federal Housing Administration (FHA)
Energy and the Environment
Regulations of the Environmental Protection Agency (EPA) and the Department of Energy are designed
to:
1.
2.
3.
Control the quality of the environment by requiring environmental impact reports and enforcing
anti-pollution standards.
Conserve existing energy sources and promote new ones.
Promote use of solar heating systems and greater use of home insulation (i.e. energy efficient).
Governmental Banking and Monetary Policy
The Federal Reserve Bank (“The Fed”) regulates the availability of money and credit, in order to stabilize
the economy and control inflation, recession, and unemployment.
The Federal Deposit Insurance Corporation (FDIC) insures consumer deposits at banks, helping provide
funds for real estate financing.
Fiscal Policy
Recession, inflation, and unemployment are also controlled by the taxation and spending powers of
government. Real estate and business are sometimes favored with certain tax incentives such as:
1.
2.
3.
Home interest deductions on income tax
Interest and depreciation deductions for real estate investments
Other well-publicized “tax-reform” programs
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
5.3 THE ECONOMIC PRINCIPLES OF VALUATION
Real estate is both a form and a source of wealth.
1.
2.
As a form of wealth, real estate competes with other goods and services.
As a source of wealth, real estate combines with other economic forces and agents to produce
income and other amenities for its users.
Economic principles define and predict basic market patterns. This is true in the consumption as well as
in the development of real estate.
Principles of Real Estate Marketability
Substitution
The value of any replaceable property tends to equal its cost of replacement or the price of a substitute.
This principle underlies all three approaches to value.
Conformity
A reasonable degree of conformity results in maximum value. A lack of market conformity in size, style,
quality, or use can be detrimental to value (i.e. over-improvement).
Progression and Regression
When a property does not conform in size or quality, its value tends to seek the level of the surrounding
properties.
Change
Real estate markets and values are influenced by the many physical, social, economic, and political
changes that constantly occur at various degrees and rates.
Supply and Demand
Real estate prices tend to increase when effective demand exceeds supply, and they tend to decrease when
supply is greater than demand.
Competition
Market demand generates profits, and profits encourage competition. In turn, competition holds down
profits because new supply tends to overshoot demand, thus leading to “ruinous” competition.
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
Principles of Real Estate Productivity
Agents of Production
All real estate production (rental income, for example) depends on or results from the use of labor,
coordination, capital, and land.
Surplus Productivity, Balance, and Contribution
Income that is available to land after the other economic agents have been paid for is known as the
“surplus of productivity.” A proper balance of the agents maximizes the income available to land. The
value of any agent is determined by its contribution to the whole.
Increasing and Decreasing Returns
Income and other benefits from real estate may be increased by adding capital improvements. But the
greatest increase occurs only up to the point of balance in the agents of production. Beyond that point,
added expenditures don’t result in proportional added value or income.
Highest and Best Use, Consistent Use
The most profitable and likely use of a property is its highest and best use. If land is not put to such use,
the principle of consistent use requires that the appraiser recognize this fact in valuing the existing
structures, and that land and improvements must be appraised on the basis of the same use.
[Instructor: Highest and best use will be covered in Chapter 6.]
Anticipation
Value is the present worth of future benefits, whether they be in the form of income or intangible
amenities. The principle of anticipation is fundamental to the income approach to value.
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 5
SUMMARY
[Instructor: You may refer back to your outline to summarize.]
Important Terms and Concepts
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Instructor’s Manual: Basic Real Estate Appraisal, 7th. Edition
Chapter 5
Agents of production
Amenities
Demand
Demography
Economic forces
Fiscal policy
Gross domestic product
(GDP)
Monetary policy
Monetary theory
Over-improvement
Physical forces
Political forces
Principle of:
anticipation
balance
change
competition
conformity
consistent use
contribution
highest and best use
increasing and
decreasing returns
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Principle of:
progression and regression
substitution
supply and demand
surplus productivity
Purchasing power
Real estate cycle
Scarcity
Secondary market
Social forces
Surplus of productivity
Transferability
Utility
Instructor’s Manual: Basic Real Estate Appraisal, 7th. Edition
Chapter 5
REVIEWING YOUR UNDERSTANDING
[Instructor: See end of text chapter for student review questions.]
STUDENT EXERCISES
[Instructor: Suggested Multiple Choice and True/False questions are available to use for Chapter
5.]
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