Download CHAPTER 2 BASIC VALUATION CONCEPTS

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 homogeneity
 market freedom--low external controls
 knowledgeable participants
 many buyers and sellers who, individually, cannot
influence market prices
 products 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 knowledge
 high transaction costs
 limited number of buyers or sellers
 short-run demand / supply imbalances due to
location, regulation, or political constraints.
Location Theory
 Classical Location Theory
 rent differences result from the accessibility of
land to markets and users
 Neoclassical 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 Theory
 Location Decision Factors of Firms:
 transportation costs
 proximity to customers
 proximity to suppliers
 proximity to work force
 land requirements
 type of service or product
 high-density / low-density demand
 weight-gaining / weight-losing production
HOW SPACE MARKETS OPERATE
 Physical and Financial Asset Markets
 Functions of Space Markets:
 to allocate existing space
 to expand or contract space to meet conditions
 to determine new uses for land
 Demand and Supply Model With Vacancy
Va = S-D
 natural vacancy
HOW SPACE MARKETS OPERATE
 Demand and Supply Model With Vacancy
Va = S-D
 Natural Vacancy
 Rents
 equilibrium rent
 net contract rent
 effective 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 Value
Price = 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 rate
 RPj, denotes the required risk premium
THE ASSET MARKET
 Tobin’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’ Prices
 Interaction with Securitized Market
Space and Asset Market Interaction
 The Economic Fundamentals Matter
 Events 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 Influences
 Do 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