Download Chapter 1 Microeconomic Concepts

Microeconomics
Valuation & Appraisal
Adam Smith
“A dwelling house, as such, contributes nothing to the
revenue of its inhabitant. If it is lett (sic) to a tenant for
rent, as the house itself can produce nothing, the tenant
must always pay the rent out of some other revenue ...
The revenue of the whole body of people can never be in
the smallest degree increased by it.”
Valuing property developments
1. Why does land have value?
2. Development valuations differ markedly from other
areas of valuation, why?
3. What does the value of a piece of land depend on?
4. Why is it difficult to rely solely on the comparison
method to value development land?
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1. Short-run supply of and
demand for real estate
• A property has value because it has utility and is scarce
• Economics; the science of choice, the allocation of scarce
resources amongst welfare maximising consumers
• Demand, measured by opportunity cost, is limited by budget
constraint - a reflection of the distribution of resource-buying
capacity throughout an economy
• The market is the distribution mechanism
• So value will be determined by utility, scarcity, opportunity cost
and budget constraint and is reflected in the basic economic
principle of supply and demand
4
Payment
for use of
land (rent)
1. Short-run supply of and
demand for property
Supply (S)
P*
Demand (D)
Q*
Quantity
of land
Figure 1
5
a) Land rent
Rent
MRP
(downwardsloping because
the law of
diminishing
returns means
MP decreases
as quantity of
land increases,
assume MR is
constant
S (supply of all land)
Price is determined solely by demand
P1
More economic
rent...
P
E
D1
Economic rent
O
D
Q
Increase in price of commodity produced
from land or increase in land’s productivity
Quantity of
land
Figure 2
9
b) Land use rents
Price
or rent
S
P*
Economic
rent
Transfer
earnings
(opportunity
cost)
D
Q*
Quantity of
land
Figure 3
10
b) Land use rents (over space)
City centre
Rent
S (inelastic)
Large
increase in
rent
Economic
rent
D2
Transfer
earnings
O
Figure 4
D1
Quantity of
land
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b) Land use rents (over space)
City fringe
Rent
S (elastic)
Small
increase
in rent
Economic
rent
D2
Transfer
earnings
O
D1
Quantity of
land
Figure 5
12
Rent (£)
b) Land use rents (over time)
S
S1
r1
r2
r*
D1
D
O
Office
floor-space (m2)
Figure 6
13
c) Land use intensity
• The quantity of land that a user demands depends not only on its
price and the price of the final product but also on its productivity
• Productivity of land can usually be increased by using it more
intensively through the addition of capital (e.g. more floor-space)
• If land is cheap it will not take much building before it will pay to
acquire more land to provide more accommodation whereas, if
land is expensive, a large amount of building may take place
before building costs increase to a level where it pays to acquire
more land to provide extra accommodation
• The process is subject to the principle of diminishing returns
15
3. Location and land use
• To understand commercial rent we are not only concerned about
supply and demand of land as a whole, of land for particular uses
and the intensity of use but also where the land is
• Land close to a market or a supply of labour will yield the same
output as land that is further away but would incur lower labour
and capital costs due to accessibility advantages
• Assuming the price of the output remains the same regardless of
where it was produced, the utility value of the prime site is
greater and this value is reflected in the rent
19
Cost
s
3. Location and land use
Difference
between
revenue and
cost (surplus
profit)
Total cost
(including
transport)
Total
revenue
R
Costs (exclg
transport)
0 (market
location)
Y
Distance from
market
Figure 9
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Revenue / costs
(£)
3. Location and land use
Total cost
for use A
Total cost
for use B
Revenue
from both
uses
R
B
A
0
X
Y
Distance from
market
Figure 10
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Rent-earning capacity
3. Location and land use
A
M
B
C
D
N
X
AY
Figure 11
BZ
C
D
Distance
from
market
22
Rent
3. Location and land use
Bid-rent
curves
Increasing
profit
Market rent
O
(CBD)
X
Figure 12
Distance from
CBD
23
Rent
3. Location and land use
OR
Distance from CBD
O
I
Figure 13
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Summary
• Supply, demand and markets
– Scarcity, choice, opportunity cost, budget constraint
– Allocation of scarce resources to satisfy the competing needs
– Demand for real estate largely a derived demand
• Competitive market with distinguishing characteristics
– Competitive: profit-maximising behaviour, supply allocated to most profitable
demand (in terms of use and intensity, subject to regulation)
– Characteristics: decentralised, fewer transactions, heterogeneous, physically
immobile, durable product , in finite supply
• Price mechanism
– Real estate rent is a surplus from the MRP generated after having deducted
the unit costs of optimally employed factors of production involved in using
land in its most profitable manner
– Paid to landowner by user
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Summary
1. Ricardian land rent theory
– MRP theory and law of diminishing returns
– Elastic demand and inelastic supply
2. Neo-classical land use rent theory
– Elastic demand and elastic supply
– Optimum land use allocation due to competition
– Transfer earnings and economic rent
3. Marshallian land use intensity and rent theory
– Margin of building
– Land use intensity: to maximise revenue from a site capital must be
added to point where MRP=MC
– Land use rent: When MRP=MC surplus revenue (rent) is also
maximised, the highest bidder is therefore also the most intensive
user of the land
4. Urban location theory
– Bid-rent theory
– accessibility