Primary geographic units are metropolitan areas (or metropolitan statistical areas, Mass) Even Within a single metropolitan area considerable geographic segmentation Of space markets exists, for example the downtown or central business district (CAB) area. Space markets are also segmented by property usage type (Office, retail, industrial and multifamily residential) Supply, demand & rent in the space market. Demand function: looks like the classical demand functions of economic theory Supply is ‘kinked’: the vertical reflects the fact that the supply of office space is almost completely inelastic.
There’s extreme longevity of built space. The kink in the supply function occurs at the current quantity of built space tat rent level that equates (on a capitalized present value basis) to the lowers marginal cost of supplying additional space to the market. MAC = costs of developing new buildings / The level tot rent that is just sufficient to stimulate profitable new development in the market is called the replacement cost level of rent. ( tends to be the long-run equilibrium rent. Rising supply line (after kink) it would costs more to develop the next office building than it did to develop the last one.
Decreasing supply line location rent decreases over time in real terms, this occurs when a location is losing its relative centrality, 1_1. 6 The principal cause of a rising supply function is land scarcity in the presence of growing usage demand. This results in an increase in location rent. I. Asset market. The asset market is the market for ownership of real estate assets. It is often referred to as the property market & it must be viewed as part Of the larger capital market. _2,1, Capital markets, I I Equity assets I Debt assets & IBO’S I Public markets I Stocks Reedits Mutual funds I Bonds MBPS Money instruments
I Private markets I Real property I Private equity I Hedge funds I Bank loans Awhile mortgages Venture debt 1. 2. 2 Pricing of real estate assets Think in terms of property value per dollar of current net rent or income. The inverse tot the price/earnings multiple: capitalization rate (or cap rate, or overall rate OAR) is simply the property operating earnings divided by the property asset price or value. Cap rate = similar to a current yield Property values can be represented as earnings (net rents) divided by the cap rate.
The cap rate is determined by capital investment supply & demand in the set market and is based on 3 major factors: 1. Opportunity cost of capital increase demand, increase in the price investors are willing to pay for the property, this results in a decrease of the cap rate. 2. Growth expectations Risk Asset market investors are seeking future cash flows – financial rather than physical assets. Real estate asset markets are much more integrated than real estate space markets. Chi. 2 Real estate system.
The real estate development industry is the engine of entrepreneurial activity that assembles and applies the financial and physical resources to construct ewe built space. It is only the demand for new built space that supports the development industry. Three major components tooth real estate system: – The space market – The asset market – The development industry The real estate system (as depicted below) is, in principle, forward-looking to varying degrees in several aspects of the system. [pick] The above picture gives a visual overview of the Real Estate System and includes the major elements and linkages among the three major components.
Some explanations: Both the supply and demand sides Of the real estate asset market consist Of investors; all of these investors are operating within the broader capital markets. The space and asset markets, reflecting the underlying economic base and the capital markets, interact to produce current real estate asset market values. This is the output of the asset market and he input into the development industry. Negative feedback loops dampening mechanisms that tend to make a system self-regulating, preventing it from spiraling out of control.
The principal negative feedback loop in the real estate system is the ability of the asset market to regulate the flow of financial capital to the development industry. Audiovisual and Wheaton four-quadrant model. The concept of long-run equilibrium involves allowing the markets sufficient time for the supply of built space to adjust to the demand. Explanations to the four factor model: – The northeast quadrant depicts the determination of rent in the space Horizontal axis = physical stock Of space Vertical axis rent .
The northwest quadrant depicts the asset market valuation process, relating the equilibrium property prices (horizontal axis) to the level of current rent (vertical axis). The line represents the cap rate or OAR. Represents the property price The southwest quadrant depicts the operation of the development industry – physical asset production process. The relationship is between property prices and the annual amount of construction activity, including rehabilitation and redevelopment new development The outward slope Of the construction function line represents rising long- run marginal costs in the supply of built space.
The key to whether rents must rise with a growth in demand lies in the shape of the construction function in the southwest quadrant – The southeast quadrant links the rate of construction to the total stock of lilt space available in the usage market. The line relates the average rate Of space construction per year to the total stock of space that can be indefinitely maintained in the market. On average over the long run, a certain amount Of new construction per year is necessary just to maintain a given stock of space available in the market. The Q picture depicts a long-run steady-state equilibrium.
Property prices in the real estate asset markets, along with liquidity and volume tot sales transactions in that market, often appear to go through extended periods of rise and fall, related to the ups and downs in the space market. Chapter 6: Real Estate Market Analysis. Objective: The goal Of market analysis is to characterize (both qualitative and quantitative) the supply and demand of a specific space market. 6. 1 General Features. Practical market analysis needs to be simple and based upon realistic data so that it can be used quickly and inexpensively.
Also, this way it can be easily communicated and understood in business. Thus, most analysis stems from direct and common sense procedures. There are different kinds of analysis; whereas some market analysis focuses on specific micro-level decisions, others Ochs on a broader and more general characterization of a broader market. The first type focuses mainly on individual building sites, the latter type focuses on quantifying and transiting supply and demand for space in one geographical market (e,g, downtown Chicago).
The broader supply and demand analysis focuses on a few variables, such as the vacancy rate, the rent level, the quantity of new construction started and completed, and the gross absorption rate. Vacancy rate is the percentage of the stock of built space in the market that is not currently occupied (so it depends on tock in the market and current amount of space occupied). Vacancy rates should be seen more as an equilibrium indicator, as it reflects the current balance between supply and demand. It is optimal to have some vacancy in the market, because of the search costs for both the tenant and the landlord.
For example, both suffer costs when a tenant moves, which is why contracts usually last for more than one period. Also if the demand rises, it takes a long time before new construction is completed, and thus it might be better to have some vacant buildings in ;inventory. Thus, there is also a natural vacancy rate, which is the long term average vacancy rate, this indicates when the market is approximately in balance be,even supply and demand. This is not the same in all of the markets (higher in faster-growing more volatile markets).
The market rent level refers to the level of rents being charged on new leases that are signed at the moment. The rents reported in surveys of landlords (asking rents) might be different from the rents that are actually charged to new tenants (effective rents). The quantity of new construction starts and completions represents the addition f new supply to the stock of space, thus it is an indicator of the activity on the supply side of the market. Space absorption refers to the amount of additional space that is occupied per year, so it is an indicator of the activity on the demand size tooth space market.
Gross absorption measures the total amount of space for which leases were assigned for a specific year, but as some people might move within the same market, net absorption might be a better measure, as it measures the net change in the amount of occupied space in the market. The relationship between the quantity of vacant space in one period and the next erred is the following: [pick]. The five variables described above can be combined to get other indicators, such as the month supply: [pick].
The definition of the relevant market is important. The market should be defined specifically and functionally, e. G. The downtown area. Apart from geographical scope, there is also a temporal range that should be defined. Historical analysis can give insights into the dynamics in the market. Most market analysis are future forecasts (over 5- or 1 C-years), because decisions are forward-looking in time. There are two ways of approaching the market analysis (or you can combine he two for a hybrid approach, which is often most useful).
One is the simple trend extrapolation, where one looks directly at the market supply and demand variables and extrapolates these variables into the future based on the past trends. Here you can use time-series statistical techniques, such as econometric models, but in practice these are hardly used, The other is structural analysis, where one attempts to model the structure of the market by identifying and quantifying the underlying determinants of the variables, e. G. The demand for office space is driven by employment.
The first steps in a structural analysis are o inventory the existing supply of space and to identify the fundamental sources of the demand for space usage in the relevant markets. These (the fundamental sources) are the drivers of the need for space usage in the market (e,g_ the demand drivers of retail property are aggregate disposable income, aggregate household wealth and the traffic volume of specific sites). The next step is then to relate the underlying demand sources to the amount of real estate space usage demand After that, you can develop forecasts of future demand and supply.
On the demand side, this is done by extrapolating trends or personal judgment. On the supply side, one has to look at the inventory of the projects that are currently under construction. The end result of this structural analysis is a projection of the future relation between supply and demand in the market. 6. Formal Model Of Space Market Equilibrium Dynamics and Cyclically. A dynamic model Of a space market is represented by a system Of six linked equations that reflect the relation be,even supply, demand, construction, rent and vacancy.
Output from each equation represents input in another equation, forming a complete representation of the market in equilibrium. The first two equations reflect the supply side of the market, where the first represents the development industry, and the second the total stock in the market. 1 )topic where C(t) is the amount of new space, R(t-L) is the rent prevailing the market (L represents the lag that is present between when construction decisions are made and when they are finished), K represents the trigger rent (above which construction will start) and E is the supply elasticity. ) [pick] where S(t-l) represent the previous years stock and C(t) is the new construction. The next two equations reflect the demand side of the model, where the first elates to the amount Of space potential users would like to occupy and the second equates the amount of space occupied to the demand in the previous year. 3) [pit] where N(t) reflects one of the fundamental sources (such as employment for the office market), and [pickled [pick] calibrate the model, where alpha is the intercept, eat is the price elasticity of demand and tat reflects the quantity of space usage demanded per unit of underlying need (e. . The amount of square toot per employee). 4) [pick] where the SO is the amount of space actually occupied and D(t-l) the demand in the previous year, The fifth equation reflects the definition of the vacancy rate. S) [pick] The system is made complete by the last equation, which represents rental- pricing behavior (landlords raise or lower rents when vacancy is higher or lower). 6) [pick where [pick represents the sensitivity of rental response to vacancy-rate deviations from the natural rate, as landlords are assumed to have a one year lag.
Fifth parameters are quantified, the characteristic can be simulated through time. Such a model would be specified using econometric techniques. From this model, we can observe the cyclical nature of real estate. Even when there is steady growth in the underlying source of the demand and there is no lumpiness, the cycle still exists because of the myopic behavior of the market participants.