Chapter 2:Chapter 2: The Real Estate SystemThe Real Estate SystemThe Real Estate System 1. The development industry 2. Overview of the R.E. “system” 3. The “4-Quadrant” model (4QM) 4. Using the 4QM to understand “boom & bust” cycles in R.E.2.1 Development IndustryThe Commercial Property 2.1 The Commercial Property Development Industry Financial Resources Physical Resources New Built Space Development IndustryThe Development IndustryThe Development Industry Development is a creative, entrepreneurialprocess characterized by… Vision Greed Cooperation Risk (All the most entertaining features of American capitalism.)Development (cont.)…Development (cont.)… z Cooperation: • Between public & private sectors; • Between developers & financiers. z Risk: • Even an economy in recession needs anexisting stock of built space. • New space (need for development) resultsonly from economic growth &/or change.Development (cont.)…Development (cont.)… R.E. Development is therefore dealing with the dynamic “cutting edge” of the physical built environment. This makes development the most cyclical branch of the real estate industry…2.2 The Real Estate System2.2 The Real Estate SystemExhibit 2-2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development I ustryExhibit 2-2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development Indndustry SPACE MARKET SUPPLY (Landlords) DEMAND (Tenants) RENTS & OCCUPANCY LOCAL & NATIONAL ECONOMY FORECAST FUTURE ASSET MARKET SUPPLY (Owners Selling) DEMAND (Investors Buying) CASH FLOW MKT REQ’D CAP RATE PROPERTY MARKET VALUE DEVELOPMENT INDUSTRY IS DEVELPT PROFITABLE ? CONSTR COST INCLU LAND IF YES ADDS NEW CAPI TAL MKTS = Causal flows. = Information gathering & use.“Negative feedback loops”…“Negative feedback loops”… Mechanisms within a system that tend to dampen the changes in the system, helping to keep it in control, preventing it from spiraling out of control.Example: Example: A thermostat puts a negative feedback loop into a heating and cooling (HVAC) system in a building. • When the temperature in the building getstoo low, the thermostat triggers the heater. • When the temperature in the building getstoo high, the thermostat triggers the air conditioning. The result is that the building temperature remains “under control”, within a comfortable temperature range.Concept check:Concept check: How do the development industry and the real estate asset market work together to provide a (long-run) negative feedback loop in the Real EstateSystem?… How can “forward-looking” behavior (goodforecasting of the space market) in thedevelopment industry and R.E. asset market(capital market) improve this negative feedbackloop?…2.3 The “4-Quadrant Model” (4QM)…2.3 The “4-Quadrant Model” (4QM)…Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…Quadrant Diagram… Exhibit 2-3: The DiPasquale-Wheaton 4-Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent DeterminationAsset Market: Valuation Q* R* P* C* D D2.4 Using the 4QM to help understand “boom & bust” cycles…2.4 Using the 4QM to help understand “boom & bust” cycles…EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . . 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 Price Level Index U.S. Institutional Real Estate REITs REIT bust, Recession ERISA: MPT =>P.F. demand inflation fears Boom, Tax incentives S&L Dereg Overbuilding Tax reform Disinflation Recession S&L Crisis: FIRREA Securitizatn: - REITs - CMBSExhibit 2-4a: Demand Growth in Space Market:Effect of Exhibit 2-4a: Effect of Demand Growth in Space Market: Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent DeterminationAsset Market: Valuation Q* R* P* C* D0 D1Exhibit 2-4a: nd Growth in Space Market: First phase…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Space Market: First phase… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent DeterminationAsset Market: Valuation Q* R* P* C* D0 D1 R1 P1 Can this be a long-run equilibrium result?… Doesn’t form a rectangle.Exhibit 2-4a: nd Growth in Space Market: LR Equilibrium…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent DeterminationAsset Market: Valuation Q* R* P* C* D0 D1 R1 P1 R** P** C** Q**Exhibit 2-4a: nd Growth in Space Market: LR Equilibrium…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent DeterminationAsset Market: Valuation Q* R* P* C* D0 D1 R** P** C** R1 P1Exhibit 2-4a: nd Growth in Asset Market…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Asset Market… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent DeterminationAsset Market: Valuation Q* R* P* C* 11% OAR 8% OAR D0 D1 P1 P** R** Q* * C** SR LREXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . . 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 Price Level Index U.S. Institutional Real Estate REITs REIT bust, Recession ERISA: MPT =>P.F. demand inflation fears Boom, Tax incentives S&L Dereg Overbuilding Tax reform Disinflation Recession S&L Crisis: FIRREA Securitizatn: - REITs - CMBSConcept check…Concept check… 1. What does the 4Q Model reveal about the interaction of the space market, the assetmarket, and the development industry incausing “boom & bust” cycles? 2. How can the an understanding of the 4Q Modelhelp participants in the asset market anddevelopment industry to avoid “boom & bust”cycles? [Hint: Can the 4Q Model help with“forward-looking”