REE 3043 Exam 1 Study Guide 1031 Transfer Like Kind Exchange under this method owners may exchange their properties and avoid paying capital gains at the time of Real Estate the collection of rights associated with real actions involving transaction land Vacancy Rate Va S D Where Va is the amount of vacant space in the market S is the supply of space ie square footage and D is the amount of space currently demanded rented NOI Net Operating Income Net operating income is the amount of money left over after paying the expenses of operation but before paying the mortgage payment and income taxes Real Estate in Relation to World s Rate o The Value of the world s assets was estimated by Ibbotson Associates to be 44 trillion in 1991 and 22 6 trillion in US o Real estate assets are estimated to represent nearly 50 of the world s wealth o Residential property e g single family apartments etc represents approximately 75 of the real estate wealth in the US o Homeowners and mortgage lenders on homes jointly own the majority of US property o Owner occupied homes represents about 60 of the value of all real estate in the US Owners equity accounts for 55 and mortgage debt o Commercial real estate represents about 40 of the value of all real estate in the US Owners equity accounts for 75 and mortgage debt for 45 for 25 o While few commercial mortgages are securitized only about half of the outstanding residential mortgages are unsecuritized o The trend is toward greater institutional and corporate ownership of commercial properties and increased holdings of all mortgages through mortgage backed securities largely by pension funds and other institutional investors Exemptions for Personal Residence with Taxes Home owners receive preferential tax treatment under current federal income tax laws In most cases homeowners are permitted to exclude from taxable income up to 250 000 of the capital gain realized on the sale of their principle residence The exclusion is 500 000 for married couples filing a joint income tax return The tax exclusion is allowed each time a taxpayer sells a principle residence and meets the eligibility requirements but generally no more often than once every two years 4 Classes of Real Property o 1 Real estate held as a Personal residence o 2 Real estate held for sale to others Dealer property o 3 Real estate held for use in a trade or business Trade or Business o 4 Real estate held as an investment for the production of income 3 Types of Income subject to federal taxation property Investment property o 1 Active Income o 2 Portfolio Income o 3 Passive Income Natural Vacancy Rate The long run vacancy rate in which supply and demand forces are in balance is termed the natural vacancy rate Speculative Bubble When buyers are purchasing property at higher than expected values other buyers may mimic this behavior This behavior creates what is known as a Speculative Bubble i e prices are higher than the underlying fundamentals support Traits of Perfectly Competitive Market o Product homogeneity o Free markets no transaction costs o Perfect knowledge about the competing goods and identical future expectations o Individual buyers or sellers cannot influence market prices o Products can be divided and are mobile Traits of Real Estate o Real estate may be an investment o Real estate may be a product or service o Real estate may be a business or profession o Real estate may be the urban and rural space market o Real estate may be the rights associated with owning real property The Cost of Land Relative to Central Business o The cost of the land will go down the farther you get away from the central business o The cost of land will go up the closer you get to central business o i e the closer your apartment is to campus the higher the rent will be The farther your apartment is from campus the cheaper your rent will be Classical and Neoclassical Views o Classical Land Economics Prior to 1776 economists recognized that value was derived from an asset s utility or its usefulness to people and its scarcity Early 19th century classical economists argued that rent the periodic payment for space was determined by the cost of labor and capital in production o The Neoclassical Tradition is Still Followed Today Neoclassical economists in the late 1800s and early 1900s demonstrated that value results from the intersection of supply cost and demand utility Classical and Neoclassical Location Theory o Classical Location theory Von Thunen argued that rent results from accessibility of land to the markets and users Access creates value because it lowers transportation costs Most productive users can afford the highest cost locations The bid rent curve indicates the rent received relative to the distance from the market activity center o Neoclassical Location Theory The Neoclassical view of location decisions recognizes land as a factor of production along with labor capital and entrepreneurial effort Rents are still based on the users substituting location and transportation High rents occur in and around central locations because producers bid up central locations to avoid transportation costs Space and Asset Market Refer to Chapter 8 of the Target Copy Packet State Federal Government is the single entity that owns most real estate Residential Real Estate possesses most property in US Know what Landlord is deducting Tax Credit o Tax credits are allowances that are deductible directly from the taxes owed Rehabilitation tax credits are available to individuals investing in historic rehabilitation and low income housing Bid Rent Curve o The bid rent curve indicates the rent received relative to the distance from the market activity center Tobin s Q o Tobin defined the equilibrium condition as Q 1 where Q is the market divided by replacement value when evaluating financial markets The Q statistic can be applied to understand if real estate prices are too high or low o Q Real Estate Price or value Replacement Cost o If Q 1 opportunity to develop competing properties and sell them for abnormal profit o If Q 1 price of properties cheap relative to replacement cost 3 Types of Values o Market Value can be defined as the price a typical buyer would pay if the property were placed on the market i e the most probable selling price of a property o Investment Value can be defined as the price a particular investor as opposed to the typical investor is willing to pay given the investor s unique tax situation