REE3043 Exam 1 Study Guide Study For Exam Chapter 1 Real Estate Perspectives Classical Land Economics o Value is derived from an asset s utility and its scarcity o Value is determined by its relationship to the costs of production o Land owners receive what remains the residual after labor and capital costs are covered The Neoclassical Tradition o Value is determined by the intersection of supply cost and demand utility o The fundamental factors of demand and supply explain much of the market s behavior in valuing space Ideas About Property Rights and Contracts o Value is greatly affected by property rights o Property and contract laws define the fundamental rights of property ownership o Contract laws facilitate the transfer of property rights o Lease and sale contracts enable prices to be established Financial Economics o Real estate investment and valuation decisions require market analysis and the application of advanced financial techniques developed by financial economists The Institutions o Real estate values are affected by market and social institutions Examples primary and secondary lending institutions government agencies real estate ownership types household types Technological Change o Real estate values are affected by technological change technological change and its effect on location decisions e commerce and its effect on real estate services the internet and its effect on the availability of data Real Estate In The World Economy o The Relative Wealth of Real Estate In 1991 the total value of the world s assets was estimated to be 44 trillion Real estate assets represent almost one half of the world s total wealth Real estate assets in the U S represent almost 30 of the world s real estate wealth o Real Estate in the U S represents approximately 15 of the world wealth The value of residential property represents almost 75 of U S real estate o Investments To Improve Land 1 o Who Owns America Observations from available data Home equity and residential mortgage debt constitutes the largest portion of U S real estate The value of residential mortgage debt is greater than debt on commercial property For commercial property the value of un securitized mortgages far exceeds securitized Real Estate Defined o The term real estate may refer to The land and all permanent attachments to the land or the bundle of rights associated with owning real property o In practice real estate and real property are commonly used interchangeably Real Estate Perspectives 1 The Investment Perspective 2 The Market Perspective 3 The Valuation Perspective 4 The Mortgage Finance Perspective 5 The Legal Perspective Chapter 8 Real Estate Markets Largest Real Estate Markets o Asset Market o Space Market Location Makes Markets Interesting o Competitive market conditions include product homogeneity market freedom low external controls many buyers and sellers who individually cannot influence market prices products that are divisible and mobile knowledgeable participants Real Estate Market Price Behavior o Market imperfections may cause transaction prices to deviate from fundamental market values Imperfections include Imperfect knowledge High transaction costs Location Theory o Classical Location Theory Limited number of buyers or sellers Short run demand supply imbalances due to location regulation or political constraints Rent differences result from the accessibility of land to markets and users The most productive users can afford the highest cost locations 2 o Neoclassical Location Theory Recognizes land as a factor of production along with labor capital and entrepreneurial effort Rents are still based on users substituting location and transportation High rents occur in and around central locations because producers bid up central locations to avoid transportation costs o The Bid Rent Curve The value of land decreases as you get away from the Market Activity Center MAC The MAC is where the tallest buildings are located o 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 o 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 o Functions of Space Markets to allocate existing space among those who demand space to expand or contract space to meet conditions to determine new uses for land o Demand and Supply Model With Vacancy Va S D Natural Vacancy Rents Equilibrium rent Net contract rent Effective contract rent The long run vacancy rate in which supply and demand forces are in balance Housing Demand and Supply Factors o Housing factors of demand include New household formations age composition of new households household income and mortgage credit conditions 3 o Housing factors of supply include Prices of factors of production productivity factors number of builders in the market and credit conditions Number of consumers customer income consumer tastes and preferences prices of substitute Prices and productivity of factors of production number of developers developer expectations and credit conditions Retail Demand and Supply Factors o Retail factors of demand include products and credit conditions o Retail factors of supply include Office Demand and Supply Factors o Office factors of demand include square feet per employee o Office factors of supply include Similar to retail market supply factors The Asset Market Number of local firms types of business of local firms growth in local firms and office space o Real estate values vary according to their physical characteristics their locations and the economic conditions of the market o Real estate values depend on income expectations and its relative riskiness o Prices and Value Price PV of the expected cash flows Property prices depend on a property s expected income level its growth and the discount rate o 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 o Tobin s Q Q real estate Price or value Replacement Cost If Q 1 Opportunity exists to develop competing properties