Application of system dynamics modeling in real estate market analysis Konrad Zelazowski, MSc Department of Investment and Real Estate University of Lodz e-mail: kzelazowski@uni.lodz.pl tel.: (+48)(42) 635 51 90

Classic models of real estate markets They do not account for the time factor (time course of adjustment processes) They do not reflect complex interrelations between the variables and processes (feedback, short- and long-term relationships) Their potential for modification and expansion is limited.

System Dynamics Society “System dynamics is a methodology for studying and managing complex feedback systems, such as one finds in business and other social systems.” System Dynamics Society

System dynamics consists of the following research stages: Identifying the problem Putting forth a research hypothesis Constructing a model simulating the functioning of the selected system Verifying the correctness of the model and determining the extent to which it reflects reality Conducting simulations of the system’s functioning in order to verify the proposed hypotheses Drawing conclusions or selecting the optimum solution

Building blocks used in system dynamics modeling: Stocks Flows (inflows, outflows) Converters Connectors

Residential market model

Equations: Price(t) = Price(t - dt) + (Price_adjustments) * dt INIT Price = 2000 INFLOWS: Price_adjustments = (Optimum_price-Price)/Time_delays_in_price_adjustments Stock_of_available_real_estate(t) = Stock_of_available_real_estate(t - dt) + (Construction - Sales) * dt INIT Stock_of_available_real_estate = Optimum_stock_of_available_real_estate Construction = HISTORY(Supply_of_new_real_estate,TIME-Supply_delay) OUTFLOWS: Sales = Total_real_estate_demand Consumption_demand = (28000-6*Price)*Demand_disturbances Disproportion_in_real_estate_stock = Stock_of_available_real_estate/Optimum_stock_of_available_real_estate Optimum_price = Influence_of_stock_disproportion_on_price*Price Optimum_stock_of_available_real_estate = Total_real_estate_demand Speculation = 4 Speculative_demand = (Price-HISTORY(Price,TIME-1))*Speculation Supply_delay = 0 Supply_of_new_real_estate = 10000+3*Price Time_delays_in_price_adjustments = 1 Total_real_estate_demand = Consumption_demand+Speculative_demand Demand_disturbances = GRAPH(TIME) (1.00, 1.00), (2.40, 1.00), (3.80, 1.00), (5.20, 1.00), (6.60, 1.50), (8.00, 2.00), (9.40, 2.00), (10.8, 2.00), (12.2, 2.00), (13.6, 2.00), (15.0, 2.00) Influence_of_stock_disproportion_on_price = GRAPH(Disproportion_in_real_estate_stock) (0.00, 1.95), (0.2, 1.60), (0.4, 1.42), (0.6, 1.16), (0.8, 1.10), (1.00, 1.00), (1.20, 0.67), (1.40, 0.54), (1.60, 0.29), (1.80, 0.2), (2.00, 0.12)

The demand side: Consumption demand as a decreasing function of price. Speculative demand as a function of real estate price changes. Demand disturbances, a variable representing positive and negative demand shocks.

The supply side: Available real estate stock. Supply of new real estate. Optimum stock of available real estate. Disproportion in the real estate stock.

Mechanism of price adjustments: Current real estate price level. Optimum price. Influence of stock disproportion on prices. Time delays in price adjustments.

Market behaviour simulations Scenario assumes that after 5-period equilibrium, real estate market experiences a rapid increase in consumption demand for housing units

Classic model S Price D’ D Quantity

Price adjustment path in the case of a demand shock without time delays in the reaction of supply side No speculative investments

Price adjustment path in the case of a demand shock without time delays in the reaction of supply side Speculative investments appear

Price adjustment path in the case of a demand shock with time delays in the reaction of supply side (4 period delay) No speculative investments

Price adjustment path in the case of a demand shock with time delays in the reaction of supply side (4 period delay) Speculative investments appear

Market reaction on the positive demand shock

Conclusions the occurrence of time delays in market mechanism reactions prolong the process of forming a new market equilibrium supply-side time delays lead to a stronger price reaction in the initial phase of market adjustment price fluctuations in market mechanism adjustment are additionally reinforced by speculative investments

Summary System dynamics is an effective approach to the modeling of complex systems. It allows to construct detailed models of economic reality by incorporation of quantitative and qualitative data. Due to its unquestionable advantages system dynamics should be considered as a useful tool in education and real-life applications.