ECONOMY FOR REAL ESTATE (BPE 33902) Prepared By:- Sr Norjariah binti Arif, Department of Real Estate Management, FPTP, UTHM. 25 September 2013

LECTURE 2 a)Types and physical characteristics of Real Estate b)the Real Estate Market and its Imperfections

OBJECTIVES Describe the principal types of real estate which are traded in the market Describe the main elements of real estate which determine its economic characteristics and performance as an investment Explain the characteristics of the real estate market by comparison with the perfect market

Types of Real Estate Farmland Includes estates and smallholdings. Most estates owned by Corporate sector 2. Commercial real estate Freehold and leasehold interests in offices and retail shops or stores

Types of Real Estate 3. Industrial Real estate consist principally of factories, warehouses and hi-tech space. Industrial real estate generally less attractive investment than shops and office 2. Residential A major investment sector

SAQ: What are the principal ‘goods’ which are traded in the real estate market? The principal ‘goods’ are freehold and leasehold interest in commercial, industrial and residential property

Physical Characteristics of Real Estate RE has certain characteristics , distinguish from other commodities. These are of great significance, and require to be clearly stated. By understanding the nature of both the intangible legal interest and the tangible property can a sound understanding of prices be achieved.

Objectives You should be able to describe the main elements of real estate which determine its economic characteristics and performance as an investment

1. Dual components Land Capital improvements A property may consist mostly of building and a smaller amount of land. In other cases, eg farms, the land content is the greater Buildings Roadways Provision of utilities eg water supply, electricity, drains etc

2. Durability Durability is a measure of the useful life of a commodity. Pure land is very durable. Buildings and other capital improvements are relatively durable compared with most other goods. This durability enables the right to use real estate to be separated from ownership.

3. Fixed Location The location of all real estate is fixed. This means that all properties are unique at least in respect of location, and their values will be determined by demand in that location

4. Heterogeneity Heterogeneity is a measure of uniformity Heterogeneous vs homogeneous This heterogeneity means that the value of each real estate interest is unknown to the market and must be individually appraised

5. Stock Elasticity The total amount of land in the world, in any country, or in any location is essentially fixed. However, this characteristic can vary because over long periods, the amount of land used for different purposes cganges. The other component of real estate, mainly buildings is man-made. This means that it is elastic in the long run.

The elasticity of stock of any property type depends on: The pure land requirements of that use The proportion of total land stock in that location currently employed in that use

Examples Paddy Land in Kedah cannot be significantly increased The stock elasticity of offices in towns and cities is much greater. This is due to the small proportion of land devoted to office use and the availability of land which is transferable from other uses

Continuation Despite the overall fixed stock of land, the stock of commercial and industrial real estate is elastic in the long run. However, it is relatively inelastic compared with most other goods, owing to the devt. Constraints which may be imposed by governments and overall land scarcity

The Real Estate Market and its Imperfections The concept of perfect market and examine the main criteria characterising such a market. By comparing the real estate market with the perfect market, we can gain insight into the behaviour

Objectives To explain the characteristics of the real estate market by comparison with the perfect market Discuss the differences in the characteristics of the real estate market and the stock market

The Perfect Market A perfect market- perfect competition. No individual buyer or seller could influence price. Prices would be determined by the forces of dd and ss, responding instantly to any change in dd or ss. At any point of time, the goods traded would be correctly priced.

The characteristics of a perfect market are as follows: The goods traded are homogeneous and divisible Large numbers of buyers and sellers act independently Information is free and available to all There are no transaction costs or taxes Investors are rational and strive to maximize utility

The Imperfect Real Estate Market By comparison with the stock market we shall examine how far the real estate market shows the characteristics of imperfect market. Homogenous and divisible goods Equity shares (common stock ) are identical, low price to enable even small investors to buy. It can be bought and sold in amounts which suit individual investors.

Cont… Real estate investments are highly priced, indivisible and heterogeneous. The implication is that it provides a seller or lessor with an element of monopoly power. Absence of substitute property on the market at the same time, together with a lack of knowledge of the appropriate rent or price level, may enable the seller or lessor to achieve a figure higher than the true market value.

Cont… 2. Large numbers of buyers and sellers Indivisibility of real estate and the large sums of money required for direct investment, few investors have financial resources – property companies. This distinguishes the real estate market from the stock market, the number and diversity of investors is far greater.

Cont.. 3. Free and available information RE heterogeneous nature and indivisibility- uncertainty about appropriate prices and rents. Small number of deals – lack of reliable evidence of market value. RE market has no formal market place where prices are quoted and deals publicly witnessed. Some deals and prices go unreported.

Cont… 4. Transaction Costs and Taxes The complexity of RE, lack of free and reliable info, make it essential to employ professional experts, particularly brokers or agents, appraisers and lawyers. The cost of these experts, together with time factor, discourage short term trading and frequent ‘in and out’ operations.

Conclusion The RE market fails to meet the main prerequisites of the concept of a perfect market. The goods are highly priced and indivisible. Relatively small buyers and sellers, transactions costs are high, and the heterogeneity results in obscurity about their qualities and true values.

Cont… Contrasts with stock market where info is freely available and where the market come as close as any to the perfect market concept. The relative perfection of the stock market means that stock prices are sensitive and respond quickly to new info or a change in sentiment.

Price stability The imperfection of the real estate market is the reason for the relative stabllity of prices. RE do not react to short term changes in market condition. Constrains imposed onto the property. Eg bumiputra units cannot be sold to non-bumiputra without state’s consent or approval.

Learning Outcomes You should know the characteristics of the RE market by comparison with the perfect market You should know the differences in the characteristics of the RE market and the stock market

Real estate information is rarely transparent SAQ: One criterion of the perfect market is that info is free and available to all. List the less perfect characteristics of the Re market. RE market has no formally organised marketplace, so many process and deals are not publicised Many real estate deals involve some form of consideration apart from price Real estate information is rarely transparent Small number of deals in any sub-market

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