Session Seven Residential Real Estate Markets Page 33

Real estate economic characteristics 1.Fixed supply in short run 2.Immobile-Local market is key 3.Long economic life 4.Lack of standardization Key Concept: Short term movements in prices and rents caused by changes in demand, not in supply.

What is a “market”? A place where buyers and sellers meet to exchange items of value. Competition varies directly with: –Number of buyers –Number of sellers –Homogeneity of units available –Knowledge by all parties vs. advantage over the other party to distort price or market activity

Real Estate Markets Imperfect Perfect market would have numerous knowledgeable buyers and sellers Few buyers and sellers Not knowledgeable Perfect market sells homogeneous, small and inexpensive products Page 33

List four examples of homogenous products: 1._______________________ 2._______________________ 3._______________________ 4._______________________ Page 33

Characteristics of the Real Estate Market Buyers & sellers are not numerous –Local nature of the market –Number of buyers/sellers for a particular class of property is usually limited –Number of buyers/sellers is small in comparison to other commodities Real estate is heterogeneous, bulky, expensive –Each property has a different location that is permanently fixed Combined land, capital & financing is unique –Soil, topography, climate unique –Expense of durability and complex nature of dirt Page 33

Characteristics of the Real Estate Market Buyer/Seller knowledge is frequently poor due to –Infrequency of entry into the market –Limited number of comparable bids and offers –Complexity of legal requirements needed to transfer ownership

Characteristics of the Real Estate Market Willingness of buyers/sellers impaired due to –Limited supply of real estate –Limited number of buyers and sellers –Limited financing options for particular properties –Differences in compulsion to buy by individuals Supply of land is fixed –Land is fixed = fixed supply –Housing units (density) may be increased Construction time –Average of 2 years to increase/build units –Short run: supply limited –Long run: supply may be increased

Imperfect market compels buyers and sellers to use a real estate professional Professional has higher knowledge of legal and technical aspects Real Estate Market

Real Estate Supply Land is fixed Number of housing units on land is not fixed. Increasing supply takes a long time. Page 33

Real Estate Supply is Fixed in the Short-Run Demand Price Supply Quantity Rents and Prices change with shift in Demand $

Compare Price/Rents when Demand changes with Fixed Supply Supply Demand Equilibrium Price Quantity Short term price changes caused by demand Fixed Supply Deman d Lower Deman d Price Quantity Decrease in Demand equals Decrease in Price Old Price Quantity Fixed Supply Higher Demand Demand New Increase in Demand equals Increase in Price/Rent

Price Quantity Old Supply New Supply Old Supply New Supply Old Price New Price Same Demand Increase in Supply when Demand remains same will lower Price or Rent “Over Building” Supply * Demand

If there is an increase in demand Increased demand reduces vacancies Reduction in vacancies increases rents and prices bid for short-term fixed supply Those who cannot afford higher rents/prices: –Share space with others –Move to less expensive property –Increase density and intensity of use

Real Estate Demand Increase in Demand caused by –Population –Income –Cost –Government action Page 33

Real Estate Supply Increase in supply is caused by: –C–Construction –C–Conversion –D–Demolition –D–Destruction Page 33

If there is a decrease in demand Increased vacancies Decline in rents and prices Lower rents/prices leads to: –Moving up to higher price area –Reduced density

Assuming an increase in demand, supply will eventually change: Profit motive: Demand pushes rents & prices up Construction increases (if no growth limits) Supply overtakes increased demand, vacancies increase Vacancies lead to falling rents and prices Lower rents/prices: –Different between building costs/rents/sales narrows –No longer profitable to build

Assuming a decrease in demand, supply will change: As demand falls, vacancies increase Increased vacancies lead to fall in rents/prices –More space available at lower cost Long term affects of rent/price decrease: –Out-of-pocket costs for least desirable property –Costs exceed income generated –Abandonment or demolition

Rent controls Rents are high because demand exceeds supply To rebalance the market: –Demand must decrease –Supply must increase Rent controls tend to: Increase demand by keeping rents low Decrease supply by maintaining low rents Low returns for investors reduces construction Be politically motivated

Real Estate Agent’s Role Client/customer rely upon agent expertise Knowledgeable, ethical agent help overcome market imperfections: –Increasing number of buyers/sellers –Increase knowledge of buyer/seller Aware of rents/prices Types of profitable investmetns Lead principals through legal complexities –Give financing sources and alternatives

Real Estate Sub Markets Occupancy – The desire to receive direct services from the property Investment – The desire to receive services in the form of a profit –May be non-monetary rewards –Prestige/pride of ownership

Real Estate Market Investment Occupancy Residential Commercial Office Industrial Residential Commercial Office Industrial Own Rent 1-4 Family Multi-Family 1-4 Family Multi-Family

Forecast Variables Residential Housing SUPPLY VARIABLES 1. Rate of New Construction Construction Cost Land Availability Credit for Construction Demand for Housing 2. Rate of Conversions Interest rates Economic base trends Environmental Constraints –Coastal controls –Building moratoriums sewer and water Planning controls –Zoning –Building codes 3. Rate of Demolitions Number of existing housing units

FORECAST VARIABLES RESIDENTIAL HOUSING DEMAND VARIABLES 1. Population a. Numbersc. Owner Occupied b. Demographyd. Renters 2. Income Economic base trends and employment Disposable income trends Discretionary income for speculation and investment 3. Costs Cost of household operation 4. Credit Interest rates Loan-to-value ratios Payback periods Borrower qualifications 5. Other Factors: Tastes and Customs Single family vs. condominiums Trading up and filtering Rent vs. buying

CONCERNS FOR BOTH SUPPLY AND DEMAND IMPACT OF INFLATION 1.Actions of Federal Reserve 2.Speculators seeking gains 3.Rates of returns 4.Fiscal policy of government 5.Property and income taxes IMPACT OF ENERGY SHORTAGES 1.Transportation: Number of highways and cost of travel 2. Utility rates 3. Size of homes

Market Characteristics Owner-occupied residential –Buyers/sellers have Lack of knowledge Lack of experience –Circumstances Family reasons Employment Not profit motive –Use of agent specialists Escrow Loan brokers Real estate sales agents 1-4 unit Residential Investment –Similar to owner-occupied –Demand parallels owner- occupied 5+ multi-family Residential –Principals more informed –Principles have more experience] –Knowledge highly specialized Broker Appraiser Certified Property Manager Tax & Legal Advisors –Future profit motive forecasting

Compare Current Market Indicators Number of deeds recorded Number of loans: conventional, DVA, FHA Foreclosure rates Trends in rents and resale prices Building permits/subdivision activity Construction costs Vacancies (utility company; change of address) New home inventory Classified section activity MLS, including price changes Local population trends Government housing support programs

Affordability Index MEDIAN PRICE CALIFORNIA HOME $ __________ MEDIAN HOUSEHOLD INCOME $ ______________ Prevailing California interest rates ___________% Do we have problems right here in River City? Median Price for U. S. Home $ ______________________ Median Household Income $ ________________________ Prevailing U. S. interest rate ___________%