REAL ESTATE MARKETS LEARNING OBJECTIVES Examine the implications of fixed location on the behavior of real estate markets and how firms, households, and cities find desirable locations. Examine the relationship between the current vacancy rate and the long-run vacancy rate. Examine how competition in the capital asset market influences discount rates and real estate.

REAL ESTATE MARKETS LEARNING OBJECTIVES Examine the relationship between asset values and the replacements costs. Identify fundamental economic factors that influence movements in real estate market prices.

LOCATION MAKES MARKETS ’INTERESTING, INTERESTING’ Competitive market conditions include: product homogeneity market freedom--low external controls knowledgeable participants many buyers and sellers who, individually, cannot influence market prices products that are divisible and mobile

Real Estate Market Price Behavior Market imperfections may cause transaction prices to deviate from fundamental market values. Imperfections include: imperfect knowledge high transaction costs limited number of buyers or sellers short-run demand / supply imbalances due to location, regulation, or political constraints.

Location Theory Classical Location Theory rent differences result from the accessibility of land to markets and users Neoclassical Location Theory recognizes land as a factor of production, along with labor, capital, and entrepreneurial effort The Bid-Rent Curve

Location Theory 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

Location Theory 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 Physical and Financial Asset Markets Functions of Space Markets: to allocate existing space to expand or contract space to meet conditions to determine new uses for land Demand and Supply Model With Vacancy Va = S-D natural vacancy

HOW SPACE MARKETS OPERATE Demand and Supply Model With Vacancy Va = S-D Natural Vacancy Rents equilibrium rent net contract rent effective contract rent

Housing Demand and Supply Factors Housing factors of demand include: new household formations, age composition of new households, household income, and mortgage credit conditions. Housing factors of supply include: prices of factors of production, productivity factors, number of builders in the market, and credit conditions.

Retail Demand and Supply Factors Retail factors of demand include: number of consumers, customer income, consumer tastes and preferences, prices of substitute products, and credit conditions. Retail factors of supply include: prices and productivity of factors of production, number of developers, developer expectations, and credit conditions.

Office Demand and Supply Factors Office factors of demand include: number of local firms, types of business of local firms, growth in local firms, and office space square feet per employee. Office factors of supply include: similar to retail market supply factors.

THE ASSET MARKET Real estate values vary according to their physical characteristics, their locations, and the economic conditions of the market. Real estate values depend on income expectations and its relative riskiness.

THE ASSET MARKET Prices and Value Price = PV of the expected cash flows Prices vary according to conditions in the capital market—this affects the discount rate, E(R j ). E(R j ) = R f + RP j RP f, denotes the required risk-free rate RPj, denotes the required risk premium

THE ASSET MARKET Tobin’s Q Q (real estate) = Price (or value) Replacement Cost If Q > 1, opportunity exists to develop competing properties and sell them for abnormal profits. If Q < 1, properties are inexpensive relative to their replacement cost. ‘Noisy’ Prices Interaction with Securitized Market

Space and Asset Market Interaction The Economic Fundamentals Matter Events in space markets that determine rents and variations in rents are fundamentally linked to values in the asset market. Events in capital markets that affect interest rates and the relative attractiveness of all types of assets as investments affect real estate values.

Space and Asset Market Interaction Government Influences Do the Individuals Matter? The reservation price is the price the seller is willing to accept in negotiating a transaction. The offer price is the price the buyer is willing to accept in negotiating a transaction. Speculative Bubbles and Cycles