1. Fundamentals of Real Estate Lecture 11 Spring, 2002 Copyright © Joseph A. Petry www.cba.uiuc.edu/jpetry/Fin_264_sp02

2. 2 1. Allocate existing space among those who demand space 2. Expand or contract space to meet changing needs. 3. Determine new uses for land Function of Real Estate Markets-Ch 8

3. 3 Definition: Transaction price on land always equals the value of the land Perfectly competitive markets require: Product homogeneity Freedom of operation Perfect knowledge Many buyers and sellers Mobility and divisibility of product Is Real Estate Perfectly Competitive?

4. 4 While there are examples of why real estate does not qualify as a perfectly competitive market for all the 5 characteristics listed, the most important is: REAL ESTATE HAS A LOCATION MONOPOLY – No two properties are exactly alike – Adjacent property risk – Information costs Is Real Estate Perfectly Competitive?

5. 5 Real Estate markets are therefore imperfect— though the book argues not inefficient. Eventually market prices converge on their true value. Is Real Estate Perfectly Competitive?

6. 6 Question becomes: how do you find opportunities before prices converge? Act on opportunities quickly and ahead of other observant investors Investors cannot spend large amounts on transactions costs and expect higher than normal profits to remain Is Real Estate Perfectly Competitive?

7. 7 How does one decide whether to buy existing property or build a new development? Compare replacement cost to value. If you can replace a property with a new building for less than it would cost to buy existing property—build it. If it costs less to buy existing property compared to build it, buy existing property. Q-Ratio=market value of real estate/replacement cost Q=1. Market in equilibrium Q<1. Upward pressure on prices. Slow or no development. Buy existing buildings Q>1. Downward pressure on prices (market value). Rapid development. Is Real Estate Perfectly Competitive?

8. 8 Economic Determinants of Land Usage – As transportation costs increase, the value of land tends to decrease – As land prices increase, capital improvements on individual parcels increase – Substitution of capital for additional land – This natural tendency for similar land uses to agglomerate via market forces is “economic zoning” Determining Land Usage—Ch. 9

9. 9 Externalities Greatly Impact Land Values Real estate as an asset class represents a large percentage of most individuals portfolios, thus protecting the value of their assets against negative externalities is a significant concern. Zoning Restrictions are most significant means of achieving this goal. Private zoning restrictions can be put in place by developers as it is being built, or created via the establishment of a homeowners association. Determining Land Usage—Ch. 9

10. 10 Public Planning for Land-use control. Separation of land uses enhances property values by controlling negative externalities. A Comprehensive Plan generally guides the establishment of zoning guidelines Objective is to direct the future growth and development in a manner consistent with the needs of the community. Zoning The Regulation of land uses, population densities and building types and sizes by ordering the uses of land according to special districts or zones. Determining Land Usage—Ch. 9

11. 11 Zoning (cont’d) – Single family residential R-1: half acre lots for single family houses R-2: apartments allowed – Commercial BP: business and professional BR: retail sales and services BH: highway oriented business services – Industrial – Zoning regulations can be tested in court, but unless it is an extreme case, zoning usually holds up. Determining Land Usage—Ch. 9

12. 12 Zoning (cont’d) Rezoning requests can be made to city government – Is it consistent with comprehensive plan? – Should comprehensive plan be modified? – What would the impact be of new zoning on surrounding land uses and larger community? Variance requests can also be made – Variance is a minor deviation from the zoning regulations, which does not require a change in the zoning classification itself Determining Land Usage—Ch. 9

13. 13 New Urbanism A term used to refer to a trend toward making downtowns more livable. Incorporate office, retail, residential in an urban like setting. Environmental Hazards Asbestos/fiberglass PCBs (polychlorinated bihpenyls)/LUST (leaking underground storage tanks) Lead paint/radon Phase I, Phase II, Phase III Determining Land Usage—Ch. 9