mit center for real estate week 1:...

enter for Real EMIT C state

Week 1: Introduction

• The space versus asset market: 4 Quadrant math.

• Real Estate Micro Economics: Hedonics, Location, density, government regulations.

• Real Estate Macro Economics: timing behavior (search, moving, contracts), cycles, regional growth.

MIT Center for Real Estate

The Role of Real Estate in the Economy

• Construction [6% of GDP]• Service flow, “Shelter”, rent plus imputed

rent [20% + of GDP] • Assets [55-60% of total national wealth]• Land? Not part of GDP (we don’t make

land), but it is part of wealth. • Accounting, measurement difficulties [book

versus market value]

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Construction as a part of GDP

MIT C state

(1990)$, in billions % of GDP

Private Construction 338 6.1 Public Construction

Buildings 301 5.5 Buildings

Residential Buildings 183 3.3 Housing and Development

Nonresidential Buildings 118 2.1 Industrial

Industrial 24 0.4 Other

Office 29 0.5

Hotels/Motels 10 0.2 Nonbuilding Construction

Other Commercial 34 0.6 Infrastructure

All Other Nonresidential 21 0.4 All Other

Nonbuilding Construction 37 0.7 Total New Construction

Public Utilities 31 0.6

All Other 6 0.1 Total GDP

$, in billions % of GDP

109 2.0

46 0.8

4 0.1

1 0.0

41 0.7

63 1.1

55 1.0

8 0.1

446 8.1

5,514 100.0

Adapted from DiPasquale and Wheaton (1996)


The Value of US Real Estate Assets (1990)

$, in billions % of Total

Residential 6,122 69.8

Single Family Homes 5,419 61.7

Multifamily 552 6.3

Condominiums/Coops 96 1.1

Mobile Homes 55 0.6

Nonresidential 2,655 30.2

Retail 1,115 12.7

Office 1,009 11.5

Manufacturing 308 3.5

Warehouse 223 2.5

Total U.S. Real Estate 8,777 100.0


enter for Real EU.S. Real Estate

MIT C state

Ownership, 1990

All Real Estate Residential Only Nonresidential Only

$, in billions % $, in billions % $, in billions %

Individuals 5,088 58.0 5,071 82.8 17 0.6

Corporations 1,699 19.4 66 1.1 1,633 61.5

Partnerships 1,011 11.5 673 11.0 338 12.7

Nonprofits 411 4.7 104 1.7 307 11.6

Government 234 2.6 173 2.8 61 2.3

Institutional Investors 128 1.5 14 0.2 114 4.3

Financial Institutions 114 1.3 13 0.2 101 3.8

Other (Including Foreign 92 1.0 8 0.1 84 3.2

Total: 8,777 100.0 6,122 100.0 2,655 100.0

% of All Real Estate 100.0 69.8 30.2


Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…

Rent $

Stock (SF)Price $

Space Market:Construction

Space Market:

Valuation

Q*

R*

P*

C*

D

D

Construction (SF)

Stock Adjustment

Asset Market:

Rent Determination Asset Market:


Systems of Economic Equations• Parameters: Constants that reflect underlying

behavior, α, β, δ. • Endogenous variables: values that the model

“determines: C, S, R, P. • Exogenous variables: values that determine the

model’s variables, but which the models variables in turn do not influence: i, E.

• Equilibrium: Solution to the endogenous variables given exogenous values and parameters.

• Comparative Statics: How changes in exogenous variables change equilibrium endogenous ones.


1st quadrant

β

1). Office Demand = α1ER-β1

E= office employment R = rent per square foot

1 = rental elasticity of demand: [%change in sqft per worker/% change in rent]

2). Demand = Stock = S 3). Hence: R = (S/α1E)–1/ β1


2nd and 3rd Quadrants 4). P = R/i

i = all inclusive cap rate 5). Office Construction rate:

C/S = α2Pβ2

P = Asset Price per square foot [“Q” theory?] β2 = Price elasticity of supply: [% change in construction rate/% change in rent]


4th Quadrant 6). Replacement version:

E= fixed C= δS [Construction equals depreciation (δ is depreciation rate)]

7). Steady Demand growth version: ∆E/E = δ

Hence: C= δS [what if S grows less or more than E?]

Exhibit 2Exhibit 2--4a: Effect of4a: Effect of Demand GrowthDemand Growth in Space Market:in Space Market:

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

D0 D1

Exhibit 2Exhibit 2--4a: Effect of Demand Growth in Space Market:4a: Effect of Demand Growth in Space Market: First phaseFirst phase……

Rent $

Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

D0 D1

R1

P1

Can this be a long-run equilibrium result?…

Doesn’t form a rectangle.

Exhibit 2Exhibit 2--4a: Effect of Demand Growth in Space Market:4a: Effect of Demand Growth in Space Market: LR EquilibriumLR Equilibrium……

Rent $

Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

D0 D1

R1

P1

R**

P**

C**

Q**

Exhibit 2Exhibit 2--4a: Effect of Demand Growth in Space Market:4a: Effect of Demand Growth in Space Market: LR EquilibriumLR Equilibrium……

Rent $

Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

D0 D1

R**

P**

C**

R1

P1

Exhibit 2Exhibit 2--4a: Effect of Demand Growth in4a: Effect of Demand Growth in AssetAsset MarketMarket……

Rent $

Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

11% OAR

8% OAR

D0

D1

P1

P**

R**

Q* *

C**

SR

LR


Using the 4-Quadrant Model to assess the impact of other

changes. • What happens if Construction costs rise or the

supply schedule shifts? • Suppose depreciation speeds up (functional

obsolescence dictates shorter life spans of buildings)?

• How to interpret owner occupied space (e.g. SFU housing)?

• EXERCISE #1.


National Office ForecastCompletions Rate vs. Real Rent

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

20.00

22.00

24.00

26.00

28.00

30.00

32.00

34.00

$ Per Sqft

Forecast

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

Total Employment Growth (L) Real Rent (R) Completion Rate (L)


National Industrial Forecast$ Per Sqft

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%

-1.00%

-2.00%

Completions Rate vs. Real Rent Forecast

7.00

6.50

6.00

5.50

5.00

4.50

4.00

3.50

3.00

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007


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National Multi-Housing Forecast MIT C state

$ Per Sqft Permits vs. Real Rent

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

500.00

550.00

600.00

650.00

700.00

750.00

Forecast

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007



7.00%

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%

-1.00%

-2.00%

-3.00%

Completion Rate vs. Real Rent Forecast

National Retail Forecast $ Per Sqft

24.00

23.00

22.00

21.00

20.00

19.00

18.00

17.00

16.00

15.00

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007


enter for Real EMIT C state National Hotel Forecast

Supply Growth Rate vs. Real ADR

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

80.00

85.00

90.00

95.00

100.00

105.00

110.00

Forecast

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Total Employment Growth (L) Real ADR (R) Supply Growth Rate (L)


U.S. Single-Family MarketCompletions Rate vs. Home Price

Appreciation 1990-91 1980-81

7% 6%

5% 4% 3%

2% 1% 0%

-1% -2% -3%

-4% -5%

2001-02

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Completions Rate Employment Growth Home Price Index (2002 $)


The Historic Supply of US Office Space Broken

Ground

18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

-2%

ProjectsConstruction as % of Stock

1901 1910 1919 1928 1937 1946 1955 1964 1973 1982 1991 2000

Downtown Suburban

Real Esta t eenter for

Index of Historic Housing Prices in MIT C

Amsterdam (Real Guilders)g y ( g )

0

50

10 0

15 0

20 0

25 0

30 0

35 0

40 0

Pric

e In

dex

16481658166816781688169817081718172817381748175817681778178817981808181818281838184818581868187818881898190819181928193819481958

Y ear

16281638

1968


Real Estate Micro-economics: Cities and Land Markets

• No two properties are identical [complete product differentiation]

• Properties are close if not perfect substitutes for each other – at some price differential.

• Price differentials are extremely large, and very predictable.

• Price differentials tend to be stable over time: local neighborhoods do not have independent cyclic movements.

enter for Real EHouse prices reflect both unit characteristics and

MIT C state

location attributes


Repeat-Sale House price indices (CSW) for 15 submarkets within the greater Boston CMSA: 1982-2002

House Price Indexes, Eastern Massachusetts, by City/Town Location

0

50

Pric

e In

dex

(199

0=10

0)

Lowell Area

i

100

150

200

250

300

Boston Southeast W estern 1 Far North Shore 495 North 95 South 95 North W estern 2

495 West North Shore South Shore Worcester Area Cambr dge Area North Central

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Year


Home Prices within South California

$400

$350

$300

$250

$200

$150

$100

Median Home Price, Thousands ($ 2002.4)

77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

Los Angeles Orange County Riverside Ventura San Diego Sources: OFHEO, Torto Wheaton Research


Forecast

15

20

25

30

35

40

1980

1981

1982

1983

1985

1986

1987

1988

1990

1991

1992

1993

1995

1996

1997

1998

2000

2001

2002

2003

2005

Los Angeles Orange County Ventura County Riverside San Diego

Office Rents Move together Cyclically but notOffice Rents Move together Cyclically but not always secularlyalways secularly

TW Rent Index, 2003$ per sqft


Closely Correlated Industrial RentClosely Correlated Industrial Rent Movements: few secular differencesMovements: few secular differences

TW Rent Index, 2003$ per sqft 10.00

9.00

8.00

7.00

6.00

5.00

4.00

Forecast

1980

1981

1983

1984

1986

1987

1989

1990

1992

1993

1995

1996

1998

1999

2001

2002

2004

2005

Los Angeles Orange County Ventura County Riverside San Diego


20

25

30

35

40

45

50

55

60

65

Manhattan Office Rents vs. NJ and Conn. Suburbs

TW Index, $2002 per sqft

1980

1981

1982

1983

1985

1986

1987

1988

1990

1991

1992

1993

1995

1996

1997

1998

2000

2001

Suburban Markets Manhattan

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10

15

20

25

30

35

40

45

50

1980

1981

1982

1983

1985

1986

1987

1988

1990

1991

1992

1993

1995

1996

1997

1998

2000

2001

Office Suburban Rents in Detail MIT C state

Northern New Jersey Long Island Stamford Westchester

TW Index, $2002 per sqft


Prices and Development• Prices bring forth development: of any urban land

use.. • Development occurs so as to maximize the

residual value between: Price-capital costs (construction).

• This residual is “land value”. Development maximizes land value.

• Land Development is a natural real option: incur heavy capital costs to realize an income stream – or- wait (to do the same later) ?


What is a real Estate Market?

• Within “markets” all properties should move together: high substitutability, easy mobility.

• Between markets there exists frictions, transportation costs, immobility of resources and low substitutability.

• MSA as “market”? CMSA?


Metropolitan Housing Markets often move independently

$)

50

70

90

110

130

150

170

190

210

230

250

Hou

se P

rice

F IGURE 5. Repeat Sale House Price Indices for Selected "new " Cities: 1975-1999 (constant

Year

75

176

1

77

178

19

79

1980

19

1 19

2 83

184

1

85

186

19

87

1988

19

89

190

191 92

1

93

194

1

95

1996

19

97

1998

1

8 8 9 99 9 19 9 9 9 19 9 9 9

l l ixAt anta Dennver Houston Los Ange es Phoen

19 9 999


Metropolitan Housing Markets have some similar movements

50

70

90

Hou

se P

rice

(

110

130

150

170

190

210

230

250

Year

FIGURE 4. Repeat Sale House Price Indices for Selected "Traditional" Cities: 1975-1999 constant $)

761

771

7819

79 980

981

1982

1983 98

419

851

861

871

8819

89 990

991

1992 99

3

994

1995

1996

197

198

19 9 9 9 9 9 9 91 1 1 1 1 1 1

Chi iBoston cago New York Sanfrancisco W ash ngton D.C.

1975

1 999

mit center for real estate week 1:...

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