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LECTURE 1 THE REAL ESTATE INDUSTRY.docx

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Administrative Studies
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ADMS 3810
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LECTURE 1: THE REAL ESTATE INDUSTRY 1A: THE REAL ESTATE MARKETPLACE The real estate marketplace actually consists of a very large number of separate markets differentiated by: 1. Geographic Location – neighborhood, city and region, and national or international; and 2. Type of real estate – single-family homes, office buildings, industrial properties, etc. Indeed, since each parcel of property has a unique location that cannot be duplicated, it might almost be said that an infinite number of markets exist. After the future cash flow that is expected to be generated by the physical asset is estimated, various claims on that cash flow must be considered. Perhaps the largest claim on the net operating income is that of the lender. Another large claimant is the federal government, which takes a share – designated income taxes. The residual or remaining portion is termed the equity cash flow. To Summarize, the analysis of the real estate takes the form of a model that does the following: • Estimate the Net Operating Income (NOI) • Deducts claims by lenders, government and others that have priority over the equity claim • Estimates the residual cash flow that belongs to the equity owner. 1B: KEY DEFINITIONS Property – refers to things and objects capable of ownership. In other words, things and objects that can be used, controlled or disposed by an owner. Real Estate Property – consists of physical land plus structures and other improvements that are permanently attached. In a more technical sense, real property refers to the legal rights, interests and benefits inherent in the ownership of real estate. One owns not land as such, but a “bundle of rights” to use and dispose of land and its improvements subject to various restrictions. Concept of Permanent Attachment – Personal Property is movable whereas real estate is not. (immeubles) Bundle of Rights – society defines the bundle of rights and can change the definitions from time to time. For example, zoning land for residential use eliminates the landowner’s right to put a factory on the site. The residual claim – property ownership – confers the right to receive the cash flow from property subject to any prior claims. • The right of possession • The right of control • The right of enjoyment • The right of disposition • The right of exclusion • The right of destroying or injuring property (Another right recognized by Michael Brooks) 1C: FEATURES OF THE REAL ESTATE ASSET The key characteristic of the real estate asset is its association with land. All the features that distinguish real estate from assets that are not real estate flow from this association. These features fall into 3 main categories: !) Physical; 2) Economic; and 3) Other. Physical Features of Real Estate: • Immobility • Unique Location (Heterogeneity) • Indestructibility Immobility – real estate is fixed in location and cannot be moved. One consequence of real estate’s immobility is that real estate markets are primarily local. However, for some properties, the market may be local or international, depending on the use and property rights involved. For example, interests in single-family houses are generally traded locally. Unique Location (Heterogeneity) – Because land is immobile, it follows that every single parcel of real estate has a location that cannot be duplicated. Every parcel of real estate, being unique, is therefore heterogeneous or one of a kind. Heterogeneity implies that you do not have the perfectly competitive market situation that would necessarily provide an efficient allocation of resources. Also, this implies a lack of information by buyers and sellers. Consequently, this market requires professionals such as brokers and appraisers to provide the information required to make the market function. The fixed location implies that externalities are going to play an important role determining real estate value. Also, public infrastructure can have significant impacts on value because these services are themselves location specific. Indestructibility – Land may be mined, eroded, flooded or desolated; nevertheless, the designated location on the earth’s surface remains forever. 2.O: ECONOMIC FEATURES OF REAL ESTATE • Scarcity • Long Economic Life • Modification • Situs Scarcity – because every location is unique, only certain parcels can satisfy the requirements of a particular project or investment. So even though no absolute shortage of land exists, land for a particular purpose, at a particular time and place, may be quite scarce. One site, because of its relationship to places of employment, shopping, transportation, schools, can cost a lot more than land with similar physical features but with a slightly different location. Long Economic Life – Although improvements and additions to land are not indestructible in the sense that land itself is, they do normally have long useful lives. This relative immunity of well-maintained against physical deterioration leads to an interesting phenomenon – the fact that buildings rarely fall down but are more often torn down because a new use will make the site more productive and hence more valuable. Modification – the economic concept of modification focuses on the impact of development on the total value of a parcel – reflecting the fact that existing or potential future development can have a significant impact on value. For example, the market or investment value of a completed project will normally be greater than the total of the individual costs of the land, labor, materials and fair investment return necessary to develop the project. Situs – refers to the interaction with the uses of surrounding land parcels. The unique differences in the real estate asset make the real estate market different. There tend to be a smaller number of potential buyers and sellers for any given property type and location. Information about properties is often difficult to obtain, expensive and incomplete. Financing is property-specific and of greater importance in valuation. These differences make the real estate market less “efficient” than their stock market counterparts in the sense that it is more likely that the price of the real estate asset may deviate from its true value. 3.0 OTHER FEATURES OF THE REAL ESTATE MARKETPLACE The real estate marketplace is different from many other markets in several ways. These differences are the result of the value of individual parcels, government’s role in the marketplace, and the way in which people perceive the asset and what they expect from it. High Unit Value – Real Estate tends to have great value. Because of a large dollar expenditure needed to acquire real estate, financing always plays an important role. Thus, financial institutions, government regulations of the financial markets, and federal government monetary and fiscal policies may have a more pronounced impact on real estate than might be the case with other commodities. Government Intervention – There tends to be more government intervention in the form of taxation, development incentives, and regulations governing the use and transfer of real property than in most other markets. Perceptions – consider first the question of home ownership. One’s home always represents both an investment and a use. Home prices have been increasing significantly faster than the general rate of inflation and offering a much better return to the individual investor than other common forms of investments. Investors in income property have also experienced a change in their perception of real estate. Tax ramifications have dominated many investment decisions. More recently, economic feasibility and prospective value appreciation have assumed the forefront of investment consideration. This shift has been caused primarily by 2 factors: 1. Tax Policies 2. Inflation Perceptions affect real estate in 2 of the following ways: Expectations – It seems fair to say that most people expect continued appreciation in real estate values. This is a prime reason for the increased desire for home ownership by the general public. The same expectation on the part of income property investors can be inferred from their willingness to buy property at prices that permit them to realize a relatively small and, in some cases, negative annual cash flow. Physical Income – It is clear that satisfaction derived from the ownership of real property is often non-pecuniary in nature. Such utility derived from ownership certainly represents a return to homeowners and, as such, affects the price they are willing to pay. Users may pay a premium rent for the “right address”, whether residential or commercial. 1D: REAL ESTATE DEMAND AND SUPPLY The equity investor’s return primarily depends on the price that can be obtained for the product sold, which is space. The price that can be charged for space is a function of the same 3 elements that set any other type of price: 1. Demand 2. Supply 3. Public Policy Retr
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