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
2. Type of real estate – single-family homes, office buildings, industrial
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
• 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
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:
• Unique Location (Heterogeneity)
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
• Long Economic Life
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
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
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:
3. Public Policy Retr