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] enter for Real E 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) enter for Real EMIT C state 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 Adapted from DiPasquale and Wheaton (1996) enter for Real E U.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 Adapted from DiPasquale and Wheaton (1996) 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: enter for Real EMIT C state 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. enter for Real EMIT C state 1 st quadrant β 1). Office Demand = α 1 ER -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/α 1 E) –1/ β1 MIT Center for Real Estate 2nd and 3 rd Quadrants 4). P = R/i i = all inclusive cap rate 5). Office Construction rate: C/S = α 2 P β2 P = Asset Price per square foot [“Q” theory?] β 2 = Price elasticity of supply: [% change in construction rate/% change in rent] MIT Center for Real Estate 4 th 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?] [...]... 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) ? MIT Center for Real Estate What is a real Estate Market? • Within markets all... 16 16 16 16 16 MIT Center for Real Estate ) 40 0 35 0 30 0 25 0 20 0 15 0 10 0 50 0 MIT Center for Real Estate 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... Suburban Markets Manhattan 2001 2000 1998 1997 1996 1995 1993 1992 1991 1990 1988 1987 1986 1985 1983 1982 1981 1980 20 MIT Center for Real Estate Office Suburban Rents in Detail TW Index, $2002 per sqft 50 45 40 35 30 25 20 15 Northern New Jersey Long Island Stamford 2001 2000 1998 1997 1996 1995 1993 1992 1991 1990 1988 1987 1986 1985 1983 1982 1981 1980 10 Westchester MIT Center for Real Estate Prices and. .. do not have independent cyclic movements MIT Center for Real Estate House prices reflect both unit characteristics and location attributes MIT Center for Real Estate 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 300 Boston Southeast W estern 1 Far North Shore 495 North 95 South 95 North... of Demand Growth in Asset Market… 2Market… Rent $ Space Market: Rent Determination Asset Market: Valuation D0 11% OAR D1 R* 8% OAR R** SR P1 Price $ LR P** P* Q* C* Asset Market: Construction C** Space Market: Stock Adjustment Construction (SF) Q* * Stock (SF) MIT Center for Real Estate Using the 4-Quadrant Model to assess the impact of other changes • What happens if Construction costs rise or the. .. Estate 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? MIT Center for Real Estate Metropolitan Housing Markets often move independently FIG U R E 5 R epeat S ale H ouse P rice Indices for S... EXERCISE #1 MIT Center for Real Estate National Office Forecast Completions Rate vs Real Rent $ Per Sqft 34.00 Forecast 8.00% 32.00 6.00% 30.00 28.00 4.00% 26.00 2.00% 24.00 0.00% 22.00 -2.00% Total Employment Growth (L) Real Rent (R) Completion Rate (L) 2007 2005 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 20.00 MIT Center for Real Estate National Industrial... 1971 -2.00% MIT Center for Real Estate National Hotel Forecast Supply Growth Rate vs Real ADR 8.00% 110.00 Forecast Total Employment Growth (L) Real ADR (R) Supply Growth Rate (L) 2007 2006 2005 2004 2003 2002 2001 2000 1999 80.00 1998 -4.00% 1997 85.00 1996 -2.00% 1995 90.00 1994 0.00% 1993 95.00 1992 2.00% 1991 100.00 1990 4.00% 1989 105.00 1988 6.00% MIT Center for Real Estate U.S Single-Family Market... (1990=100) 250 MIT Center for Real Estate Home Prices within South California Median Home Price, Thousands ($ 2002.4) $400 $350 $300 $250 $200 $150 $100 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 Sources: OFHEO, Torto Wheaton Research Riverside Ventura San Diego MIT Center for Real Estate Office Rents Move together Cyclically but not always... $ Per Sqft Completions Rate vs Real Rent 7.00 Total Employment Growth (L) Real Rent (R) Completion Rate (L) 2007 2005 2003 2001 1999 3.00 1997 -2.00% 1995 3.50 1993 -1.00% 1991 4.00 1989 0.00% 1987 4.50 1985 1.00% 1983 5.00 1981 2.00% 1979 5.50 1977 3.00% 1975 6.00 1973 4.00% 1971 5.00% Forecast 6.50 MIT Center for Real Estate National Multi-Housing Forecast Permits vs Real Rent 6.00% $ Per Sqft 750.00 . Total U.S. Real Estate 8,777 100.0 Adapted from DiPasquale and Wheaton (1996) enter for Real E U.S. Real Estate MIT C state Ownership, 1990 All Real Estate. regulations. • Real Estate Macro Economics: timing behavior (search, moving, contracts), cycles, regional growth. MIT Center for Real Estate The Role of Real Estate