PAREB-QCRB Real Estate Manual 2013

10.1 INTRODUCTION TO REAL ESTATE ECONOMICS

REAL ESTATE ECONOMICS

Is the study of the economic conditions related to the real estate market. At the “macro level”, it
focuses on analysing the market size of supply and demand, prices , and related financial as-
pects. Specialized fields of real estate economy are studied, such as Housing and Condomini-
ums. At the “micro” level, real estate economics focuses on the economic impact of the market
upon the individual homeowner, buyer, renter or investor.

MAJOR TYPES OF AN ECONOMIC SYSTEM

An economic system is a structure or plan that a country follows in terms of producing, dis-
tributing and consuming its goods and services. It is composed of people and institutions, and
their social relations. There are three (3) major types:

• Traditional Economy
- A system where traditions, customs and beliefs determine the operation of a country’s
economy; society continues whatever is done in their cultural and economic history.
- Typical in underdeveloped countries, where agriculture is their main means of subsis-
tence.

• Market Economy / Capitalism

- A system where consumers and their purchase power decide and drive the economy; the
distribution of goods and services depends on who gets the supply, and not necessarily
those who need them; follows the law of supply and demand.
- National and state governments play a minor role; they make sure that the market is sta-
ble enough to carry out its economic activities properly.
- It aims to eliminate or reduce the regulation or control of prices and subsidies in the in-
dustry, creating and maintaining a competitive market.

• Command Economy / Socialism

- A system where the government makes all the major decisions related to the production,
consumption and distribution of goods and services, including price regulation
- Aim of the government is to use all available resources to develop new products for the
benefit of the society.
- Focuses more on what is needed, than what is wanted/demanded.

• Mixed Economy / Modern Mixed Capitalism

- A combination of command and market economies.
- Example: while the goods and services are produced by private entities, the government
intervenes through price regulation.

194
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013

DEFINITION OF MARKET
A market is any structure, institution or system whereby buyers and sellers meet and exchange
goods and services with value at negotiated prices. It facilitates the trade and enables the distri-
bution and allocation of resources in a society.

Terminologies:
• Buyer – the party that purchases
• Seller – the party that offers goods or services in exchange of money
• Transaction – the exchange of goods or services for money
• Perfect market – when there are many sellers and buyers competing against each other for the
available goods and services, price will settle at its lowest.
• Imperfect market – where there are more sellers and few buyers, or more buyers and few sell-
ers, and price goes up or down accordingly
• Seller’s market – there are more buyers, and few sellers
• Buyer’s market – there are more sellers, and few buyers
• Monopoly – a market with a single seller and multiple buyers
• Monopsony – a market with a single buyer and multiple sellers
• Oligopsony – a market with few buyers and multiple sellers
• Oligopoly – a market with multiply buyers and few sellers

LAW OF SUPPLY AND DEMAND

seller’s market Low supply and high demand = price tends to go higher
buyer’s market High supply and low demand = price tends to go lower

PARTICIPANTS IN THE REAL ESTATE MARKET

Just like in any economy, the real estate economy has two major participants. Those who pro -
vide the supply of real estate to the market and those who provide the demand; or the produc-
ers and the consumers.

Producers
• Owner/User – property owners who offer their products for sale or lease;
• Developers – companies who develop subdivisions and condominiums for sale;
• Investors –entities who build real estate properties for business, office buildings, hotels, re-
sorts.

Consumers
• Homebuyers – those who buy real estate for their own use;
• Renters – those who lease homes, condominium units, offices and commercial spaces for
business;
• Investors – those who purchase real estate as investment.

195
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013

INTERMEDIARIES and FACILITATORS

Both producers and consumers need the support of intermediaries and facilitators.
Producers need:
o design professionals (architects, engineers, designers)
o Allied professionals (lawyers, accountants, financial consultants)
o Building materials suppliers, contractors and builders in order to produce real estate
products.

Real estate developers also employ or engage marketers – real estate brokers and salespersons in
order to reach their target buyers.

Consumers also need real estate brokers, appraisers, and financial consultants. Those who will
employ credit to acquire property will need the facilities of lending institutions such as commer-
cial banks.

With a wide range of participants, it is no wonder the real estate economy has a vital role in the
overall economy. Every peso of capital invested in real estate is eventually converted into multi-
ple transactions thereby creating the so called multiplier effect in the economy.

PRODUCTS OF REAL ESTATE ECONOMY

In the active real estate market, the products available are either for sale or for lease. They in-
clude-
1. Land – in various categories such as commercial, residential, industrial, agricultural.
2. Homes – single-family dwellings, townhouses, rowhouses, condominiums.
3. Commercial spaces – for stores, restaurants, offices. A shopping mall such as SM and Robin-
sons is actually a commercial real estate product where spaces are leased out.

FACTORS AFFECTING SUPPLY AND DEMAND IN REAL ESTATE:

SUPPLY is affected by-

• Availability of land;
• Availability of capital for developers;
• Capability of the developers and builders;
• Bureaucracy, red tape, graft and corruption;
• Economic forecasts affecting confidence;
• Inflation and prices of building materials and labor;

DEMAND is affected by –
• Population growth patterns;
• Availability of credit;

• Purchasing power of prospective buyers/renters;

196
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013
• Infrastructure;
• Geographical economic growth patterns;

PECULARITIES OF A REAL ESTATE MARKET

• Durability of the product - Raw land is indestructible and immovable, while a building, a
major infrastructure or improvement in real estate has a long life span that can last for
decades.
• Immovability of the product - Generally, consumers come to the goods rather than the goods
go to the consumers. Thus, there is no physical market-place. In order for real estate markets
to adjust or change, people must move locations.
• High transaction cost - The financial requirement in purchasing a real estate property is huge,
have to consider a lot of costs: buying and moving costs, agent’s fee, local and national taxes,
and documentation and registration fees, ETC.
• Supply-Demand Time Gap
• Investment or Consumption - Purchasing a real estate can come with an expectation of a re -
turn (investment good), an intention of using it (consumption good), or both. This dual na -
ture means that it is typical for people to over-invest in real estate, that is, to invest more
money in an asset than it is worth on the open market.
• Heterogeneity – The state of one being different from another. Every real estate property is
unique in many ways: location, use, identification, size and shape, building and improve-
ment, financing. No two properties are alike.
• Long time delays – Any real estate production takes time to construct, design and finance.
Likewise, there is a relatively slow rate of change in the demand for consumption of new
supplies, especially during times of financial crisis.

THE PHILIPPINE HOUSING BACKLOG

For years, economists have always postulated that our country has a housing backlog of at least
4 million. This continues to grow because of our high population growth rate. A significant evi -
dence of this is the presence of many informal settlers in the urban areas. However, there is no
reliable statistics as to the actual “housing backlog” because –
1) Many Filipino families are still “unaccounted for” by our census office.
2) Population growth continues to be high ( close to 3% ) and census-taking cannot catch up.
3) Filipinos have very close family ties so they can manage to house multiple families under one
roof.

The fact that there may be 4 million homeless families does not really mean there is a demand
for 4 million homes. There is a need, but demand occurs only when there are qualified potential
homebuyers who have the capacity to buy. Out of this 4 million homeless families, how many
can afford to buy a home?

197
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013
Market for Housing Segmented Based on Current Pricing Levels
• High-end - P5 Million or more;
• Middle-end – P2 Million to P5 Million;
• Low-cost - P500,000 to P2 Million;
• Socialized - below P500,000.

Market can also be Segmented in Terms of Rental Rates in a Locality. i.e. Makati City
• High-end - P30,000 or more per month
• Middle-end – P20,000 to P30,000 per month
• Low-end - P10,000 to P20,000 per month
• Socialize - none available in Makati City

FOUR AGENTS OF PRODUCTION

1. Land and Natural Resources – the real estate component. It is the “raw material” needed to
produce new products like residential homes, industrial factories, commercial spots, etc. it is
compensated by rent/lease, mortgage, and taxes.
2. Capital - any man-made instrument that increases production of goods. E.g., machineries,
tools, mechanical lifts. It can also mean the cost of borrowing money in order to forego pro-
duction. It is compensated by interest.
3. Labor – the human physical work required to convert a parcel of land into a property with
improvements. It is compensated by wages and direct/indirect costs .
4. Entrepreneurship – the process of orchestrating land, labor and capital to produce an item. It
is a type of coordination or management. It is motivated by profit. Sometimes this called
management.

ELEMENTS/DETERMINANTS OF VALUE (D.U.S.T.)

1. Demand – The property must be needed by someone who has the purchasing power to obtain
it. Law of supply and demand.
2. Utility – The property must have useful purpose or must satisfy a need. The more useful the
property is, the more likely someone will pay for it-more uses or potential, better value.
3. Scarcity – The type of property must have some degree of rareness. This refers to the supply
of similar property in relation to the demand for it. Law of supply and demand.
4. Transferability – The ability to transfer title to the property to someone else.

PRINCIPLES OF VALUE

1. Anticipation – Affirms that the value of a property is the present worth of all present and fu-
ture benefits arising from ownership and use of real estate. The value of a property may in-
crease or decrease based on a potential purchaser’s belief that some future event will benefit
or detract from the value of the property.

198
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013
i.e. The value of a vacant lot may increase if a potential buyer was informed by a friend from
the DPWH that a major road shall be opened very close to it.

2. Balance – Land will tend to be at its highest value when the four factors of production are in
balance.
i.e. The Makati Business Center is surrounded by first class subdivisions with purchasing
power (Forbes Park, Magallanes, Urdaneta, San Lorenzo and Bel Air Villages).

3. Change – Real estate passes through a cycle of:

a. Growth, Stability, Decline, and Renewal

Real estate conditions, both physical and economic, do not remain constant, thus, changes
value. Physical change may be brought by normal wear and tear while economic change
maybe due to (1) zoning changes (residential to commercial, agricultural to residential), (2)
buyers preference and (3) tax laws change. It may not be noticeable on a day-to-day basis,
but can be seen overtime.

4. Competition – Profit attracts competition, while competition favors the consumers, too much
of it will ruin profit.
i.e. The shoe industry of Marikina is adversely affected by the competition coming from
China.

5. Conformity – The maximum value of the land is reached when it conforms to the surround -
ing land usage.
i.e. The value of the property is adversely affected if there is an under-improvement or over-
improvement of the lot.

6. Consistent Use – States that land cannot be valued on the basis of one use while the improve-
ments are valued on the basis of another. The concept of consistent use must be addressed
when properties are devoted to temporary interim uses. Improvements that do not represent
the land’s highest and best use but have substantial remaining physical lives may have an in-
terim use of temporary value, no value at all, or even negative value if substantial costs must
be incurred for their removal.

7. Contribution – The value of an improvement is equal to its contribution to the added value of
the property.
i.e. Property is in a corner unit of a major road, the roofing used of a two-storey residence is
concrete slab which cost more, instead of GI sheets, this attracted advertising company to
lease a small portion of the roof deck for announcement and advertising purposes , paying
the owner P30,000.00 per month for the next 10 years. The added income is a positive contri-
bution in the value of the property.

199
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013
8. Externalities – States that influences outside a property may have a positive or negative effect
on its value. Low interest rates encourage house production due to enhanced demand. Low
crime rates, population density, and income level may influence values of properties.

9. Highest and Best Use – Each property has one legal use that gives its greatest value. i.e.
a) A two-storey residential house is better than a bungalow if the house is to be built in a lot
with small area.
b) A vacant lot along highway currently used as agricultural should be converted and ap-
praised as commercial if there are commercial buildings constructed nearby and valua-
tion of land is zoned as commercial.
c) In a commercial area in Taguig and a purchase price of P320,000.00 per square meter, ver-
tical development should be high rise (depending on FAR) and not a walk-up type of
building.

10. Increasing and Diminishing Return – Net income of a real estate tends to increase by applica-
tion of more factors of production up to a certain point, beyond which more application will
tend to decrease net income. At the point when additional improvements bring no corre -
sponding increase in income or value, the law of decreasing returns is operating.

11. Plottage – By combining or consolidating adjacent lots into one larger lot, the resulting land
value will be higher than the sum of the value of the separate lots. Consolidation or assem -
blage is the process of merging the lots.

12. Progression – The value of a property will increase if it is near better property.
i.e. Robinsons bought a 5-hectare lot to be used for their mall. In effect all adjoining lots will
surely increase its value.

13. Regression – The value of a better property will be lessened by non-conforming uses of the
adjoining lots.
i.e. The area of a medium end cost subdivision is infiltrated by squatter’s colony.

14. Substitution – The maximum value of a property is equal to the cost of purchasing or con-
structing an equally desirable property. Market Data or Sales Comparison approach and
Cost Approach to value use the principle of substitution.
i.e. If two similar houses are for sale, the lower-priced house generally will be purchased
first.

15. Supply and Demand

o Seller’s Market - Value increases if supply decreases and demand increases
o Buyer’s Market - Value decreases if supply increases and demand decreases

16. Surplus Productivity – States that land has the last claim (not a wasting asset unlike buildings)
to the net income after the cost and other factors of production have been paid.

INFLUENCES ON REAL ESTATE VALUE:

200
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.
 PAREB-QCRB Real Estate Manual 2013

1. Physical and environmental

The range of possible liabilities imposed on property owners for environmental factors
like typhoons, earthquakes, floods, tsunami, proximity to fault lines, ill-planned develop-
ment and non-coordinated uses of properties can be overwhelming.

2. Economic
Real estate moves, everything else follows. Low interest rates coupled with high rate of
employment and purchasing power encourage developers to produce more housing.

3. Social – Area preference influences values of properties. Demand coupled with purchasing
power is an attraction to real estate developers.

4. Government and legal – Police power like zoning, height limitation, and taxation affect the
value and demand on properties.

THE ECONOMICS OF HOME ACQUISITION

1. Build
The Built Option:
a) Search for and buy a home lot;
b) Have an architect, engineer, interior design a home;
c) Engage a contractor to built-it or built-it-yourself.

2. Buy or Rent
The Buy or Rent decision: Buy if credit is liberal and property is appreciating or inflation is
high. Rent if otherwise.

Pre-selling
Home and condominium developers today offer units by pre-selling them. Typically, they at-
tract buyers by making the 20% down payment payable in 2-year instalments which are afford-
able. However, the buyer should beware – upon completion on the down payment, balance will
be passed on to a bank or any financial institution or in-house financing. Pre-selling buyers are
not aware that the subsequent amortization amounts maybe substantially larger than the initial
monthly instalments on the down payment. Thus, many pre-selling buyers may end up in de-
fault and will lose their pre-selling equity or at least half of it.

201
PAREB–QCRB : 10.1 Real Estate Economics
Prepared for QCRB. Rights reserved.