The nature of real estate (RE) and RE markets

Chapter 1
Outline
■ The nature of real estate (RE)
■ RE and the economy
■ RE markets and participants
■ Characteristics of RE markets
■ Professional career
 RE: Importance Symbol of strength, stability,
and independence
■ Real estate is the single largest
component of wealth in our society.
Because of its magnitude, it plays a key
role in shaping the economic condition of
individuals, families, and firms.
■ Changes in the value of real estate can
dramatically affect the wealth of
businesses and their capacity to grow.
■ The adequacy of the housing stock, as
well as the public infrastructure,
including roads, bridges, dams, airports,
schools, and parks, all affect the quality
of life in a region.
■ Real estate has been often becomes the
center of many regional disputes.
 Real estate (RE): Basic definitions
■ RE is property.
■ Property refers to anything that can be owned or possessed.
■ Property can be
(1) a tangible asset, e.g., land/building, automobile, clothing
(2) an intangible asset, e.g., a lease/mortgage agreement.
■ Real property is defined as rights in land and its permanent
structures. Personal property is the rest; that is, it is simply
rights in any other kind of object, including intellectual
property.
RE
■ We use the term “real estate” in 3 ways:
(1)we use it to refer to tangible assets, e.g., lands and
buildings,
(2) we use it to denote the bundle of rights that give the
owner of the rights to use tangible assets, and
(3) we use it to refer to the real estate industry or business
activities.
 RE as tangible assets
■ RE can be defined as the land and its permanent improvements.

■ Land may include-

(1) the surface of the earth,
(2) rights to air space above the land up to a certain height,
(3) rights to the subsurface down to the center of the earth and to
the minerals contained therein, and
(4) the improvements to the land, e.g., walkways and water
drainage systems, fences.
RE as tangible assets
 RE as a bundle of rights
■ The bundle of rights is the services (benefits) that RE provides its users. For
example, RE provides owners with the rights to shelter, security, privacy, doing
business, etc.
■ The bundle of property rights is subject to different limitations. For example, an
apartment owner divides his or her full interest in the property when he or she
leases an apartment.
■ The value of a bundle of rights is a function of the property’s physical, locational,
and legal characteristics.
■ The physical characteristics include the age, size, design, and construction quality
of the structure, as well as the size, shape.
■ For residential property, the locational characteristics include convenience and
access to places of employment, schools, shopping, health care facilities.
■ Bundle of rights often times is reduced by state and local land use restrictions.
 RE as an industry and profession

■ The industry has a variety of professions:

(1)brokerage,
(2) leasing and property management,
(3) appraisal,
(4) consulting and advising,
(5) property development and construction,
(7) financing, mortgage, and securitization, investment, and
(9) governmental planning, taxation, and regulation.
 Some definitions
■ Raw land: land that does not include any improvements, i.e.,
no streets or other infrastructure.
■ Real property: often interchangeable with the term “real
estate.”
■ Personal property: things that are movable and not
permanently affixed to the land, e.g., refrigerator.
 RE markets and participants
■ Real estate values derive from the interaction of three different
sectors, or markets, in the economy: local user markets, capital
markets, and property markets.
■ A market where tenants negotiate rent and other terms with property
owners or their managers is referred to as a user market.
■ The market in which required rates of return on available investment
opportunities are determined is referred to as the capital market.
■ Property markets determine the required property-specific
investment returns, property values, capitalization rates, and
construction feasibility.
Interactions in RE market
User (space) markets
■ Markets for the physical RE.
■ “Buyers” receive right to use space.
■ Sometimes called “space” market or “rental” market.
■ Where rental rates are determined.
Segmentation, I
■ User (space) market are segmented.
■ Rental prices for physically similar space can vary widely
(1) across locations, and
(2) across property types.
■ Both demand and supply side of user markets are very
specific to location and building type.
 Segmentation, II
■ In contrast, integrated markets (e.g., gasoline, steel,
financial capital) are characterized by homogeneous
commodities that can be moved from place to place.
 Capital markets
■ RE competes for funds in capital market with other asset classes,
such as stocks and bonds.
■ Investors select a mix of investments based on expected returns
and risk.
■ Bidding by investors determines required risk premiums for RE
investments.
■ Capital markets are largely integrated.
Local governments
■ Zoning codes and other land use regulations.
■ Fees on new land development.
■ Building codes.
■ Property taxes.
■ Infrastructure.
■ Local governments usually have the largest influence on RE.
■ Local developers specialize in collecting information about local
market demands and regulations.
 Central/Federal government
■ Income tax policy (e.g., tax shield for mortgage interest
expenses).
■ Housing subsidy programs.
■ Federal flood insurance program.
■ Federal agencies, e.g., Fannie Mae.
 Characteristics of RE markets, I
■ Heterogeneous products. Unlike stocks or bonds, every property is
unique: age, building design, and location give each property
distinctive characteristics. Example: most retailers prefer the going-
home side of the street, instead of the going-to-work side.
■ Location and immobile products. RE is location, and it is immobile
(the vast majority of structures removed from the land are
demolished rather than moved). Another term for location is access.
For households it is access to school, shopping, entertainment, and
places of employment. For commercial properties it may be access
to customers, the labor force, or suppliers.
■ Localized markets. A person who has a job in Rajshahi may not
want to consider a house in Dhaka. Competing properties usually lie
within a short distance of each other.
 Characteristics of RE markets, II
■ Segmented markets. Households that search for single-family
detached units may not want to consider condos.
■ High transaction costs and low liquidity.
■ Information asymmetry and agency problems. Sellers of RE
usually have better information about the properties than buyers
(the lemon problem). The agents in the industry may have
incentives to be deceiving so that deals ($$$) can be reached
quickly.
 Question
■ Why does it matter whether an asset (e.g., RE) is liquid or illiquid?
■ Liquidity indicates how much easily conversion of an asset to cash is possible without any
significance losses.  The easier it is to convert the asset, the more liquid it’s considered.
Common liquid assets include currencies and commodities, as well as debt and equity traded
in major exchanges like the New York Stock Exchange and Nasdaq. Common illiquid assets
include art, collectibles and antiques, as well as debt and equity from private, non-exchange
traded companies. Another.  
■ Does liquidity has an impact on asset prices (e.g., RE prices)?
■ aspect of liquidity deals with how price is affected by the conversion to cash.  If the asset’s price
drops when quickly converted to cash, that’s another indication that the asset is not liquid. As
securities or investments, liquid assets pay a lower yield than illiquid assets.  This is because investors
require a higher return on an illiquid asset, due to the increased difficulty of selling it for cash