Transcript McGraw-Hill/Irwin 1

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CHAPTER 8
LOCATION MAKES
MARKETS ’INTERESTING,
• Competitive market conditions include:
– product homogeneity
– market freedom--low external controls
– knowledgeable participants
– many buyers and sellers who, individually, cannot
influence market prices
– products that are divisible and mobile
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Real Estate Market Price
Behavior
• Market imperfections may cause transaction
prices to deviate from fundamental market
values. Imperfections include:
– imperfect knowledge
– high transaction costs
– limited number of buyers or sellers
– short-run demand / supply imbalances due to
location, regulation, or political constraints.
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Location Theory
• Classical Location Theory
– rent differences result from the accessibility of
land to markets and users
• Neoclassical Location Theory
– recognizes land as a factor of production, along
with labor, capital, and entrepreneurial effort
• The Bid-Rent Curve
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Location Theory
• Location Decision Factors of Households:
– users seek to avoid transportation costs, thus
having incentives to locate close to economic
centers
– the price of land decreases with distance from the
economic activity centers within urban areas, and
buyers substitute land quantity for location
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Location Theory
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• Location Decision Factors of Firms:
– transportation costs
• proximity to customers
• proximity to suppliers
• proximity to work force
– land requirements
– type of service or product
• high-density / low-density demand
• weight-gaining / weight-losing production
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HOW SPACE MARKETS
OPERATE
• Physical and Financial Asset Markets
• Functions of Space Markets:
– to allocate existing space
– to expand or contract space to meet conditions
– to determine new uses for land
• Demand and Supply Model With Vacancy
Va = S-D
– natural vacancy
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HOW SPACE MARKETS
OPERATE
• Demand and Supply Model With Vacancy
Va = S-D
• Natural Vacancy
• Rents
– equilibrium rent
– net contract rent
– effective contract rent
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Housing Demand and
Supply Factors
• Housing factors of demand include:
– new household formations, age composition of
new households, household income, and
mortgage credit conditions.
• Housing factors of supply include:
– prices of factors of production, productivity
factors, number of builders in the market, and
credit conditions.
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Retail Demand and Supply
Factors
• Retail factors of demand include:
– number of consumers, customer income,
consumer tastes and preferences, prices of
substitute products, and credit conditions.
• Retail factors of supply include:
– prices and productivity of factors of production,
number of developers, developer expectations,
and credit conditions.
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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Office Demand and Supply
Factors
• Office factors of demand include:
– number of local firms, types of business of local
firms, growth in local firms, and office space
square feet per employee.
• Office factors of supply include:
– similar to retail market supply factors.
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THE ASSET MARKET
• Real estate values vary according to their physical
characteristics, their locations, and the economic
conditions of the market.
• Real estate values depend on income expectations
and its relative riskiness.
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THE ASSET MARKET
• Prices and Value
Price = PV of the expected cash flows
• Prices vary according to conditions in the capital
market—this affects the discount rate, E(Rj).
E(Rj) = Rf + RPj
– RPf, denotes the required risk-free rate
– RPj, denotes the required risk premium
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THE ASSET MARKET
• Tobin’s Q
Q (real estate) = Price (or value)
Replacement Cost
– If Q > 1, opportunity exists to develop competing
properties and sell them for abnormal profits.
– If Q < 1, properties are inexpensive relative to their
replacement cost.
• ‘Noisy’ Prices
• Interaction with Securitized Market
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Space and Asset Market
Interaction
• The Economic Fundamentals Matter
– Events in space markets that determine rents and
variations in rents are fundamentally linked to
values in the asset market.
– Events in capital markets that affect interest rates
and the relative attractiveness of all types of
assets as investments affect real estate values.
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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Space and Asset Market
Interaction
• Government Influences
• Do the Individuals Matter?
– The reservation price is the price the seller is
willing to accept in negotiating a transaction.
– The offer price is the price the buyer is willing to
accept in negotiating a transaction.
• Speculative Bubbles and Cycles
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