Real estate economics
How many local labour markets are there in Denmark, according to DST?
29: Statistics Denmark defines an area as a commuting area if at least 65% of workers in the region live in the area (following Eurostat defintion of commuting areas
acres in a square mile
640 acres = 1 sq mile
Which factors could explain, that the number of commuting areas has decreased over the last years?
- Better infrastructure - Larger companies centering around bigger cities - General urbanisation
Reasons for Changes of relative prices between properties within an MSA?
- Physical alteration of the structure: Rehabilitation, rennovation or expansion - Changes of characteristics of neighborhoods. E.g. New highway, new tram etc. - Changes of consumer demands
What are counter arguments to decentralisation for firms?
1) Agglomeration benefits: If a firm locates far from the CBD then it misses out on agglomeration benefits. 2) Firms need a diverse mix of workers 3) Dependence on the right infrastructure to the suburbs.
Through which 5 channels do RE prices affect the economy?
1) Consumption channel 2) Investment channel 3) Financial sector channel 4) inflation channel 5) Fiscal channel
What terms add up to the price of existing structures at (d) when including future growth in the monocentric model with population growth?
1) Discounted value of land used 2) Discounted construction value 3) Current value of location rent 4) Value of future growth in location rent
Why have firms decentralised since 1990
1) Due to advanced technologies, allowing firms to communicate over a distance with ease 2) The diffuseness of transportation systems make it more appealing for especially industrial firms to locate in the suburbs.
Housing wealth effect, transmission mechanism
1) Home equity adjustment: Either sell dwellings or take mortgage on loans 2) Permanent income adjustment 3) Consumer credit adjustment:
What generates regional supply shifts?
1) Immigration of employable population 2) Labor force participation 3) Public policy programs
What, except for Tobins q could explain new investment in real estate
1) Macroeconomic fundamentals 2) Government tax income 3) Utility driven investment
What two types of housing markets in terms of the analysis of aggregate housing markets can be studied?
1) Market for housing units 2) Market for housing services
What are the three possible types of changes that regional economic growth refers to?
1) Physical growth: population, employment and capital stock growth. 2) Wealth growth: regional income and wage growth. 3) Output growth: increased volume of goods and services produced within a region.
List user costs of housing
1) Price per unit 2) Down payment and mortgage costs 3) Extra fees Life cycle patternes 4) Household size 5 )Distance to work 6) Income tax and deductibility
What are the three ways of measuring economic activity?
1) Production approach 2) Income approach 3) Expenditure approach
What generates regional demand shifts?
1) The national business cycles 2) Comparative advantages, i.e. productivity enhancing amenities or agglomeration 3) Pop. growth 4) Government consumption
How do you analyse the impact of the changes in national economy on the RE market? (Three steps)
1. Identify which quadrant is initially affected. 2. Trace the impacts through the other quadrants and arrive at a new long-run equilibrium. 3. Compare the new long-run equilibrium with the old long-run equilibrium (called "comparative static" analysis).
What are the two types of property at the real estate market?
1. Residential property markets 2. Non-residential property markets
Optimising house configuration
Builder and developers compare the incremental value of additional house features against their incremental cost Profit maximizing house: where the value of an additional square foot, bath, fireplace equals the marginal cost of construction
What should be considered when optimising the density (FAR)
Builders and developers compare the incremental value of additional house features against their incremental cost.
How does the ray in the NW quadrant rotate With a higher cap rate?
Clockwise rotation
Close substitutes
Close substitutes (from consumers' point of view) are part of the same market: Close substitutes if the cross-price elasticity of demand (CED) is large and positive. Close substitutes (from producers' point of view) are part of the same market: Close substitutes if the cross-price elasticity of supply (CES) is large and negative.
FAR - Mathematical definition
FAR = Floor area / land area
What has been the trend about firms regarding location choice over the last 70 years in the US?
Firms have moved out of the CBD, especially non service sector
What type of firms are studied in the mono centric city model with more than 2 uses?
Firms that export their products, since they thus have commuting costs, by shipping/transporting their products
What are the implications for real estate demand in the case of supply-induced regional growth?
For an elastic product demand, we should see a large increase in employment, but the average income will decrease since wages decline. Thus the increase in workers will trigger lower income demand for real estate For an inelastic product demand, the decrease in wages will be much larger implying that the output growth is small and lower end RE will be demanded.
What are the implications for real estate demand in the case of demand-induced regional growth?
For an inelastic supply curve, the, wealth effect dominates the physical effects, which should lead to increase in class A properties, as opposed to elastic supply curves.
What happens to the urban land gradient, if: Transportation improvements: reductions in 𝑘
If K decreases, it means the benefits of living closer to town becomes smaller, meaning we should see a less increase in rents pr mile moved inwards. I.e. the gradient decreases.
What happens to the urban land gradient, if: Transportation access: increases 𝑉
If V increases, we know from the definition of the border, that it will increase the border should narrow down. (inwards shift of the curve)
When is there an inelastic curve in the NE quadrant? How does the graph look?
If households/firms demand the same amount of space regardless of rent level. - Nearly vertical
the theory of fiscal capitalization
If landlords in a certain municipality receive a windfall gain for each residential property equal to the discounted value of the state aid per household, the land market fully capitalizes locational advantage, which is called the 'theory of fiscal capitalization'.
What happens to the f(C) function in the SW quadrant, if the cost of production increases?
If the variable costs of production increase, then the function in the SW quadrant will rotate clockwise.
Where is the rent determined in the 4 quadrant model?
In the property market for space use, not in the asset market for ownership. Here the supply of space is given (from the asset market).
Do firms in the "office industry" or industrial sector have the higher FAR
Industrial firms typically have a very low FAR, as opposed to office firms.
Determination of the housing rent R, at the city border R(b)
R(b) = R^a + c. I.e. the agricultural value of the lot plus the construction cost of the house. Remember that R^a = r^a*q, where q is the lot size and r^a is the agricultural land rent
Determination of (annual) housing rent 𝑅 per housing unit at any "interior" location 𝑑, in the mono centric city
R(d) = R(b) + k*(b-d) So in words, the rent at any point is the border rent plus the saving of commuting costs by moving closer to the city. In the city center, d = 0, meaning we should multiply the full border length by the commuting costs, and add it to the border rent
What is the sign of f'(c)?
Assume f′ (C) > 0, i.e. the cost of replacement through new construction increases with greater building activity.
What is true about urban density?
At locations at which land is more valuable, development tends to use less land (the more expensive factor) per housing unit and relatively more structural capital (the less expensive factor). I.e. denser residential development at more central locations, where land is more expensive.
Pros for distinction between types of real estate?
At the macroeconomic level, housing markets clearly behave differently from those of non-residential property (no close movement in prices/rents and level of construction) and housing markets are guided by different institutions from those of commercial real estate markets (residential brokerage versus industrial/office brokerage firms, residential mortgage market versus commercial financing). At the micro level, the behaviour of participants in the residential and non-residential property markets is based on different economic theories and motives.
Cons for distinction in the real estate market?
At the micro level, the distinction between residential and non-residential property is not as clear; they compete for a common resource: land. Therefore, at the micro level the price of commercial property is related to the price of residential property and their locations are closely linked through the commuting of workers and travel of shoppers. The extensive government regulation of land in the two uses (e.g. through zoning) has important impacts on both types of property markets.
Ricardian rent
Ricardian rent refers to the payments that a tenant would offer for housing, or, alternatively, to the annual amount that an owner would be willing to pay for the right of occupancy or use.
Assuming that housing is a homogenous good, what does basic economic theory suggest demand should be equal to?
S^d = 𝛼P_t +V_t^d
What is the aggregate supply of housing, available at time t?
S_t = 𝛼𝑃_t + (1−𝛿)*𝑆_t-1−𝑽_t
For demand induced growth, what is true about the relative magnitude of delta_w, delta_p and delta_k?
Since demand induced growth increases the real wages, it must be such, that the change in wages is larger than the change in prices. Since the change in price is a weighted average of the change in wages and changes in rents, then the change in rents must be smaller than the change in price.
What must happen if the sub center is overly small due to zoning?
Since the demand for residential and office building are not equal, the office rents will be higher in the city center. The higher rents compensate the smaller wages.
What does transportation network refer to ?
Subcenters with different transporting capacities will have different sizes. A center with a greater capacity will grow until travel costs to its edge equal those of center with lower capacity
When is the model for Regional growth in equilibrium?
The economy is in equilibrium when the solutions in each of the markets are internally consistent. In such an equilibrium, the region's economy is stable and not growing.
Real Estate Investments
The flow of real estate is the value of new buildings put in place each year, less losses from the stock through depreciation or demolition: ∆S = C − δS. New completions represent an important component of national investment
If a household has higher commuting costs than another, is the housing rent curve then steeper or flatter than for the group with the highest preference?
The group with the highest commuting costs will have the steepest curve.
How does a growth rate in the commuting costs affect the house prices?
The growth rate will be deducted in the denominator of the pricing equation, meaning that a positive growth in commuting costs willl decrease the costs.
For workers at a particular plant - what ensures that they are indifferent to different residential locations?
The land rent must be such that it compensates the worker for the commuting costs associated with travelling from border, b, to the city center, located at d. (r(d) = r^a + (k/q)*(b-d)
What happens if there are two different groups of households with regard to their different commuting costs?
The location equilibrium includes giving all the best locations to the group that values it most, such that all houses within a certain distance to the city center, m, will be given to that population group. M-b is then given to the residual group
How does the cap rate relate to perceived risk of real estate, the long term interest rate and a more generous tax rate?
The lower the long-term interest rate, perceived risk of real estate, and more generous tax treatment of depreciation of real estate, the lower the Cap rate.
Describe the model with a CBD and a subcenter
The model assumes a linear city, and zero commuting costs within the CBD and the sub-centres. Thus workers must only pay to get to the CBD/subCBD edge. Decentralising firms will be able to employ workers nearby the sub center as they will outbid the CBD residents due to smaller commuting costs.
Real Estate assets
The national stock of buildings, the land on which they are built and all vacant land
What must happen if the sub center is overly large due to zoning?
The overly large subcenter means the office rents will be smaller than residential wages in the center. Thus we should experience higher wages as compensation
What happens to the optimal FAR, as prices in general increase (i.e. at a better location)?
With a higher house price, we will see a substitution of capital for land and that the optimal FAR rises, which helps to offset the rise in prices
NET REAL ESTATE INVESTMENTS
Yearly construction of new structures net of depreciation/demolitions of existing construction
Can there be growth in a region, even with zero growth in regional income or employment?
Yes, due to e.g. location shifts or replacement demand (depreciation, obsolescence of existing stock etc.)
What are the gradients of each of the curves in the mono centric model with two purposes of use, and which one is larger?
firms gradient is - Q*d, where as populations* is -k/q We assume - Q*d<-k/q
If n grows at rate 2g , then b grows at rate?
g Can be proved, by writing out the expression db_o/dn_o
If the growth rate of the population is 2*g, then how can we write the population size, at time t, from population size at time t = 0?
n_t = n_o*e^(2*g*t)
The urban land rent pr. acre
r(d) = r^a +k*(b-d)/q
In the model of mono centric city with 2 types of uses (non-residential and residential): Firms profit function when including rents costs pr. unit
π = (S-AC-sd)-r_f(d)/q Where S is the sales price, AC is the average cost, s is the shipping cost and d is the distance to the port. r_f is the rent price and q is the quantity produced.
The Asset market
The asset market measures the ownership of real estate. This is where buildings are bought and sold.
Cap rate
The capitalization rate is abbreviated Cap rate. The Cap rate i = annual rent R (per square foot)/current value of asset P (per square foot) (including opportunity costs). The Cap rate is an all-inclusive after-tax total rate of return on an investment after adjustment for risk. The capital market is assumed to adjust the prices of particular assets efficiently so that each investment earns a common risk-adjusted, after-tax total rate of return. The Danish translation of Cap rate is "afkast krav".
Long Run equilibrium in the markets for RE assets and use
The combined property and asset markets are in equilibrium when the starting and ending levels of stock are the same. If the starting value of stock exceeds the finishing value, then rents, prices, and construction must all rise to be in equilibrium. If the initial stock is less than the finishing stock, then rents, prices, and construction must be decreased to be in equilibrium.
What does the f(C) curve represent in the SW quadrant of 4 qudrant model?
The curve f(C) represents the replacement cost of real estate.
What happens to the urban land gradient, if: - The population, N, Grows?
The curve shifts outwards, moving the city border outwards, to include more people, meaning rents will increase.
What happens to the curve in the NE quadrant if the economy improves (deteriorates)?
The curve shifts upward (downward).
What makes the f(C) curve in SW more horizontal?
The curve will be more horizontal in case of construction bottle necks, scarce land, and other impediments to development (inelastic supply).
What must hold about the relative magnitudes of changes in prices and changes in wealth, for the supply-induced growth?
The decrease in wages must exceed that of prices (∆*𝑤 > ∆*𝑃).
Why do firms leave the CBD for a sub-centre?
The subcenter worker between CBD and SC pays the same land rent, but have shorter commuting time to SC than CBD, hence the wages can be smaller.
Link between asset market and property market
- The rent levels determined in the property market are central in determining the demand for real estate assets. Because when acquiring an asset, investors are purchasing a future income. - The asset prices determine the level of new construction which determines the stock available in the property market.
Total cost of production in a model with agglomeration benefits
C(s) = w(S) +A(s) where S is the size of the subcenter, and A (A'(s) <0) is the agglomeration benefit The larger the subcenter, the higher the wage, since the commuting costs increase.
What are determinants for demand for aggregate housing?
Current income Permanent income Demographic factors Transport costs Tenure choice User costs of renting Mortgage interest rates Proximity to work and amenities Dwelling characteristics
NE quadrant axises and equation
D (R, E) = S 1st axis: Stock of space (in units of space, e.g. square feet or square metres) denoted S 2nd axis: Rent (per unit of space) denoted R
Hedonic regression
Hedonic regression analysis is often used to analyze markets for goods and services that are heterogeneous, meaning that they vary in terms of their characteristics and attributes. It is a useful tool for understanding how different factors influence the value or price of a product or service, and for making informed decisions about pricing
Gross real investments in real estate
It is the RE flow: Yearly construction of new structures
What are determinants for supply for aggregate housing?
Land availability Expected price at completion National / regional regulations Cost of construction Cost of land Developers required rate of return Taxes Building technology Long term interest rates
Is there a separate commercial land market?
Not if there is no zoning. However if the government creates zoning barriers, it could create either excess supply or demand such that the city would split into residential and commercial land markets
Is the stock of land part of national GDP?
Not part of GDP (we don't make land), but it is part of wealth
Model for optimising FAR
P = alpha - Beta*FAR Where alpha is the price for all housing and location factors besides FAR (Ceteris Paribus) Beta is the marginal impact of FAR on price per square foot C = Mu + tau*FAR Where Mu is the baseline cost of construction, and tau is the marginal impact of FAR on costs. The optimal far is the intersect of C and P, where the profit differentiated w.r.t. Far is equal to zero.
What are the two conditions for spatial equilibrium in the model of mono centric city with two uses?
That agricultural land rent in the residential market should equal the r(b), i.e. the rent at the border for the non residential market. Also the rent in the place where the two curves intersect should be equal for the two purposes. r_f(m) = r(m)
What is the problem about measuring RE contribution to the SNA?
That the contribution consists of value added from: 1) New construction and renovation 2) Supplies of materials and equipment 3) Facilitating transactions in RE 4) Other shelter services But only 1) is easily measurable...
Housing wealth effect (HWE)
The HWE measures the change in consumption that may happen as a result of changes in house prices. The size of such effect depends on the share of housing wealth from households' total wealth.
Function and axises of the SE quadrant of the 4 quadrant model
The propery market and stock adjustment ∆S = C − δS 1st axis: The annual flow of new construction (in units of space, e.g. square feet) denoted C 2nd axis: Stock of space (in units of space, e.g. square feet or square metres) denoted S
Tobin's q
The ratio of market price of housing unit to construction cost and land cost determines whether we should see excess supply of real estate. Thus If q > 1 then construction will increase
Proof of the distance from the border to the city center in the Monocentric city model:
The required area in the city is N x q, i.e. the number of households, multiplied by the lot size for each household. This, on the other hand has to be equal to radius^2 x pi, multiplied by the fraction that is habitable, i.e. V. Thus Nxq = b^2*π*V => b = sqrt((N*q)/(π*V))
agglomeration economies
The savings to an individual enterprise derived for locational association with a cluster of other similar economic activities, such as other factories or retail stores Arguments are: 1) Information sharing 2) Convenience 3) Leisure spots emerge 4) Easy access to switching jobs 5) Especially high revenue firms need labour market density
Urban wage gradient
The urban wage gradient depicts how wages decrease with the distance to the CBD, since the subcenter is smaller than CBD, then commuting time is shorter, which is reflected in the wage. It tells us that dw/dd < 0
For residents at a particular home location what ensures that they are indifferent to switching jobs?
The wages. Jobs closer to the center must compensate for the incremental additional cost of commuting. This is why there should be a wage gradient.
What is the function in the SW quadrant, and what are the axises?
This is the asset market for construction. 2nd axis: Price (per unit of space) denoted P P = f(C) 1st axis: The annual flow of new construction (in units of space, e.g. square feet) denoted C
The Property Market in 4-quadrant model
This is the righthand side of the four-quadrant model. In the property market (market for RE use or space) demand comes from the occupiers of space (tenants or owners, firms or households).
Real estate assets are durable goods?
True
What is the equilibrium requirement, related to Tobins Q, in SW quadrant?
We are in eq'm in the asset market, when Tobins q is equal to 1: Tobin's q: P/f(c) = 1. When prices are above f (C), the amount of construction will increase.
How can we estimate a model for housing consumption and income?
We can state the household demand H as a Cobb Douglas function H = a*P^\beta*Y^theta and state the expenditures, defined as PxH where, P is the price. We can thus estimate a model with the P as explanatory variable and Y, and use it to measure the elasticities.
How does the 4-quadrant model work?
We move in a counter clockwise rotation.Starting with a level of stock, the property market determines rents, which are then translated into property prices by the asset market. These asset prices, in turn, generate new construction, which, back in the property market, eventually yields a new level of stock.
NW quadrant axises and equation
i = PR 1st axis: Rent (per unit of space) denoted R 2nd axis: Price (per unit of space) denoted P
What happens to the urban land gradient, if: - The city becomes more dense?
if 1/q ^ it means the gradient of the urban land rent curve will increase, moving the border inwards