Real estate notes Chapter 1 Space market - Space market is the market for the usage or right to use real property like land and built space - Demand side: on the demand side of this market are individuals, household and firm or institutions that was to use space for consumption or production. - Supply side: real estate owners who rent space. - Segmentation: location and type specific. Asset market - Is the market for the ownership of real estate asset/property such as land and building. - They rent the building - Can be seen as a part of the larger Capital market. o Divided into four categories. Public market: small homogenous units or share of ownership. In asset trade in public exchanges Privat marekt: those who trade asset in private transaction between individualsbuyers and sellers, a whole asset can be traded in a single transaction The four-quadrant model - The linkages between space market and asset market, development industry - Chapter 3 - - - Zipfs law o The size of cities follow a striking pattern known as rank/size rule o Factor of Pattern city location Centralizing (Centripetal) Forces: These are factors or influences that pull people, businesses, and activities towards the city center. Centralizing forces can include better job opportunities, cultural attractions, educational institutions, and access to public services. They encourage urbanization and concentration within the city. Opposing Decentralizing (Centrifugal) Forces: These are forces that push people, businesses, and activities away from the city center and towards the periphery or suburbs. Decentralizing forces can include factors like traffic congestion, high living costs in the city center, and the desire for more space and a quieter environment in suburban areas. Centripetal forces – inward forces - Economies of scale o It cheaper and more efficient to produces more of a good or services in larger volume at fewer sites. o Fixed production costs o Increasing quantity of production to obtain greater efficiency. - Economies of agglomeration o Are cost or productivity advantages of the clustering of. Firms or work sites physical near each other. o Clustering different types of workers with abilities to help each other if they are physically near each other. o Vertical linkages upstream and downstream linkages in production processes - Positive locational externalities o One firm benefits from the nearby location of another firms without the first firm being able to capture all these benefits itself. Centrifugal forces – outward forces - More costly to produce goods and services in large cities. Central place theory and the urban hierarchy - Chapter 4: The location and residual nature of the land value - Real estate value of land comes from derived demand: people are willing to pay for land not because of the value land has in and of itself, but because land is necessary to obtain other things that have consumption or production value. - The residual theory of land value o Where the factory is located will affect how profitable the manufacturing operation is because of the costs of getting raw material to the factory and the finished product from the factory to retail sales. o Location is fixed in the LR and not able to move it o Equilibrium: land value reflected on Euler’s theorem According to this theorem each factor of production will be paid an equilibrium price or wage equal to its marginal product that is equal to marginal value of what I contribute to the production process. - The role of transport cost: the bid rent curve o The residual value differs from one place to another because of the difference in transportations cost. o factory could make more profit if they are located nearer to the highway where delivery cost of both its input and output where lower. o The bid rent curve: is the max rent that a potential user would bid or willing to pay for a site or location, essentially the same thing as residual value. shows how bid rent changes as a function of user distance from some central point, which is the point where transportation cost are minimized, the points which bid rent or residual value is maximized As you move away from the central point, the bid-rent falls as the transportation costs rise due to the less-central location. - - The classic monocentric city model o One central point exist in the whole city and this central point applies to all potential uses of the land. o All household commute every day to produces some good that enable them to earn the income to meet their housing costs and consumptions, the income pays for the transportation costs. Circlopolis, the quintessential monocentric city o o - Chapter 5 – inside the city II Property rent and property value. - Property value o Property value are the present value of the expected future rents the proport could receive, else thing being equal, the property value will be greater where rents are greater. o Market value o Is the worth of the property in the current market, represent how much property is worth being sold in open market. o Can be influenced by various factors, incl. location, size, conditions, amenities, local real estate trends, economic factors. o Higher uncertainty or risk can lower property’s value because investor require higher return and lower price to compensate additional risk. o A higher growth rate in the future rents will increases the PV of those rents and increase property value, else being equal. - Property rent o Is the expected future growth rate of the rents. o The amount of money a tenant pays to the property owner or landlord in exchange to use the property. o Depends on location, size, condition amenities and demand. o If property is expected to experience higher growth rate in future rents, this can increase PV of those rents and increases property value. The effect of uncertainty on land value - The land provides its owner with a call option to building or construction the building, in that wat the owner can profits from. Uncertainty - Upside (develop the property) and downside (owner don’t want to develop due to avoid losses) of the uncertainty. - Irreversibility of construction: ones a building is built it very difficult and expensive to remove it. - The land is more valuable the more uncertainty or volatility. - Irreversibility premium: deals with land value and uncertainty, add risks and additional cost to land developments or investments decision that cannot be reversed or altered due to uncertain future conditions. - Growth premium: future growth and development, This means that the land's value is not solely based on its current use but also on the expectation that it can be used for more valuable purposes in the future. Chapter 6 – real estate market analysis Construction starts or completion - New supply to the stock of space available in the market - Construction takes time com months to years to finished - New supply can not enter the market until the construction is complete but leasing of tenant in advance. - An indicators of activity on the supply side Absorption - The amount of additional space that is occupied per year - An indicator od the activity on the demand side of space market - Gross absorptions: o measures the total amount of space for which leases where signed during the year. o Relevant for measuring of the demand for leasing. Gross absorption measures the total square footage of space that was leased or rented during a specified time frame. o High gross absorption figures can suggest a strong demand for commercial space, while low figures may indicate a weaker market. o it does not differentiate between tenants who are entering the market for the first time (representing new demand) and tenants who are relocating within the same market (representing internal reshuffling or churn) - Net absorptions o The net change in the amount of occupied space in the market o Use to understand the actual growth or reduction in the amount of occupied space within a specific real estate market o Net absorptions = total leased space – total vacated space If net abosprtion >absortption then vacancy rises o - - - Net absorptions > net construction completions then vacancy decline in the market, more space are being occupied than added to the market Net absorptions < net construction completions then the vacancy rises, more space is available than tenants are leasing. The vacancy rate o Is the percentage of stock of built space in the market that is currently not occupied. o One must know the total stock of space in the market and the amount of space that is currently vacant. The natural vacancy rate o The level of vacancy expected to occur under unusual factors/market disturbance o Calculated based on several year in the long terms o Indicates that the market is in balance when demand matches supply. o Vacancy below natural rate level means the market is a sellers or landlords market or that rental market is tight because demand > supply o If vacancy above natural level means the market is said to be buyers or tenants market with supply > demand Month supply o o How long is will take in months for all the vacant space in the market to be absorbed (driving the market down to a zero vacancy rate) - Trend extrapolation vs structural analysis o Trend extrapolation Time series statistical techniques with historical trend o Structure analysis Space is driven by the demand Lecture 6 the basic idea: DCF and NPV Greater fool theory - Suggest that someone else a greater fool would be willing to buy an asset or property for a higher price than you did. - The price of an asset is not judged by its intrinsic value - According to the theory investors believe they can profits from buying over valued asset with the hope of selling them to someone else at even higher price in the future - Riske and irrational investment behavior that relies on expectation that there is always someone else willing to be a higher price. Discounted cash flow DCF - Financial valuation method based on: o Forecast of expected future cash flows o Ascertain the required total return o Discount the cash flows to PV at the required rate of return - Based on the principle. That the value of an asset = PV of it expected future cash flows - In other words, it helps investors and analysts assess the worth of an investment by estimating the sum of the future cash flows that investment is expected to generate, and then discounting those cash flows back to their present value. - - R= total return risk free interest component (accounts for time value of. money) and risk premium component (accounts for the risk): r=. rf+RP the higher discount rate, the more risky cash flows, such cash fows have higher cost of capita in the asset markets intralease discount rate vs interlease discount rate - intralease o rate used to discount future lease payments when calculating PV of lease liabilities, reflect on lessee borrowing rate - interlease o when lessee has multiple leases o Instead of using a specific rate for each individual lease, the interlease discount rate represents the incremental borrowing rate that the lessee would have incurred to borrow funds to finance a similar portfolio of leases o reversion cash flow representing projected proceeds from future resale of the property - Terminal Value = Final Year Cash Flow * (1 + g) / (r - g) Blended IRR - Multiple cash flows or financing sources with different IRR 1. Mixed Financing: In some projects or investments, the financing may come from multiple sources, each with its own cost of capital or rate of return. The blended IRR is used to calculate the overall internal rate of return that takes into account the mix of these different financing sources. 2. Combining Projects: When an organization is considering several investment projects simultaneously, each project may have its own expected rate of return. The blended IRR helps calculate the overall rate of return for the combined set of projects. To calculate the blended IRR, you need to consider the cash flows associated with each financing source or project, along with the respective rates of return or cost of capital. The formula involves finding the rate of return that equates the total cash inflows with the total cash outflows, taking into account the weights (proportions) of each financing source or project. Here's a simplified example: Suppose you are considering two projects, Project A and Project B, with the following information: Project A has an expected rate of return (IRR) of 10% and requires $500,000 in investment. Project B has an expected IRR of 15% and requires $300,000 in investment. You also have a third financing source, which is a bank loan with an interest rate of 8%. You plan to borrow $200,000 from the bank. To calculate the blended IRR for this combination of investments and financing, you would consider the cash flows from Project A, Project B, and the loan, along with their respective proportions in the total investment. Once you have the cash flows and weights, you can use financial software or a financial calculator to find the blended IRR, which is the rate at which the net present value of all these cash flows equals zero. Direct capitalization - Esitmates the propertys nets operatinnc income NOI Noi= gross income – operating expenses Cap rate is the component of direct capitalization and is dervied from market data such as propertytype,location and market condition A lower cap rate implies a higher property value, while a higher cap rate implies a lower property value. The gross incomoe multiplier GIM - A valuation metirc used to asses the relative value of an icnom eproducingproperty - Residential or small uni t poppreties - A simple ratio tha tcomparres the pporertysamrekt price or value toits gross srental income Lecture 7:
