MIT OpenCourseWare
http://ocw.mit.edu
11.433J / 15.021J Real Estate Economics
Fall 2008
For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms.
MIT Center for Real Estate
Week 1: Introduction
• The space versus asset market: 4 Quadrant
math.
• Real Estate Micro Economics: Hedonics,
Location, density, government regulations.
• Real Estate Macro Economics: timing
behavior (search, moving, contracts),
cycles, regional growth.
MIT Center for Real Estate
The Role of Real Estate in the
Economy
• Construction [6% of GDP]
• Service flow, “Shelter”, rent plus imputed
rent [20% + of GDP]
• Assets [55-60% of total national wealth]
• Land? Not part of GDP (we don’t make
land), but it is part of wealth.
• Accounting, measurement difficulties [book
versus market value]
MIT Center for Real Estate
Value of New Construction Put in Place, 2002
$ (in Billions)
% of GDP
650
6.1
422
167
17
38
10
56
46
4.0
1.6
0.2
0.4
0.1
0.5
0.4
54
7
0.5
0.1
Public Construction
Buildings
Housing and development
Industrial
Other
Nonbuilding construction
Infrastructure
All other
210
102
6
2
94
108
97
11
2.0
1.0
0.1
0.0
0.9
1.0
0.9
0.1
Total new construction
861
8.1
10,624
100.0
Private Construction
Buildings
Residential buildings
Nonresidential buildings
Industrial
Office
Hotels/Motels
Other commercial
All other nonresidential
Nonbuilding construction
Public utilities
All other
Total GDP:
Source: Current Construction Reports, Series C30, U.S. Census Bureau. Gross Domestic
Product from Economic Report of the President, 2004
Figure by MIT OpenCourseWare.
MIT Center for Real Estate
The Value of US Real Estate Assets (1990)
$, in billions
% of Total
Residential
6,122
69.8
Single Family Homes
5,419
61.7
Multifamily
552
6.3
Condominiums/Coops
96
1.1
Mobile Homes
55
0.6
Nonresidential
2,655
30.2
Retail
1,115
12.7
Office
1,009
11.5
Manufacturing
308
3.5
Warehouse
223
2.5
8,777
100.0
Total U.S. Real Estate
Adapted from DiPasquale and Wheaton (1996)
MIT Center for Real Estate
U.S. Real Estate
Ownership, 1990
All Real Estate
Residential Only
Nonresidential Only
$, in billions
%
$, in billions
%
$, in billions
%
Individuals
5,088
58.0
5,071
82.8
17
0.6
Corporations
1,699
19.4
66
1.1
1,633
61.5
Partnerships
1,011
11.5
673
11.0
338
12.7
Nonprofits
411
4.7
104
1.7
307
11.6
Government
234
2.6
173
2.8
61
2.3
Institutional Investors
128
1.5
14
0.2
114
4.3
Financial Institutions
114
1.3
13
0.2
101
3.8
Other (Including Foreign
92
1.0
8
0.1
84
3.2
8,777
100.0
6,122
100.0
2,655
100.0
Total:
% of All Real Estate
Adapted from DiPasquale and Wheaton (1996)
100.0
69.8
30.2
Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…
Rent $
D
Space Market:
Rent Determination
Asset Market:
Valuation
R*
D
Price $
Q*
P*
C*
Asset Market:
Construction
Space Market:
Stock Adjustment
Construction (SF)
Stock (SF)
MIT Center for Real Estate
Systems of Economic Equations
• Parameters: Constants that reflect underlying
behavior, α, β, δ.
• Endogenous variables: values that the model
“determines: C, S, R, P.
• Exogenous variables: values that determine the
model’s variables, but which the models variables
in turn do not influence: i, E.
• Equilibrium: Solution to the endogenous variables
given exogenous values and parameters.
• Comparative Statics: How changes in exogenous
variables change equilibrium endogenous ones.
MIT Center for Real Estate
1st quadrant
1). Office Demand = α1ER-β1
E= office employment
R = rent per square foot
β1 = rental elasticity of demand, %change
in sqft per worker/% change in rent]
α1 = sqft / E when R=$1
2). Demand = Stock = S
3). Hence: R = (S/α1E)–1/ β1 {downward sloping schedule}
MIT Center for Real Estate
2nd and 3rd Quadrants
4). P = R/i
i = all inclusive cap rate
5). Office Construction rate:
C/S = α2Pβ2
P = Asset Price per square foot
[“Q” theory?]
β2 = Price elasticity of supply:
[% change in construction rate/% change
in price]
MIT Center for Real Estate
4th Quadrant
6). Replacement version (graph):
E= fixed, δS = building losses
ΔS/S = C/S - δ [Construction rate – loss
rate equals net additions = 0 in equilibrium]
7). Steady Demand growth version:
ΔE/E = δ, no losses
Hence: ΔS/S - ΔE/E = C/S - δ
[what happens to S/E if C/S >< δ ?]
Effect of Demand Growth in Space Market: More
Jobs
MIT Center for Real Estate
Asset Market:
Valuation
Rent $
Space Market:
Rent Determination
D1
D0
R*
Price $
P*
Q*
C*
Asset Market:
Construction
Space Market:
Stock Adjustment
Construction (SF)
Stock (SF)
Effect of Demand Growth in Space Market:
First phase…
MIT Center for Real Estate
Asset Market:
Valuation
Space Market:
Rent Determination
Rent $
D0
D1
Doesn’t form a
rectangle.
R*
Excess (negative)
vacancy…
Price $
P*
Q*
C*
Asset Market:
Construction
Space Market:
Stock Adjustment
Construction (SF)
Stock (SF)
Effect of Demand Growth in Space Market:
2nd phase…
MIT Center for Real Estate
Asset Market:
Valuation
Rent $
Space Market:
Rent Determination
D0
R1
D1
Rents spike and get rid of
excess (negative) vacancy
R*
Price $
P1
P*
Q*
Stock (SF)
Can this be a longrun equilibrium
result?…
C*
Doesn’t form a
rectangle.
Asset Market:
Construction
Space Market:
Stock Adjustment
Construction (SF)
Effect of Demand Growth in Space Market: LR Equilibrium…
MIT Center for Real Estate
Asset Market: Rent $
Valuation
Space Market:
Rent Determination
D0
R1
R**
D1
R*
P**
Price $
P1
P*
Q*
In long run equilibrium
new supply tempers
initial rent spike
C*
Asset Market:
Construction
C**
Q** Stock (SF)
Space Market:
Stock Adjustment
Construction (SF)
Effect of Demand Growth in Asset Market…
MIT Center for Real Estate
Asset Market:
Valuation
D0
Space Market:
Rent Determination
Rent $
11% CAP
D1
R*
8%CAP
R**
SR
P1
Price $
LR
P**
Q**
P*
Q*
C*
Asset Market:
Construction
C**
Space Market:
Stock Adjustment
Construction (SF)
Stock (SF)
MIT Center for Real Estate
Using the 4-Quadrant Model to
assess the impact of other changes.
• What happens if Construction costs rise or the
supply schedule shifts?
• Suppose depreciation speeds up (functional
obsolescence dictates shorter life spans of
buildings)?
• How to interpret owner occupied space (e.g.
Single Family Housing)?
• EXERCISE #1.
MIT Center for Real Estate
Current Issues: using the diagram
• Zero (or negative) population and labor force
growth in: Japan, Germany, Italy, Spain…?
• Increasing use of the Internet for retail
shopping?
• Expanded availability of (subprime) mortgage
credit to households previously ineligible?
• Continued global saving glut from growth in
Asia – where savings rates are 20%+
MIT Center for Real Estate
Real Estate Macro-economics: Real
Estate Cycles and Secular Trends
• What are real estate cycles? Truly independent
oscillations or just reactions to the economy.
• Cycles vary with Property type.
• Cycles are related to broader capital markets.
• Secular trend: growth rates of the stock
(construction) slow as economy matures.
• Secular trend: Prices adjusted for inflation rise
over time?
MIT Center for Real Estate
3.2
4
2.8
3
2.4
2
2.0
1
1.6
0
1.2
-1
0.8
-2
0.4
-3
0.0
New Jobs (L)
Sources: BLS, BOC, TWR.
Total Housing Starts (R)
Total housing starts,
millions of units
5
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Year-over-year change in total
employment, millions
Prefect Historic correlation between economic recessions
and Housing Production – except for the last 5 years
MIT Center for Real Estate
Prefect Historic correlation between economic recessions
and Housing Prices – except for the last 5 years
6%
12%
5%
10%
4%
8%
6%
job growth
3%
4%
2%
2%
1%
0%
0%
-2%
-1%
based on 4-qtr
moving averages
-2%
-6%
-8%
19
69
19 Q3
71
19 Q1
72
19 Q3
74
19 Q1
75
19 Q3
77
19 Q1
78
19 Q3
80
19 Q1
81
19 Q3
83
19 Q1
84
19 Q3
86
19 Q1
87
19 Q3
89
19 Q1
90
19 Q3
92
19 Q1
93
19 Q3
95
19 Q1
96
19 Q3
98
19 Q1
99
20 Q3
01
20 Q1
02
20 Q3
04
20 Q1
05
20 Q3
07
Q
1
-3%
-4%
Job Grow th
Real Median Home Price Grow th (lagged)
real median home prices
Housing and U.S. Job Growth
MIT Center for Real Estate
With offices, building booms follow rents. The booms
then generate falling rents = endogenous cycle?
140
Office construction and rent growth (TWR sum of markets)
15
Forecast
120
Completions Historical average
100
10
5
80
60
0
40
-5
Completions in msf (L)
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
0
1988
20
-10
TWR rent inflation in % (R)
Figure by MIT OpenCourseWare.
MIT Center for Real Estate
National Office Market
Completions Rate vs. Real Rent
$ Per Sqft
Forecast
34.00
8.00%
32.00
6.00%
30.00
28.00
4.00%
26.00
2.00%
24.00
0.00%
22.00
Total Employment Growth (L)
Real Rent (R)
Completion Rate (L)
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
20.00
1971
-2.00%
MIT Center for Real Estate
Historically: Rents over the “cycle”
mean revert around Development costs
PPI: Construction
TWR Rent Index
200
31
190
29
180
27
170
25
160
150
23
140
21
130
19
120
17
100
15
19
88
Q
19 1
89
Q
19 1
90
Q
19 1
91
Q
19 1
92
Q
19 1
93
Q
19 1
94
Q
19 1
95
Q
19 1
96
Q
19 1
97
Q
19 1
98
Q
19 1
99
Q
20 1
00
Q
20 1
01
Q
20 1
02
Q
20 1
03
Q
20 1
04
Q
20 1
05
Q
20 1
06
Q
20 1
07
Q
20 1
08
Q
1
110
PPI: Construction Materials and Components
Source: BLS, TWR Office Outlook XL, Summer 2008
TWR Rent Index
MIT Center for Real Estate
Over the long run there also are:
little cycles and Big cycles
Broken
Ground
Projects
Construction as % of Stock
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
-2%
1901 1910 1919 1928 1937 1946 1955 1964 1973 1982 1991 2000
Downtown
Suburban
Y ear
19
19
19
68
58
48
38
28
18
g
19
19
08
98
88
(
19
19
18
78
68
58
48
38
28
18
08
98
88
Index of Historic Housing Prices in
Amsterdam (Real Guilders)
y
18
18
18
18
18
18
18
18
18
17
78
68
58
48
38
28
18
08
98
88
78
68
58
48
38
28
Price Index
g
17
17
17
17
17
17
17
17
17
16
16
16
16
16
16
16
16
MIT Center for Real Estate
)
400
350
300
250
200
150
100
50
0
MIT Center for Real Estate
CPI Apartment Rent Indices for Selected "traditional" Cities: 1918-1999 (constant $)
400
350
250
200
150
100
50
Year
NEW YORK
BOSTON
CHICAGO
WASHINGTON D. C.
SANFRANCISCO
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
1936
1933
1930
1927
1924
1921
0
1918
Apartment Rent
300
MIT Center for Real Estate
Long run Appreciation? Just inflation (3.5%) for 100 years
in NYC, but lots of decade risk
Price Index 1899 = 1.0
constant dollars/square ft.
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
1899
1909
1919
Source: MIT 2002 Thesis
1929
1939
1949
1959
1969
1979
1989
1999
MIT Center for Real Estate
Real Estate Micro-economics:
Cities and Land Markets
• No two properties are identical [complete product
differentiation]
• Properties are close if not perfect substitutes for
each other – at some price differential.
• Price differentials are extremely large, and very
predictable.
• Price differentials tend to be stable over time:
local neighborhoods do not have independent
cyclic movements.
MIT Center for Real Estate
House prices reflect both unit characteristics and
location attributes
In(sale)
17.19
8.52
5.71
9.34
In(sqrt)
Sale amount against square feet, Phoenix
Figure by MIT OpenCourseWare.
MIT Center for Real Estate
Repeat-Sale House price indices (CSW) for 15 submarkets
within the greater Boston CMSA: 1982-2002 (current $)
House Price Indexes, Eastern M assachusetts, by City/Tow n Location
300
Boston
Southeast
W estern 1
Far North Shore
495 North
95 South
95 N orth
W estern 2
Lowell Area
495 W est
North Shore
South Shore
W orcester Area
Cam bridge Area
North Central
200
150
100
50
Year
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
0
1982
Price Index (1990=100)
250
MIT Center for Real Estate
Home Prices within South California
Median Home Price,
Thousands ($ 2002.4)
$400
$350
$300
$250
$200
$150
$100
77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
Los Angeles
Orange County
Sources: OFHEO, Torto Wheaton Research
Riverside
Ventura
San Diego
MIT Center for Real Estate
Office Rents Move together Cyclically but not
always secularly
TW Rent Index, 2003$ per sqft
40
Forecast
35
30
25
20
Los Angeles
Orange County
Ventura County
Riverside
2005
2003
2002
2001
2000
1998
1997
1996
1995
1993
1992
1991
1990
1988
1987
1986
1985
1983
1982
1981
1980
15
San Diego
MIT Center for Real Estate
Closely Correlated Industrial Rent
Movements: few secular differences
TW Rent Index, 2003$ per sqft
10.00
Forecast
9.00
8.00
7.00
6.00
5.00
Los Angeles
Orange County
Ventura County
Riverside
2005
2004
2002
2001
1999
1998
1996
1995
1993
1992
1990
1989
1987
1986
1984
1983
1981
1980
4.00
San Diego
MIT Center for Real Estate
Manhattan Office Rents vs. NJ and
Conn. Suburbs
TW Index, $2002 per sqft
65
60
55
50
45
40
35
30
25
Suburban Markets
Manhattan
2001
2000
1998
1997
1996
1995
1993
1992
1991
1990
1988
1987
1986
1985
1983
1982
1981
1980
20
MIT Center for Real Estate
Office Suburban Rents in Detail
TW Index, $2002 per sqft
50
45
40
35
30
25
20
15
Northern New Jersey
Long Island
Stamford
2001
2000
1998
1997
1996
1995
1993
1992
1991
1990
1988
1987
1986
1985
1983
1982
1981
1980
10
Westchester
MIT Center for Real Estate
Prices and Development
• Prices bring forth development: of any urban land
use..
• Development occurs so as to maximize the
residual value between: Price-capital costs
(construction).
• This residual is “land value”. Development
maximizes land value.
• Land Development is a natural real option: incur
heavy capital costs to realize an income stream –
or- wait (to do the same later) ?
MIT Center for Real Estate
What is a real Estate Market?
• Within “markets” all properties should
move together: high substitutability, easy
mobility.
• Between markets there exists frictions,
transportation costs, immobility of
resources and low substitutability.
• MSA as “market”? CMSA?
MIT Center for Real Estate
Between Markets – there can be huge differences in
both long term growth and cyclic risk
1 9 8 0 = 1 0 0 (C o n s ta n t $ 2 0 0 5 )
350
300
B o s to n
250
Los
A n g e le
s
Ch ic a g
o
200
150
Na tio n
100
Da lla s
50
0
1980
1985
1990
1995
2000
2005
MIT Center for Real Estate
Metropolitan Housing Markets
can even move independently
FIGURE 5. Repeat Sale House Price Indices for Selected "new" Cities: 1975-1999 (constant
$)
250
230
210
170
150
130
110
90
70
Year
Atlanta
Dennver
Houston
Los Angeles
Phoenix
98
99
19
19
97
19
96
19
95
94
19
19
93
19
91
92
19
19
90
19
89
88
19
19
87
19
86
19
84
85
19
19
83
19
81
82
19
19
80
19
78
79
19
19
77
19
76
19
75
50
19
House Price
190
MIT Center for Real Estate
Although sometimes they are subject
to a common economy wide Shock
FIGURE 4. Repeat Sale House Price Indices for Selected "Traditional" Cities: 1975-1999 (constant $)
250
230
210
170
150
130
110
90
70
Year
Boston
Chicago
New York
Sanfrancisco
Washington D.C.
98
97
99
19
19
19
96
19
94
93
92
91
90
89
95
19
19
19
19
19
19
19
88
19
87
85
84
83
82
86
19
19
19
19
19
19
81
19
79
78
77
76
80
19
19
19
19
19
75
50
19
House Price
190