Market Analysis for Real Estate Samuel Azasu, Aoosciate Professor (Real Estate) Wits University samuel.azasu@wits.ac.za +27712233620 Real Estate Market Analysis – A Primer Executive Summary Welcome to the masterclass in Real Estate Market Analysis. Real estate market analysis is one of the most fundamental skills required by anyone who wants to be a credible decision maker in the real estate market. This course will bring you into contact with some of the fundamental tools with which you can identify and analyze the presence and magnitude of investment opportunities in the real estate market. It will help you understand what drives real estate market opportunities within a metropolitan area and within the immediate vicinity of specific assets and potential investments. Whether you are an investor, developer, property manager, investment analyst, property valuer or asset manager, you will find the skills of market analysis an indispensable tool in your decision making process. 2017-07-14 2 Real Estate Market Analysis – A Primer Contents Executive Summary ...................................................... 2 Contents ...................................................................... 3 Topic 1: The importance of market analysis.................. 5 Optional Progress Check ................................................. 7 Topic 2: The components of market analysis ................ 8 Metropolitan growth analysis....................................... 9 Demand gap analysis.................................................... 9 Site and neighborhood analysis .................................... 9 Optional Progress Check ............................................... 10 Topic 3: The uses of real estate market analysis ......... 11 Optional Progress Check ............................................... 12 Discussion Activity...................................................... 13 Assignment ................................................................ 13 2017-07-14 3 Real Estate Market Analysis – A Primer An Introduction to Real Estate Market Analysis Wits University wishes to develop a piece of land along Jorissen Street in partnership with Oil Star (Pty) Ltd. • The property is owned by Oil Star (Pty) Ltd and is currently being operated as a Caltex filling station. • It is 1,490m2 in extent and comprises erven 2939 to 2941, located on the corner of Jorissen and Station Streets, opposite the main entrance to Wits. • Oil Star wants to improve the filling station and envisaged that this could be done in partnership with Wits by building an apartment above the garage. • Wits has an ongoing problem – the number of students it accepts each year exceeds the number of housing units available. In addition, Wits attracts a significant number of postdoctoral students, visiting researchers and newly arrived full-time employees from abroad and has struggled to house all of them. Wits also sees an opportunity to provide entry-level housing for recent graduates as Braamfontein has become an attractive lifestyle choice for urban pioneers like single, recently employed, young graduates. • The student and affordable entry-level housing market were explored in detail with the hope that the building could be adapted to cater for both of these housing segments. • It approached a development consultant who came up with a development proposal for a multi-story student housing development. • Wits and Oil Star have now approached Sibongile Mbatha, a market analyst, for his advice on whether the consultant’s proposal is viable. Wits wants Mbatha to undertake a market analysis and marketability study to uncover the opportunities presented by the site in order to advice Wits whether or not the consultant’s advice is viable. Mbatha agreed the logical starting point is to assess the development prospects of the land. He called a meeting of his team of analysts to discuss Wits’ request. How should Mbatha and his team go about the market analysis? 2017-07-14 4 Real Estate Market Analysis – A Primer In this module you'll learn: How to describe real estate market analysis, its components and its contribution to real estate decision-making. The following topics will be covered: Topic 1: The importance of market analysis Topic 2: The components of market analysis Topic 3: The uses of real estate market analysis Topic 1: The importance of market analysis In this topic you will be expected to: Explain market analysis and its contribution to real estate decision-making. The following key question will be answered as you explore this topic: 1. What is real estate market analysis? 2. Why is real estate market analysis important? 3. What contribution does real estate market analysis make to real estate decision-making? To assess your understanding of this topic you will have the opportunity to complete an Optional Progress Check activity before moving onto the next topic Market analysis is a process of investigating and measuring the income potential of a prospective investment, acquisition or development at both the broader market level and within the immediate surroundings of the specific asset. Many acquisitions and developments fail because the income potential of the asset was not ascertained before the decision was made to pursue the investment. For example, an investor could decide to build a shopping mall in a mining area without determining how long the mines would remain open. The mines provide jobs and generate income that enables people to patronise the mall. As a consequence, when the mines suddenly close, jobs are lost and incomes disappear, shop owners in the mall would find their wares remain unsold; the mall owner would not receive the necessary rents to make the mall remain a viable investment. 2017-07-14 5 Real Estate Market Analysis – A Primer Another example: a developer may find there is the need for an office building in the market, which created an investment opportunity. He then mobilised resources and developed an office complex. However, the office was built in an area that was difficult to reach as it was far away from major transportation routes and other businesses As a result, no business would rent the offices, leading to a failure of the development. A third example is one of a housing complex whose owner is struggling to sell the units in the complex because the complex is not only too expensive; it is far from schools, hospitals and shopping centres and is adjacent to a high crime neighbourhood. In all of these cases, a systematic market analysis would have highlighted some of the problems associated with each development, leading to the investor not going ahead with the project or modifying it by, for example, building the office in a more accessible location. In the case of the office development, even though there is a need for an office in the market area, it was built in the wrong neighbourhood. Market analysis enables the developer to determine not only if there is demand for office space but in which is the most suitable neighbourhood to build one. Market analysis also enables the developer to determine how much specific groups of buyers are willing to pay for a specific housing unit. It also enables the developer to determine which neighbourhood attributes would make the units attractive to buyers. Real estate market analysis runs counter to the belief that supply of a building creates its own demand. Many developers, investors and property owners, especially those who have been successful in the past, are tempted to believe their successful decisions in the past guarantees successful investment and development decisions in future. The fundamental assumption behind this attitude is that whatever conditions led to past successful investments remain. In particular, demand for the prospective investment remains at the level of the market area of the property and within the vicinity of the project. The risk is that conditions may have changed in the sense that demand may no longer exist or too many projects that serve the same need as the particular project are in the pipeline and will be ready at the same time as the prospective project. Consequently, if the investor were to go ahead with the project, he/she would find the project has few or no buyers or renters. What market analysis does is enable the developer or investor to determine with a reasonable degree of certainty the income producing prospects of a development at the level of both the market area and the neighbourhood of the project beforehand. It thus contributes to informed decision making and prevents market participants from basing decisions on beliefs or past successes. 2017-07-14 6 Real Estate Market Analysis – A Primer What contribution does real estate market analysis make to real estate decision-making? Developers usually have some sense of profit opportunities when they first consider a site or development idea. Being entrepreneurs, they are constantly looking at market trends, observing rival developers and looking for new needs in the market they can meet. Consequently, when a developer identifies an opportunity and looks for ways to take advantage of that opportunity, he has to look beyond intuition and gut feelings as the basis for investing millions of Rands in construction. The developer needs sound evidence about market opportunities before proceeding even to the preliminary design phase, which is why he needs market analysis. Market analysis replaces excessive reliance on intuition and complacency due to past success in real estate decision making. There is a mistaken notion that supply of new developments creates their own demand. In everyday language, some market players believe if they “build it, they (buyers/renters) will come”. This attitude to real estate developments can lead to costly failures such as empty shopping centres or office buildings. The problem with this approach is that intuition replaces a systematic search for evidence that there is demand for an apartment complex, office building or shopping centre before resources are mobilized to develop it. Given the large sums of money and bank loans that people use for these projects, failure to establish evidence of demand for an asset would lead to problems for the developers, banks and investors alike. Market analysis thus protects developers, investors, and property managers from costly investment and development failures. Summary Market analysis is a process of investigating and measuring the income potential of a prospective investment, acquisition or development at both the broader market level and within the immediate surroundings of the specific asset. It enables the developer or investor to seek evidence about the income producing prospects of a development at the level of both the market area and the neighborhood of the project before committing resources. It thus contributes to informed decision making and protects market participants from making bad decisions rooted mostly in beliefs or past successes. Optional Progress Check Before moving onto the next topic, there is an Optional Progress Check activity that will assist you in assessing yourself on how well you understood the key learning points in the topic. These exercises are self-checks only. Answer the following questions and submit the correct answer. Experienced developers believe given their past success, if they develop a new shopping mall, their past reputation will guarantee new shoppers. True/False and why? 2017-07-14 7 Real Estate Market Analysis – A Primer There are two problems with this attitude: • Future conditions may differ from the conditions that led to past success, e.g. impending job losses may lead to reduced purchasing power that would undermine the success of a new shopping centre. A better approach is to establish there is still enough purchasing power to justify building a new mall, which market analysis can help accomplish. • Supply does not create its own demand. Demand for retail would be created by new spending power in the market area. Therefore if there is no growth in spending power, a new mall could lie empty. Topic 2: The components of market analysis In this topic you will be expected to: • Describe the contribution and the outcomes of each of the components of market analysis. The following key questions will be answered as you explore this topic: 1. What are the components of real estate market analysis? 2. What is metropolitan growth analysis, demand gap analysis and site and neighbourhood analysis? 3. What information does each of the components provide? To assess your understanding of this topic you will have the opportunity to complete an Optional Progress Check activity before moving onto the next topic. Real estate market analysis has three components: • An analysis of growth in the metropolitan area in which the prospective investment is being contemplated. • An analysis of the excess demand for the asset class(es) favoured by the type of growth in the metro (demand gap analysis) within a defined market area. • An analysis of the site and neighbourhood of the specific project. 2017-07-14 8 Real Estate Market Analysis – A Primer Metropolitan growth analysis Metropolitan growth analysis examines and identifies the sources of metro growth, e.g., changes in demand for the metro’s output, migration patterns and economic specialization and the effects on population, income and employment. The analysis of the effects is then used to make inferences about which asset classes are likely to benefit from this type of growth. Demand gap analysis Demand gap analysis takes a closer look at the asset classes identified at the conclusion of metro growth analysis by measuring the extent by which demand for these assets exceed supply for them in a defined market area. Only on the basis of excess demand does any of the asset classes merit further analysis at the final stage of a market analysis process. Site and neighborhood analysis Site and neighborhood analysis starts from the initial ideas about what development or investment is suitable from the demand gap analysis. It then analyses the suitability of the site and neighborhood of the potential project using criteria specific to the asset class to arrive at conclusions of the most marketable development at the site, the best prices/rents that the project could command and the speed with which it could be sold or rented. What information does each of the components provide? Metropolitan growth analysis must provide information on the type of growth taking place in the metro, the forces behind metro growth, a forecast of future growth and the asset classes likely to benefit from the types of growth the metro is experiencing. Demand gap analysis must provide information on the excess number of aggregate housing units in a market area; it could also provide information on the number of units of a particular type in a market area and the number of households that qualify for that housing type. For retail property, demand gap analysis must identify excess spending power within the trade area of a potential retail development. A retail development would be profitable only if the spending potential within the trade area of the proposed development exceeds the volume of expenditures currently being supported by current retail facilities. For the office market, gap analysis measures excess demand and the direction of real rent changes. This means for example, if the employment is growing in sectors that use office space, exceeds the number of office projects in the pipeline, there would be excess demand, necessitating new developments. Site and neighbourhood analysis enables an assessment of the competitiveness of the attributes of the project and its immediate environment. This stage of the analysis provides information such as achievable prices/rents and how quickly a project will sell or rent and how the project should be phased to maximise development revenues. It also enables the analyst to refine the project attributes to match the needs of the target market. The three components of market analysis provide information that guides the next component. The first component of a market analysis report covers the sources, and consequences of metro 2017-07-14 9 Real Estate Market Analysis – A Primer The different stages of the market analysis process that Mbatha and his team have to pursue are sequential in the sense of one stage feeding into the next. The first component of a market analysis has the metro as the unit of analysis. In the case of the Wits project, we are looking at Johannesburg metro. It covers the roots of growth in the Johannesburg metro and analyses the impact of metro growth on output population, employment and incomes. Metro growth analysis concludes by drawing attention to the asset classes likely to benefit from the dominant impacts of growth in the metro. This means, for example, if wealth growth is the dominant growth consequence, it would spell good news for high end residential and retail real estate. The second component of the study focuses on the market area for the different asset classes. It looks for and measures the level of excess demand for the asset classes identified in the previous step. Using this information, Mbatha and his team of analysts growth with implications for the different asset classes. The second component of the study covers an assessment of demand gaps at the level of the market area using the outcomes of metro growth analysis. The third component is the marketability of the project (for the asset classes with excess demand) at the site and its neighbourhood and provides information on the most marketable project attributes, achievable prices/rents and absorption. Before moving onto the next topic, there is an Optional Progress Check activity that will assist you in assessing yourself on how well you understood the key learning points in the topic. These exercises are selfchecks only; your answers will not count towards your overall course mark. Optional Progress Check Answer the following questions and submit the correct answer. 1. Metro growth analysis uncovers demand gaps for different asset classes in a market area, True/False 2. Site and neighbourhood analysis is the same as marketability analysis, True/False 3. A developer should be able to start a project with site and neighbourhood analysis only, True/False 4. Metro growth analysis covers a province of the country in which a project is situated, True/False 5. A market analysis is the same as a feasibility study. True/False? 6. A market study is not needed if an area with sufficient spending power has no shopping centre. True/False? 7. The extent of marketability analysis is: A. The metropolitan area would then proceed with the third B. The market area of the project component – an analysis of the C. The site and immediate neighbourhood of the project proposed project site and its immediate neighbourhood. The goal Gap analysis always covers the metro, True/False. is to use this analysis to derive information on the most marketable project characteristics, achievable prices/rents and speed with which it could sold or rented out. 2017-07-14 10 Real Estate Market Analysis – A Primer Topic 3: The uses of real estate market analysis In this topic you will be expected to: Outline the importance of using real estate market analysis to make informed decisions. The following key questions will be answered as you explore this topic: 1. Who are the users of market analysis? 2. What decisions are made with market analyses? 3. What can go wrong with failure to do market analysis? To assess your understanding of this topic you will have the opportunity to complete an Optional Progress Check activity before moving onto the next topic. Practically every player in the real estate market must rely directly or indirectly on some market analysis for decision making. Users of market analysis include developers, investment analysts, property managers and Valuers. Other users include architects and lenders. Market analyses are used to provide inputs for development feasibility studies. A feasibility study compares the cost and the value of a project under consideration, e.g. an office building. If the cost exceeds the value of the office, the proposal is not feasible. However, if the sales revenue is projected to exceed the cost, the proposal is feasible. As a result development proposals submitted to banks for financing have to be grounded in sound market analysis. This is because the bank needs assurance that a proposed development for which funding is sought is profitable so that the borrower can repay the loan with interest when the development succeeds. Investment proposals designed to evaluate potential acquisitions of real estate also require market analyses. This enables investors to make sound investment decisions. Valuations of commercial real estate also require market analysis as assumptions about future demand, rentals, growth projections and cap rates need to be supported by market analyses. A property management plan is an operating plan developed to maximize a property’s potential and support the owner’s objectives. Market analysis is used to support inferences about market rental rates for the subject based on demand gaps in the market area and the competitiveness of the property relative to competing properties. Market analyses are thus useful for the property manager in planning how to maximize an asset’s investment potential on behalf of the owner A failure to do market analyses could mean developing an asset for which there is no demand within the market area, leaving the asset unsold or vacant because no one would rent it. Even where there is demand, it may have the wrong attributes relative to the target market. For example, a developer may build retirement homes in an area dominated by families with 2017-07-14 11 Real Estate Market Analysis – A Primer children. Even though families need homes, the attributes of their preferred homes would differ from that of retired people. As a result, the finished retirement home project would be an utter failure. A failure to do market analysis could result in a high end shopping centre dominated by lowincome residents. A market analysis would have uncovered their income levels and spending patterns, enabling the development of a shopping centre that meets their needs. Summary Market analyses are used by all the principal decision makers and market players in the real estate industry. Developers need the outcomes of market analyses as inputs for their feasibility studies, while investors need it to guide acquisition decisions for example as the information provided by market analyses would provide an indication of whether a potential acquisition would make investment sense. They thus need the market analyses to support the assumptions they use in their investment decision models. Property managers would need it for their property management plans as rental forecasts would have to be based on knowing the demand gaps for the asset under management and the asset’s income prospects going forward. A failure to do market analysis could mislead a developer about the profit prospects of an investment, especially when they have been successful at that type of investment in the past. If they assume the past would repeat itself, they could go ahead when in fact, market conditions may have changed. Optional Progress Check Before moving onto the next topic, there is an Optional Progress Check activity that will assist you in assessing yourself on how well you understood the key learning points in the topic. These exercises are self-checks only; your answers will not count towards your overall course mark. Answer the following questions and submit the correct answer. 1. A developer acquires a piece of land for R30 000. Suppose construction costs total R100, 000. If the expected selling price for the proposed housing project is between R100, 000 to R110, 000, the developer’s total investment of R130, 000 indicates that this project is not feasible. How did the developer arrive at the conclusions on the expected selling price? The market analysis. Specifically, the micro analysis of the site and neighborhood provides price information 2. Which of the following is true about market analyses (choose the correct answer and explain why the other alternatives are wrong): A. Supply creates its own demand 2017-07-14 12 Real Estate Market Analysis – A Primer B. Market analyses are needed only if funding for the asset is already secured C. A retail project for a virgin market only needs a site and neighborhood analysis D. A market analysis is important regardless of what our track record is concerning how successful we were in executing similar projects in the past D is correct A goes against the laws of economics. Many developers have lost many by basing their decisions on this belief. B is wrong. Market analyses must be done before funding is released for a project. Otherwise a bank risks lending money for which demand has not been established. C is wrong. A project in a virgin market can still go wrong if the product mix is wrong or if the scale of the project exceeds the spending power of the trade area of the facility Discussion Activity Moneyweb published an article in 2009 on South Africa’s worst shopping centres. The article can be found by following this link: http://www.moneyweb.co.za/archive/south-africas-worstshopping-centres/ Another article reviews the recent opening of the Mall of Africa. You can access that article by following this link: http://www.bdlive.co.za/business/property/2016/04/26/mall-of-africas-opening-adds-to-sasoversupply-of-shopping-centre-space These two articles raise the following questions: • From article 1, which failures of market analysis can you identify? From article 2, does South Africa have an oversupply of retail? What evidence would you need to answer this question? Assignment A fund manager has been assigned the task of investing in retail properties. He chose to invest in one of the thriving mining areas in the Northwest Province of South Africa. At the time he was contemplating opening the mall, news started trickling in that China’s economy was slowing down and its ability to purchase commodities in the global market was threatened. In spite of 2017-07-14 13 Real Estate Market Analysis – A Primer that, the fund manager was convinced the investment would succeed. He based it on the population in the town, the attractive pay packages of the workers and the new housing developments underway in the town. Two years after the mall opened, the mines reduced their output in response to falling demand from major consumers, especially China. As a result, thousands of mineworkers were laid off. Some relocated and those who were left behind were compelled to rely on meagre unemployment benefits from the government. Following the departure of some workers and decline in earnings of those left behind, the mall started struggling. What mistakes did this fund manager make? How could this have been avoided? 2017-07-14 14
