FIN 331 Chapter 1

Chapter 1
The Nature of Real Estate and Real
Estate Markets
Real Estate
FIN 331
“Real estate is the single largest
component of wealth in the global
economy. The importance of real
estate is highlighted in terms of its
roles in the global and domestic
economies, as well as its prominence
in the investment portfolios of U.S.
households.” [Ling & Archer, Real Estate 4 ed]
Chapter 1 General Concepts
A. Types of Property
1. Tangible: Physical assets that can be owned. It can be real
or personal property.
2. Intangible: Non-physical assets such as stocks, bonds,
mortgages, leases
B. Real Estate as a;
1. Tangible asset: raw land, Improvements to raw land,
2. Bundle of Rights: exclusive possession, use, disposition, can
be unbundled
3. As a profession
Chapter 1 General Concepts
C. Real Estate and the Economy
Half of the world’s wealth
Generates over 28% of U.S. gross domestic product (GDP)
Housing alone accounts for almost 20%
Generates nearly 70% of local government revenue (property tax)
Creates jobs for nearly 9 million Americans
D. Real Estate Values Determined by
1. User (Space) markets: physical real estate and supply vs. demand
2. Capital markets: RE competes for funds along with financial claims
(stocks & Bonds)
3. Impact of governmental sector on rates: raising funds by selling debt
Chapter 1 General Concepts
E. Real Estate Markets and Participants
1. User Market: Buyers receive rights (or bundles of rights), generally
2. Capital suppliers: households >>> financial institutions (banks,
financial service companies)
F. Characteristics of Real Estate Markets
1. Heterogeneous Products (no 2 alike in every aspect)
2. Markets localized and segmented
3. Private Markets
a. Equity/Owners: from individuals to partnerships to LLC to specialized funds
b. Debt/Lenders: Banks, thrifts, finance companies, private lenders
4. Public Markets
a. Publicly traded REITs and real estate companies
b. Commercial Mortgage-Backed Securities (CMBS) and mortgage REITs
Wall Street: Money Never Sleeps
Gecko’s talk on Financial Crisis
A.The Community Reinvestment Act (1977) [CRA]
1. Principle Objective: Increase home ownership in the US
2. Related Objectives: end practice of “redlining” by
commercial banks
3. Requirements of the Act:
The Act requires banks and thrifts to make loans
throughout their entire market, operate depository
facilities in certain neighborhoods, and collect data
about lending habits to be periodically reported to
federal supervisory agencies. These agencies use CRA
ratings when evaluating applications for mergers and
CRA Act modified in 1995
1. Letter from General Council to Comptroller of the Currency
a. In Re Small Business Loans
Furthermore, the CRA regulations do not require an institution
to verify revenue amounts; thus, the institution may rely on the
gross annual revenue amount provided by the borrower in the
ordinary course of business.
b. In Re Consumer Loans
The CRA regulations do not require an institution to verify
income amounts; thus, the institution may rely on the income
amounts provided by the borrower on the loan application.
2. The beginning of NINJA loans (No Income, No Job, No Assets)
C. Michelle Minton (Competitive Enterprise Institute) on
Negative Results of CRA
1. Increased risk to banks: as CRA rankings increased, bank risk
increased as measured by CAMEL ratings (Capital adequacy,
Asset quality, Management, Earnings, Liquidity).
2. Increased costs to small lenders: includes the cumulative costs of
writing riskier loans (e.g.; to buyers with low FICO scores).
3. Cites study by George Benston (Emory U) suggesting that larger
banks made loans in low and middle income markets (LMI) at a
4. Rent Seeking opportunity for activist organizations: e.g., ACORN
received hundreds of thousands of dollars from JP Morgan and
Chase Manhattan Bank in exchange for ACORN’s approval of
proposed mergers.
A. Important Key terms: Real Estate, Capital
Markets, User Markets, Property Markets,
Capitalization Rates, Tangible & Intangible
Assets, Real Property
B. Study Questions: 1, 3, 4, 5, 7
Real estate as an industry and profession
Property management
Asset management
Real Estate Law
Market consulting
 Planning
 Government regulation
and taxation
 Housing assistance
 Mortgage finance
 Construction finance
 Long-term finance
 Investment management
Land Use in the United States: 2007
Aggregate Market Values of Selected
Asset Categories: 2011
U.S. Household Wealth: 2011
User Market
A. Market for the physical real estate
B. “Buyers” receive right to use space
1. Called the “space” market or “rental market”
C. Where rental rates are determined
D. These markets are very “local” and usually
highly competitive
E. Separate local markets for various property
types: retail, office, industrial, etc.
Capital Markets
A. RE competes for funds in capital market with
other asset classes, such as stocks and bonds
B. Investors select a mix of investments based
on expected returns & risk
C. Bidding by investors determines:
1. risk free rates of various maturities (i.e., the
Treasury “yield” curve)
2. required risk premiums for risky investments
Public Capital Markets
A. Small homogeneous units (shares) of
ownership in assets trade in public exchanges
B. Many buyers and sellers
C. Price quotes available for all to see
D. Characterized by a high degree of liquidity
E. Informationally efficient
Private Capital/Property Markets
A. Absence of centralized market (or even price
B. Assets trade infrequently in private
transactions (thus a lack of transparency)
C. Common for “whole” assets to be traded in a
single transaction (indivisibility)
D. Less liquidity than public markets
E. Higher transaction costs
Property (Asset) Market
A. Market for ownership claims to RE assets
B. Buyers/owners receive rights to cash flows
generated by leasing space to tenants
C. Demand (supply) side of property market is
made up of investors wanting to buy (sell)
D. Property market is integrated, not
segmented like space market
1. i.e., investment capital can come from anywhere