Chapter 5
Real Estate Economics & Value
Basic Real Estate Appraisal: Principles & Procedures – 9th Edition
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STUDENT LEARNING OUTCOMES
• List the Four Basic Elements of Value
• List and give examples of the broad
forces that affect value
• Define Real Estate Cycles
• Name major supply & demand factors
• Describe Federal government’s role in
the economy
• Explain how Principles of Value relate to
the Marketing and Productivity of Real
Estate
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5.1 REAL ESTATE VALUE INFLUENCES
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• Real Estate has No Intrinsic Value
• Value is Derived from Rights and
Benefits that come from:
• Ownership
• Possession
• Use
i.e. Property Rights
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FOUR ESSENTIALS ELEMENTS OF VALUE
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Utility
• Usefulness; ability to create desire for possession
Scarcity
• In relatively short supply; a lack of abundance
Demand
• The desire to possess plus the ability to buy; plus
the effective purchasing power to implement it
Transferability
• Ability to change the owner or use; marketable title
In Combination They Create Market Value
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BROAD FORCES INFLUENCING VALUE
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Physical Forces
Social Forces
Economic Forces
Political Forces
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PHYSICAL FORCES
• Natural Resources
• Developed Resources
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SOCIAL FORCES
1. Demographics
2. Neighborhood Stability
3. Population
4. Life Styles and Living Standards
5. Attitudes; Behavior, Law, Government
6. Attitudes; Development, Growth, Ecology
7. Attitudes; Public Education
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ECONOMIC FORCES
1.
2.
3.
4.
5.
6.
7.
8.
9.
Income Levels
Employment
Wages and Jobs
Money and Credit
Price Levels
Personal Savings
General Business Activity
Supply and Demand for Housing
Production of Goods and Services
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POLITICAL FORCES
1. Zoning and Land Use
2. Building and Safety
3. Environmental Laws
4. Endangered Species Act
5. Police, Fire, and Health
6. Crime Prevention
7. Public Works
8. Fiscal Policy
9. Monetary Policy
10.Government Sponsored Programs
11.Government Regulations
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5.2 HOW ECONOMIC TRENDS
AFFECT REAL ESTATE
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• Economic Trends & the Business Cycle
• Real Estate Supply Factors
• Real Estate Demand Factors
• Federal Government Activity
Detailed on the following slides
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ECONOMIC TRENDS / BUSINESS CYCLE
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• An Economic Trend is a Pattern of Changes
• Cycles – a Change Repeats Itself
• Business Cycles
• Real Estate Cycles
• Number of New Subdivision Lots
• Amount of New Construction
• Volume of Sales
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REAL ESTATE SUPPLY FACTORS
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• Housing Supply
(Existing)
• New Construction
(Near-term Additions)
• Supply of Vacant Land
(Future Supply)
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REAL ESTATE DEMAND FACTORS
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• Population
• Households
• Purchasing Power
• Affected by Employment, Wage/ Income Levels
• Disposal Income (After Taxes)
• Depends on Availability of Financing / Credit
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FEDERAL GOVERNMENT ACTIVITY
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Department of Housing and Urban
Development (HUD) Programs
• FNMA
• FHA (Federal Housing Administration)
• Federal Home Loan Mortgage Corporation
(Freddie Mac)
Mortgage-Backed Securities are
sold on the Secondary Market
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FEDERAL GOVERNMENT ACTIVITY
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Energy and the Environment
• Environmental Protection Agency (EPA)
• Energy-Efficient Appliances
• Energy-Efficient Homes
• Green Building
• Sustainable Design
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FEDERAL GOVERNMENT PROGRAMS
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Government Banking & Monetary Policy
• Federal Reserve
• Monetary Policy (Interest Rates, etc.)
• FDIC (Insures consumer deposits at banks)
Fiscal Policy
• Taxation (Tax Reform, etc.)
• Spending
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5.3 ECONOMIC PRINCIPLES OF VALUE
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• They Define & Predict Market Patterns
• The Principles Apply Collectively
• Rarely Independent of Each Other
• There are two groups of Principles:
• Principles of Marketability
• Principles of Productivity
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PRINCIPLES OF REAL ESTATE
MARKETABILITY
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• Principle of Substitution
• Principle of Conformity
• Principles of Progression & Regression
• Principle of Change
• Principle of Supply and Demand
• Principle of Competition
Detailed on the following slides
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PRINCIPLE OF SUBSTITUTION
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• When a Property can Easily be
replaced by Another, the Value of
Such a Property Tends to be Set by
the Cost of Acquiring an Equally
Desirable Substitute
• A Basic Concept Behind Each of the
Three Approaches to Value
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PRINCIPLE OF CONFORMITY
Maximum Value is Achieved when
Properties are Similar as to…
• Size
• Style
• Quality
• Amenities / Utility
Example: A 5-bedroom home in a 3-bedroom
neighborhood does not conform; it would be an
over-improvement and it’s value suffers
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PRINCIPLES OF
PROGRESSON AND REGRESSION
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Progression
• Lower-value properties benefit (increase in
value) from proximity to higher-value
properties
Regression
• Higher-value properties suffer (decrease in
value) from proximity to lower-value
properties
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PROGRESSION OR REGRESSION?
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If the home on the left is typical –
which principle applies to the home on
the right?
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PRINCIPLE OF CHANGE
Change is Eternal, as to these Conditions:
• Physical
• Social
• Economic
• Political
Four Stages (i.e. Neighborhood Cycle)
apply:
• Development, Stability, Decline & Renaissance
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PRINCIPLE OF SUPPLY AND DEMAND
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• Price Goes Up with an Increase in Demand
or Decrease in Supply
• Price Goes Down with a Decrease in
Demand or Increase in Supply
• Theoretically, when Supply and Demand
are in Balance, Market Prices Reflect the
Cost of Production with a Reasonable
Profit
Supply
P
R
I
C
E
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Demand
QUANTITY
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PRINCIPLE OF COMPETITION
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• Market Demand Generates Profits
• Profits Generate Competition
• Excess Profits Usually Generate
Ruinous Competition
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PRINCIPLES OF REAL ESTATE
PRODUCTIVITY
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• Agents of Production
• Principles of Surplus Productivity, Balance
& Contribution
• Principle of Increasing & Decreasing
Returns
• Principle of Highest & Best Use
• Principle of Consistent Use
• Principle of Anticipation
Detailed on the following slides
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AGENTS OF PRODUCTION
• Labor
• Coordination
• Management, Effort
• Capital
• Construction Costs, Returns
• Land
• Residual – Last $’s to the Land
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PRINCIPLE OF SURPLUS PRODUCTIVITY
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• The Net Income or Other Benefits
that Remain after the Cost of Labor,
Coordination, and Capital have been
satisfied have been described as the
“Residual” Returns to Land
• Surplus of Productivity
• Dollar Amount of Surplus Income
becomes Basis for Land Value
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PRINCIPLE OF BALANCE
• Proper Balance in the Agents of
Production is Required if the
Maximum Value is to Result from the
Costs Invested
• Consistent with Principle of Conformity
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PRINCIPLE OF CONTRIBUTION
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• The Benefit of An Agent of Production
Depends Not on Cost But How Much
it Contributes to Value
• A pool may cost $25,000, but only
contribute $10,000 of value.
The Principle of Surplus Productivity is the Basis for
the Principle of Increasing and Decreasing Returns
and the Principle of Highest and Best Use
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PRINCIPLE OF INCREASING &
DECREASING RETURNS
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Fertilizer Principle
• Added increments of fertilizer and
labor do not result in equal increases
in crop yield
• This principle helps property owners
make decisions about adding
improvements or remodeling
• What to add, and to what degree
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PRINCIPLE OF HIGHEST & BEST USE
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• Highest and Best Use Means the Most
Profitable Use
• Theoretical Balance Between Land
and Improvements
• Helps in estimating land value
• Highest and Best Use:
• As If Vacant
• As Improved
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PRINCIPLE OF CONSISTENT USE
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Corollary to the Principle of Highest
and Best Use…
• Land and Improvements must be
appraised on the basis of the same use
• If highest and best use for a site is for
apartment development, the house value
cannot be added to the apartment site
value
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PRINCIPLE OF ANTICIPATION
• Value is essentially an expression of
the Present Worth of Future Benefits
• This Principle underlies the Income
Approach to Value
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CHAPTER SUMMARY
Real estate is a basic and fundamental
form of wealth, it has no intrinsic value.
Its market value is a measure of the
rights that the owners control, valued at
prices set in the market. But in order to
enter the market, the rights must have
the four elements of utility, scarcity,
demand, and transferability.
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CHAPTER SUMMARY (Con’t.)
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We know that real estate is affected by
changing business conditions, such as
employment, income and price levels,
production volumes, and building
construction costs. Thus, it is possible to
analyze and better understand real
estate by observing key supply and
demand factors in the general economy.
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IMPORTANT TERMS & CONCEPTS
Agents of Production
Physical Forces
Amenities
Political Forces
Business Cycles
Principle of Anticipation
Demand
Principle of Change
Demography
Principle of Competition
Economic Forces
Principle of Conformity
Fiscal Policy
Principle of Increasing & Decreasing Returns
Gross Domestic Product (GNP)
Principles of Progression & Regression
Monetary Policy
Principle of Substitution
Monetary Theory
Principle of Supply and Demand
Over-Improvement
Principles of Highest & Best Use and
Consistent Use
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IMPORTANT TERMS & CONCEPTS
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Principles of Surplus Productivity, Balance, and Contribution
Purchasing Power
Real Estate Cycle
Scarcity
Secondary Markets
Social Forces
Supply
Surplus of Productivity
Transferability
Utility
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