MIT Center for Real Estate

enter for Real EMIT C state 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] enter for Real E Construction as a part of GDP MIT C state (1990) $, in billions % of GDP Private Construction 338 6.1 Public Construction Buildings 301 5.5 Buildings Residential Buildings 183 3.3 Housing and Development Nonresidential Buildings 118 2.1 Industrial Industrial 24 0.4 Other Office 29 0.5 Hotels/Motels 10 0.2 Nonbuilding Construction Other Commercial 34 0.6 Infrastructure All Other Nonresidential 21 0.4 All Other Nonbuilding Construction 37 0.7 Total New Construction Public Utilities 31 0.6 All Other 6 0.1 Total GDP $, in billions % of GDP 109 2.0 46 0.8 4 0.1 1 0.0 41 0.7 63 1.1 55 1.0 8 0.1 446 8.1 5,514 100.0 Adapted from DiPasquale and Wheaton (1996) enter for Real EMIT C state 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 Total U.S. Real Estate 8,777 100.0 Adapted from DiPasquale and Wheaton (1996) enter for Real E U.S. Real Estate MIT C state 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 Total: 8,777 100.0 6,122 100.0 2,655 100.0 % of All Real Estate 100.0 69.8 30.2 Adapted from DiPasquale and Wheaton (1996) Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram… Rent $ Stock (SF)Price $ Space Market:Construction Space Market: Valuation Q* R* P* C* D D Construction (SF) Stock Adjustment Asset Market: Rent Determination Asset Market: enter for Real EMIT C state 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. enter for Real EMIT C state 1st quadrant β 1). Office Demand = α1ER-β1 E= office employment R = rent per square foot 1 = rental elasticity of demand: [%change in sqft per worker/% change in rent] 2). Demand = Stock = S 3). Hence: R = (S/α1E)–1/ β1 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 rent] MIT Center for Real Estate 4th Quadrant 6). Replacement version: E= fixed C= δS [Construction equals depreciation (δ is depreciation rate)] 7). Steady Demand growth version: ∆E/E = δ Hence: C= δS [what if S grows less or more than E?] Exhibit 2-4a: Effect of Demand Growth in Space Market: Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0 D1 Exhibit 2-4a: Effect of Demand Growth in Space Market: First phase… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0 D1 R1 P1 Can this be a long- run equilibrium result?… Doesn’t form a rectangle. Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0 D1 R1 P1 R** P** C** Q** Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0 D1 R** P** C** R1 P1 Exhibit 2-4a: Effect of Demand Growth in Asset Market… Rent $ Stock (SF)Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* 11% OAR 8% OAR D0 D1 P1 P** R** Q* * C** SR LR 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. SFU housing)? • EXERCISE #1. enter for Real EMIT C state National Office Forecast Completions Rate vs. Real Rent -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 20.00 22.00 24.00 26.00 28.00 30.00 32.00 34.00 $ Per Sqft Forecast 1 9 7 1 1 9 7 3 1 9 7 5 1 9 7 7 1 9 7 9 1 9 8 1 1 9 8 3 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 0 0 1 2 0 0 3 2 0 0 5 2 0 0 7 Total Employment Growth (L) Real Rent (R) Completion Rate (L) enter for Real EMIT C state National Industrial Forecast $ Per Sqft 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% Completions Rate vs. Real Rent Forecast 7.00 6.50 6.00 5.50 5.00 4.50 4.00 3.50 3.00 1 9 7 1 1 9 7 3 1 9 7 5 1 9 7 7 1 9 7 9 1 9 8 1 1 9 8 3 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 0 0 1 2 0 0 3 2 0 0 5 2 0 0 7 Total Employment Growth (L) Real Rent (R) Completion Rate (L) enter for Real E National Multi-Housing Forecast MIT C state $ Per Sqft Permits vs. Real Rent -2.00% -1.00% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 500.00 550.00 600.00 650.00 700.00 750.00 Forecast 1 9 7 1 1 9 7 3 1 9 7 5 1 9 7 7 1 9 7 9 1 9 8 1 1 9 8 3 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 0 0 1 2 0 0 3 2 0 0 5 2 0 0 7 Total Employment Growth (L) Real Rent (R) Completion Rate (L) enter for Real EMIT C state 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% -3.00% Completion Rate vs. Real Rent Forecast National Retail Forecast $ Per Sqft 24.00 23.00 22.00 21.00 20.00 19.00 18.00 17.00 16.00 15.00 1 9 7 1 1 9 7 3 1 9 7 5 1 9 7 7 1 9 7 9 1 9 8 1 1 9 8 3 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 0 0 1 2 0 0 3 2 0 0 5 2 0 0 7 Total Employment Growth (L) Real Rent (R) Completion Rate (L) enter for Real EMIT C state National Hotel Forecast Supply Growth Rate vs. Real ADR -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 80.00 85.00 90.00 95.00 100.00 105.00 110.00 Forecast 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 Total Employment Growth (L) Real ADR (R) Supply Growth Rate (L) enter for Real EMIT C state U.S. Single-Family Market Completions Rate vs. Home Price Appreciation 1990-91 1980-81 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% 2001-02 1 9 7 6 1 9 7 7 1 9 7 8 1 9 7 9 1 9 8 0 1 9 8 1 1 9 8 2 1 9 8 3 1 9 8 4 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 Completions Rate Employment Growth Home Price Index (2002 $) enter for Real EMIT C state The Historic Supply of US Office Space Broken Ground 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% ProjectsConstruction as % of Stock 1901 1910 1919 1928 1937 1946 1955 1964 1973 1982 1991 2000 Downtown Suburban Real Esta t e enter for Index of Historic Housing Prices in MIT C Amsterdam (Real Guilders) g y ( g ) 0 50 10 0 15 0 20 0 25 0 30 0 35 0 40 0 P r i c e I n d e x 1 6 4 8 1 6 5 8 1 6 6 8 1 6 7 8 1 6 8 8 1 6 9 8 1 7 0 8 1 7 1 8 1 7 2 8 1 7 3 8 1 7 4 8 1 7 5 8 1 7 6 8 1 7 7 8 1 7 8 8 1 7 9 8 1 8 0 8 1 8 1 8 1 8 2 8 1 8 3 8 1 8 4 8 1 8 5 8 1 8 6 8 1 8 7 8 1 8 8 8 1 8 9 8 1 9 0 8 1 9 1 8 1 9 2 8 1 9 3 8 1 9 4 8 1 9 5 8 Y ear 1 6 2 8 1 6 3 8 1 9 6 8 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. enter for Real E House prices reflect both unit characteristics and MIT C state location attributes enter for Real EMIT C state Repeat-Sale House price indices (CSW) for 15 submarkets within the greater Boston CMSA: 1982-2002 House Price Indexes, Eastern Massachusetts, by City/Town Location 0 50 P r i c e I n d e x ( 1 9 9 0 = 1 0 0 ) Lowell Area i 100 150 200 250 300 Boston Southeast W estern 1 Far North Shore 495 North 95 South 95 North W estern 2 495 West North Shore South Shore Worcester Area Cambr dge Area North Central 1 9 8 2 1 9 8 3 1 9 8 4 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 Year enter for Real EMIT C state Home Prices within South California $400 $350 $300 $250 $200 $150 $100 Median Home Price, Thousands ($ 2002.4) 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 Riverside Ventura San Diego Sources: OFHEO, Torto Wheaton Research MIT Center for Real Estate Forecast 15 20 25 30 35 40 1 9 8 0 1 9 8 1 1 9 8 2 1 9 8 3 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 5 Los Angeles Orange County Ventura County Riverside San Diego Office Rents Move together Cyclically but not always secularly TW Rent Index, 2003$ per sqft MIT Center for Real Estate Closely Correlated Industrial Rent Movements: few secular differences TW Rent Index, 2003$ per sqft 10.00 9.00 8.00 7.00 6.00 5.00 4.00 Forecast 1 9 8 0 1 9 8 1 1 9 8 3 1 9 8 4 1 9 8 6 1 9 8 7 1 9 8 9 1 9 9 0 1 9 9 2 1 9 9 3 1 9 9 5 1 9 9 6 1 9 9 8 1 9 9 9 2 0 0 1 2 0 0 2 2 0 0 4 2 0 0 5 Los Angeles Orange County Ventura County Riverside San Diego enter for Real EMIT C state 20 25 30 35 40 45 50 55 60 65 Manhattan Office Rents vs. NJ and Conn. Suburbs TW Index, $2002 per sqft 1 9 8 0 1 9 8 1 1 9 8 2 1 9 8 3 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 2 0 0 0 2 0 0 1 Suburban Markets Manhattan enter for Real E 10 15 20 25 30 35 40 45 50 1 9 8 0 1 9 8 1 1 9 8 2 1 9 8 3 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 2 0 0 0 2 0 0 1 Office Suburban Rents in Detail MIT C state Northern New Jersey Long Island Stamford Westchester TW Index, $2002 per sqft enter for Real EMIT C state 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) ? enter for Real EMIT C state 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? enter for Real EMIT C state Metropolitan Housing Markets often move independently $) 50 70 90 110 130 150 170 190 210 230 250 H o u s e P r i c e F IGURE 5. Repeat Sale House Price Indices for Selected "new" Cities: 1975-1999 (constant Year 7 5 1 7 6 1 7 7 1 7 8 1 9 7 9 1 9 8 0 1 9 1 1 9 2 8 3 1 8 4 1 8 5 1 8 6 1 9 8 7 1 9 8 8 1 9 8 9 1 9 0 1 9 1 9 2 1 9 3 1 9 4 1 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 8 8 9 99 9 1 9 9 9 9 1 9 9 9 9 l l ixAt anta Dennver Houston Los Ange es Phoen 1 9 9 9 9 9 enter for Real EMIT C state Metropolitan Housing Markets have some similar movements 50 70 90 H o u s e P r i c e ( 110 130 150 170 190 210 230 250 Year FIGURE 4. Repeat Sale House Price Indices for Selected "Traditional" Cities: 1975-1999 constant $) 7 6 1 7 7 1 7 8 1 9 7 9 9 8 0 9 8 1 1 9 8 2 1 9 8 3 9 8 4 1 9 8 5 1 8 6 1 8 7 1 8 8 1 9 8 9 9 9 0 9 9 1 1 9 9 2 9 9 3 9 9 4 1 9 9 5 1 9 9 6 1 9 7 1 9 8 19 9 9 9 9 9 9 91 1 1 1 1 1 1 Chi iBoston cago New York Sanfrancisco W ash ngton D.C. 1 9 7 5 1 9 9 9