Chapter 2 The Real Estate System The Real

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Chapter 2: The Real Estate System

Chapter 2: The Real Estate System

The Real Estate System 1. The development industry 2. Overview of the R. E.

The Real Estate System 1. The development industry 2. Overview of the R. E. “system” 3. The “ 4 -Quadrant” model (4 QM) 4. Using the 4 QM to understand “boom & bust” cycles in R. E.

2. 1 The Commercial Property Development Industry Financial Resources Development Industry Physical Resources New

2. 1 The Commercial Property Development Industry Financial Resources Development Industry Physical Resources New Built Space

The Development Industry Development is a creative, entrepreneurial process characterized by… Vision Greed Cooperation

The Development Industry Development is a creative, entrepreneurial process characterized by… Vision Greed Cooperation Risk (All the most entertaining features of American capitalism. )

Development (cont. )… Cooperation: · Between public & private sectors; · Between developers &

Development (cont. )… Cooperation: · Between public & private sectors; · Between developers & financiers. l Risk: · Even an economy in recession needs an existing stock of built space. · New space (need for development) results only from economic growth &/or change. l

Development (cont. )… R. E. Development is therefore dealing with the dynamic “cutting edge”

Development (cont. )… R. E. Development is therefore dealing with the dynamic “cutting edge” of the physical built environment. This makes development the most cyclical branch of the real estate industry…

Exhibit 2 - 1 US commercial property construction starts by property type as percent

Exhibit 2 - 1 US commercial property construction starts by property type as percent of existing stock…

2. 2 The Real Estate System

2. 2 The Real Estate System

 Exhibit 2 -2: The “Real Estate System”: Interaction of the Space Market, Asset

Exhibit 2 -2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development Industry SPACE MARKET SUPPLY (Landlords) ADDS NEW LOCAL & NATIONAL ECONOMY DEMAND (Tenants) RENTS & OCCUPANCY FORECAST FUTURE DEVELOPMENT INDUSTRY ASSET MARKET IF YES IS DEVELPT PROFITABLE ? CONSTR COST INCLU LAND SUPPLY (Owners Selling) CASH FLOW PROPERTY MARKET VALUE MKT REQ’D CAP RATE DEMAND (Investors Buying) = Causal flows. = Information gathering & use. CAPI TAL MKTS

“Negative feedback loops”… Mechanisms within a system that tend to dampen the changes in

“Negative feedback loops”… Mechanisms within a system that tend to dampen the changes in the system, helping to keep it in control, preventing it from spiraling out of control.

Example: A thermostat puts a negative feedback loop into a heating and cooling (HVAC)

Example: A thermostat puts a negative feedback loop into a heating and cooling (HVAC) system in a building. · When the temperature in the building gets too low, thermostat triggers the heater. · When the temperature in the building gets too high, thermostat triggers the air conditioning. The result is that the building temperature remains “under control”, within a comfortable temperature range.

Concept check: How do the development industry and the real estate asset market work

Concept check: How do the development industry and the real estate asset market work together to provide a (longrun) negative feedback loop in the Real Estate System? … How can “forward-looking” behavior (good forecasting of the space market) in the development industry and R. E. asset market (capital market) improve this negative feedback loop? …

2. 3 The “ 4 -Quadrant Model” (4 QM)…

2. 3 The “ 4 -Quadrant Model” (4 QM)…

Exhibit 2 -3: The Di. Pasquale -Wheaton 4 -Quadrant Diagram… Exhibit 2 -3: The

Exhibit 2 -3: The Di. Pasquale -Wheaton 4 -Quadrant Diagram… Exhibit 2 -3: The Di. Pasquale-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)

2. 4 Using the 4 QM to help understand “boom & bust” cycles…

2. 4 Using the 4 QM to help understand “boom & bust” cycles…

EXHIBIT 7 -10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST

EXHIBIT 7 -10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY. . .

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: Rent $ Space

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: Rent $ Space Market: Rent Determination Asset Market: Valuation D 0 D 1 R* Price $ P* Q* C* Asset Market: Construction Space Market: Stock Adjustment Construction (SF) Stock (SF)

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: First phase… Rent

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: First phase… Rent $ Can this be a long- Space Market: run equilibrium Rent Determination Asset Market: Valuation result? … D 0 R 1 Doesn’t form a rectangle. R* Price $ P 1 P* Q* C* Asset Market: Construction Space Market: Stock Adjustment Construction (SF) Stock (SF)

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent $ Space Market: Rent Determination Asset Market: Valuation D 0 R 1 R** D 1 R* P** Price $ P 1 P* Q* C* Asset Market: Construction C** Space Market: Stock Adjustment Construction (SF) Q** Stock (SF)

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent

Exhibit 2 -4 a: Effect of Demand Growth in Space Market: LR Equilibrium… Rent $ Space Market: Rent Determination Asset Market: Valuation D 0 R 1 R** D 1 R* P** Price $ P 1 P* Q* C* Asset Market: Construction C** Space Market: Stock Adjustment Construction (SF) Stock (SF)

Exhibit 2 -4 a: Effect of Demand Growth in Asset Market… Rent $ Space

Exhibit 2 -4 a: Effect of Demand Growth in Asset Market… Rent $ Space Market: Rent Determination Asset Market: Valuation D 0 11% OAR D 1 R* 8% OAR R** SR P 1 Price $ LR P** Q** P* Q* C* Asset Market: Construction C** Space Market: Stock Adjustment Construction (SF) Stock (SF)

EXHIBIT 7 -10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST

EXHIBIT 7 -10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY. . .

Concept check… 1. What does the 4 Q Model reveal about the interaction of

Concept check… 1. What does the 4 Q Model reveal about the interaction of the space market, the asset market, and the development industry in causing “boom & bust” cycles? 2. How can the an understanding of the 4 Q Model help participants in the asset market and development industry to avoid “boom & bust” cycles? [Hint: Can the 4 Q Model help with “forward-looking” decision-making? …]