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

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Presentation on theme: "Chapter 2: The Real Estate System. 1. The development industry 2. Overview of the R.E. “system” 3. The “4-Quadrant” model (4QM) 4. Using the 4QM to understand."— Presentation transcript:

1 Chapter 2: The Real Estate System

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

3 2.1 The Commercial Property Development Industry Financial Resources Physical Resources New Built Space Development Industry

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

5 Development (cont.)… Cooperation:  Between public & private sectors;  Between developers & financiers. 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.

6 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…

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

8 2.2 The Real Estate System

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

10 “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.

11 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, the thermostat triggers the heater.  When the temperature in the building gets too high, the thermostat triggers the air conditioning. The result is that the building temperature remains “under control”, within a comfortable temperature range.

12 Concept check: How do the development industry and the real estate asset market work together to provide a (long- run) 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?…

13 2.3 The “4-Quadrant Model” (4QM)…

14 Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram… Rent $ Stock (SF) Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D D

15 2.4 Using the 4QM to help understand “boom & bust” cycles…

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

17 Rent $ Stock (SF) Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0D0 D1D1 Exhibit 2-4a: Effect of Demand Growth in Space Market:

18 Rent $ Stock (SF) Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0D0 D1D1 R1R1 P1P1 Exhibit 2-4a: Effect of Demand Growth in Space Market: First phase… Can this be a long- run equilibrium result?… Doesn’t form a rectangle.

19 Rent $ Stock (SF) Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0D0 D1D1 R1R1 P1P1 Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium… R** P** C** Q**

20 Rent $ Stock (SF) Price $ Construction (SF) Space Market: Stock Adjustment Asset Market: Construction Space Market: Rent Determination Asset Market: Valuation Q* R* P* C* D0D0 D1D1 R** P** C** R1R1 P1P1 Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium…

21 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 D0D0 D1D1 P1P1 P** R** Q* * C** SR LR Exhibit 2-4a: Effect of Demand Growth in Asset Market…

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

23 1. What does the 4Q 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 4Q Model help participants in the asset market and development industry to avoid “boom & bust” cycles? [Hint: Can the 4Q Model help with “forward-looking” decision-making?…] Concept check…


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