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Chapter 2: The Real Estate System © 2014 OnCourse Learning. All Rights Reserved.1.

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Presentation on theme: "Chapter 2: The Real Estate System © 2014 OnCourse Learning. All Rights Reserved.1."— Presentation transcript:

1 Chapter 2: The Real Estate System © 2014 OnCourse Learning. All Rights Reserved.1

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 “boom & bust” cycles in R.E. 2© 2014 OnCourse Learning. All Rights Reserved.

3 2.1 The Commercial Property Development Industry Financial Resources Physical Resources New Built Space Development Industry 3© 2014 OnCourse Learning. All Rights Reserved.

4 The Development Industry Development is a creative, entrepreneurial process characterized by… Vision Greed Cooperation Risk 4© 2014 OnCourse Learning. All Rights Reserved. (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. 5© 2014 OnCourse Learning. All Rights Reserved.

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… 6© 2014 OnCourse Learning. All Rights Reserved.

7 Gray shade indicates GDP recession 7© 2014 OnCourse Learning. All Rights Reserved.

8 8

9 9

10 2.2 The Real Estate System 10© 2014 OnCourse Learning. All Rights Reserved.

11 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. 11© 2014 OnCourse Learning. All Rights Reserved.

12 “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. 12© 2014 OnCourse Learning. All Rights Reserved.

13 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. 13© 2014 OnCourse Learning. All Rights Reserved.

14 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?… 14© 2014 OnCourse Learning. All Rights Reserved.

15 2.3 The “4-Quadrant Model” (4QM)… 15© 2014 OnCourse Learning. All Rights Reserved.

16 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 16 © 2014 OnCourse Learning. All Rights Reserved.

17 2.4 Using the 4QM to help understand “boom & bust” cycles… 17© 2014 OnCourse Learning. All Rights Reserved.

18 EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY... 18© 2014 OnCourse Learning. All Rights Reserved.

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 Exhibit 2-4a: Effect of Demand Growth in Space Market: 19 © 2014 OnCourse Learning. All Rights Reserved.

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 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. 20 © 2014 OnCourse Learning. All Rights Reserved.

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* D0D0 D1D1 R1R1 P1P1 Exhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium… R** P** C** Q** 21 © 2014 OnCourse Learning. All Rights Reserved.

22 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… 22 © 2014 OnCourse Learning. All Rights Reserved.

23 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… 23 © 2014 OnCourse Learning. All Rights Reserved.

24 EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY... 24© 2014 OnCourse Learning. All Rights Reserved.

25 Exhibit 2-5: Real CRE Prices & Rents: : Rent Cycle & Asset Price Cycle Not Necessarily the Same… 1986=100 shaded bars = GDP recessions… 25© 2014 OnCourse Learning. All Rights Reserved.

26 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… 26© 2014 OnCourse Learning. All Rights Reserved.


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