REAL ESTATE ECONOMICS AND VALUE Chapter 5

CHAPTER TERMS AND CONCEPTS Agents of production Amenities Demand Demography Economic forces Fiscal policy Gross domestic product (GDP) Monetary policy Monetary theory Over-improvement Physical forces Political forces Principle of anticipation Principle of change Principle of competition Principle of conformity Principle of increasing and decreasing returns 2

CHAPTER TERMS AND CONCEPTS Principle of progression and principle of regression Principle of substitution Principle of supply and demand Principles of highest and best use and consistent use Principles of surplus productivity, balance, and contribution Purchasing power Real estate cycle Scarcity Secondary market Social forces Supply Surplus of productivity Transferability Utility 3

LEARNING OUTCOMES 1.List the four basic elements of value. 2.List and give examples of the broad forces that affect value. 3.Define real estate cycles. 4.Name the major supply and demand factors that cause economic changes affecting real estate. 5.Describe the federal government’s role in the economy. 6.Explain how the principles of value relate to the marketing and productivity of real estate. 4

THE REAL ESTATE VALUE INFLUENCES Real Estate has no Intrinsic Value Value is Derived from Rights and Benefits that Come from : o Ownership o Possession and o Use 5

FOUR ESSENTIALS OF VALUE Utility  Usefulness; the ability to create a desire for possession Scarcity  In relatively short supply; a lack of abundance Demand  The desire to possess plus the ability to buy; effective purchasing power Transferability  The ability to change the owner or use; marketable title 6 = Market Value

BROAD FORCES INFLUENCING VALUE Physical Forces Social Forces Economic Forces Political Forces 7

PHYSICAL FORCES Natural Resources Developed Resources 8

SOCIAL FORCES 1.Demographics 2.Neighborhood Stability 3.Population 4.Life Styles 5.Attitudes; Behavior 6.Attitudes; Development 7.Attitudes; Public Education 9

ECONOMIC FORCES 1.Income Levels 2.Employment 3.Wages and Jobs 4.Money and Credit 5.Price Levels 6.Personal Savings 7.General Business Activity 8.Supply and Demand for Housing 9.Production of Goods and Services 10

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 11

HOW ECONOMIC TRENDS AFFECT REAL ESTATE  Economic Trends and the Business Cycle  Real Estate Supply Factors  Real Estate Demand Factors  Federal Government Activity 12

ECONOMIC TRENDS AND THE BUSINESS CYCLE  An Economic Trend is a Pattern of Changes  Cycles  Business cycles  Real Estate Cycles  The Cycle of Construction  New Home Sales  Volume of Sales 13 Used by Permission of Alma Dizon:

REAL ESTATE SUPPLY FACTORS Housing Supply New Construction Supply of Vacant Land 14

REAL ESTATE DEMAND FACTORS  Population  Purchasing Power 15

FEDERAL GOVERNMENT ACTIVITY Housing and Urban Development Programs o FNMA  Federal National Mortgage Association  Secondary Market o FHA  Federal Housing Administration 16 Figure 5.5: Government Housing Project under Construction

FEDERAL GOVERNMENT PROGRAMS Energy and the Environment o EPA  Environmental Protection Agency o FEMA  Flood Maps Governmental Banking and Monetary Policy o Federal Reserve  Monetary Policy Actions 17

THE ECONOMIC PRINCIPLES OF VALUATION  Principle of Substitution  Principle of Conformity  Principle of Progression  Principle of regression  Principle of Change  Principle of Supply and Demand  Principle of Competition 18

PRINCIPLE OF SUBSTITUTION When a Property Easily can be Replaced by Another, the Value of Such a Property Tends to be Set by the Cost of Acquiring an Equally Desirable Substitute The Principle of Substitution is a Basic Concept Behind Each of the Three Approaches to Value 19

PRINCIPLE OF CONFORMITY Maximum Value  Properties are similar o Size o Style o Quality o Amenities/Utility Over-improvement  5 bedroom in a 3 bedroom neighborhood 20

PRINCIPLES OF REGRESSION & PROGRESSION Progression o Lower value properties benefit from being close to high value properties Regression o Higher value properties tend to decrease in value when close to lower value properties. Is This an Illustration of Progression or Regression? 21

PRINCIPLE OF CHANGE Change is Eternal o Physical o Social o Economic o Political conditions Neighborhood Change o Development (growth) o Stability o Decline o Renaissance (rebirth) 22

PRINCIPLE OF SUPPLY AND DEMAND 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 Reasonable Profit 23 PricePrice Quantity Deman d Supply

Principle of Competition  Market Demand Generates Profits  Profits Generate Competition  Excess Profits Usually Generate Ruinous Competition 24

PRINCIPLES OF REAL ESTATE PRODUCTIVITY 1.Agents of Production 2.Principles of: a)Surplus Productivity b)Balance c)Contribution 3.Principle of Increasing and Decreasing Returns 4.Principle of Highest and Best Use 5.Principle of Consistent Use 6.Principle of Anticipation 25

AGENTS OF PRODUCTION o Labor o Coordination o Capitol o Land 26

PRINCIPLE OF SURPLUS PRODUCTIVITY 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 becomes Basis of Land Value 27

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 28

PRINCIPLE OF CONTRIBUTION 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. Principle of Surplus Productivity is the basis for the Principle of increasing and decreasing returns and the principle of highest and best use. 29

INCREASING & DECREASING RETURNS Fertilizer Principle! o Added increments of fertilizer and labor do not result in equal increases in crop yield o This principle helps property owners make decisions about adding improvements or remodeling  What to add and to what degree 30

PRINCIPLE OF HIGHEST AND BEST USE 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:  Vacant  Improved 31

PRINCIPLE OF CONSISTENT USE Corollary to the Principle of Highest and Best Use  Must appraise land and improvements on the basis of the same use.  This photo shows that the improvements (house) are a detriment to development of town homes. 32

PRINCIPLE OF ANTICIPATION Value is the Present Worth of Future Benefits The Principle of Anticipation Underlies the Income Approach to Value. 33

SUMMARY 34 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. 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.