Real Estate Economics & Value Basic Real Estate Appraisal: Principles & Procedures – 9 th Edition © 2015 OnCourse Learning Chapter 5

STUDENT LEARNING OUTCOMES List the Four Basic Elements of Value List and give examples of the broad forces that affect value Define Real Estate Cycles Name major supply & demand factors Describe Federal government’s role in the economy Explain how Principles of Value relate to the Marketing and Productivity of Real Estate 2 Page 118 © 2015 OnCourse Learning

5.1 REAL ESTATE VALUE INFLUENCES Real Estate has No Intrinsic Value Value is Derived from Rights and Benefits that come from: Ownership Possession Use i.e. Property Rights 3 Page 119 © 2015 OnCourse Learning

FOUR ESSENTIALS ELEMENTS OF VALUE Utility Usefulness; ability to create desire for possession Scarcity In relatively short supply; a lack of abundance Demand The desire to possess plus the ability to buy; plus the effective purchasing power to implement it Transferability Ability to change the owner or use; marketable title In Combination They Create Market Value 4 Page 119 © 2015 OnCourse Learning

BROAD FORCES INFLUENCING VALUE Physical Forces Social Forces Economic Forces Political Forces 5 Page 120 © 2015 OnCourse Learning

PHYSICAL FORCES Natural Resources Developed Resources 6 Page 120 © 2015 OnCourse Learning

SOCIAL FORCES 1.Demographics 2.Neighborhood Stability 3.Population 4.Life Styles and Living Standards 5.Attitudes; Behavior, Law, Government 6.Attitudes; Development, Growth, Ecology 7.Attitudes; Public Education 7 Page 121 © 2015 OnCourse Learning

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 8 Page 122 © 2015 OnCourse Learning

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 9 Page 122 © 2015 OnCourse Learning

5.2 HOW ECONOMIC TRENDS AFFECT REAL ESTATE Economic Trends & the Business Cycle Real Estate Supply Factors Real Estate Demand Factors Federal Government Activity Detailed on the following slides 10 Page 123 © 2015 OnCourse Learning

ECONOMIC TRENDS / BUSINESS CYCLE An Economic Trend is a Pattern of Changes Cycles – a Change Repeats Itself Business Cycles Real Estate Cycles Number of New Subdivision Lots Amount of New Construction Volume of Sales 11 Page 124 © 2015 OnCourse Learning

REAL ESTATE SUPPLY FACTORS Housing Supply (Existing) New Construction (Near-term Additions) Supply of Vacant Land (Future Supply) 12 Page 126 © 2015 OnCourse Learning

REAL ESTATE DEMAND FACTORS Population Households Purchasing Power Affected by Employment, Wage/ Income Levels Disposal Income (After Taxes) Depends on Availability of Financing / Credit 13 Page 127 © 2015 OnCourse Learning

FEDERAL GOVERNMENT ACTIVITY Department of Housing and Urban Development (HUD) Programs FNMA FHA (Federal Housing Administration) Federal Home Loan Mortgage Corporation (Freddie Mac) Mortgage-Backed Securities are sold on the Secondary Market 14 Page 130 © 2015 OnCourse Learning

FEDERAL GOVERNMENT ACTIVITY Energy and the Environment Environmental Protection Agency (EPA) Energy-Efficient Appliances Energy-Efficient Homes Green Building Sustainable Design 15 Page 131 © 2015 OnCourse Learning

FEDERAL GOVERNMENT PROGRAMS Government Banking & Monetary Policy Federal Reserve Monetary Policy (Interest Rates, etc.) FDIC (Insures consumer deposits at banks) Fiscal Policy Taxation (Tax Reform, etc.) Spending 16 Page 132 © 2015 OnCourse Learning

5.3 ECONOMIC PRINCIPLES OF VALUE They Define & Predict Market Patterns The Principles Apply Collectively Rarely Independent of Each Other There are two groups of Principles: Principles of Marketability Principles of Productivity 17 Page 133 © 2015 OnCourse Learning

PRINCIPLES OF REAL ESTATE MARKETABILITY Principle of Substitution Principle of Conformity Principles of Progression & Regression Principle of Change Principle of Supply and Demand Principle of Competition Detailed on the following slides 18 Page 134 © 2015 OnCourse Learning

PRINCIPLE OF SUBSTITUTION When a Property can Easily be replaced by Another, the Value of Such a Property Tends to be Set by the Cost of Acquiring an Equally Desirable Substitute A Basic Concept Behind Each of the Three Approaches to Value 19 Page 134 © 2015 OnCourse Learning

PRINCIPLE OF CONFORMITY Maximum Value is Achieved when Properties are Similar as to… Size Style Quality Amenities / Utility Example: A 5-bedroom home in a 3-bedroom neighborhood does not conform; it would be an over-improvement and it’s value suffers 20 Page 134 © 2015 OnCourse Learning

PRINCIPLES OF PROGRESSON AND REGRESSION Progression Lower-value properties benefit (increase in value) from proximity to higher-value properties Regression Higher-value properties suffer (decrease in value) from proximity to lower-value properties 21 Page 135 © 2015 OnCourse Learning

PROGRESSION OR REGRESSION? If the home on the left is typical – which principle applies to the home on the right? 22 Page 135 © 2015 OnCourse Learning

PRINCIPLE OF CHANGE Change is Eternal, as to these Conditions: Physical Social Economic Political Four Stages (i.e. Neighborhood Cycle) apply: Development, Stability, Decline & Renaissance 23 Page 135 © 2015 OnCourse Learning

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 a Reasonable Profit 24 Page 135 © 2015 OnCourse Learning P R I C E QUANTITY Demand Supply

PRINCIPLE OF COMPETITION Market Demand Generates Profits Profits Generate Competition Excess Profits Usually Generate Ruinous Competition 25 Page 136 © 2015 OnCourse Learning

PRINCIPLES OF REAL ESTATE PRODUCTIVITY Agents of Production Principles of Surplus Productivity, Balance & Contribution Principle of Increasing & Decreasing Returns Principle of Highest & Best Use Principle of Consistent Use Principle of Anticipation Detailed on the following slides 26 Page 136 © 2015 OnCourse Learning

AGENTS OF PRODUCTION Labor Coordination Management, Effort Capital Construction Costs, Returns Land Residual – Last $’s to the Land 27 Page 136 © 2015 OnCourse Learning

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 Income becomes Basis for Land Value 28 Page 137 © 2015 OnCourse Learning

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 29 Page 137 © 2015 OnCourse Learning

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. The Principle of Surplus Productivity is the Basis for the Principle of Increasing and Decreasing Returns and the Principle of Highest and Best Use 30 Page 138 © 2015 OnCourse Learning

PRINCIPLE OF INCREASING & DECREASING RETURNS Fertilizer Principle Added increments of fertilizer and labor do not result in equal increases in crop yield This principle helps property owners make decisions about adding improvements or remodeling What to add, and to what degree 31 Page 138 © 2015 OnCourse Learning

PRINCIPLE OF HIGHEST & 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 If Vacant As Improved 32 Page 138 © 2015 OnCourse Learning

PRINCIPLE OF CONSISTENT USE Corollary to the Principle of Highest and Best Use… Land and Improvements must be appraised on the basis of the same use If highest and best use for a site is for apartment development, the house value cannot be added to the apartment site value 33 Page 139 © 2015 OnCourse Learning

PRINCIPLE OF ANTICIPATION Value is essentially an expression of the Present Worth of Future Benefits This Principle underlies the Income Approach to Value 34 Page 139 © 2015 OnCourse Learning

CHAPTER SUMMARY 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. 35 Page 139 © 2015 OnCourse Learning

CHAPTER SUMMARY (Con’t.) 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. 36 Page 140 © 2015 OnCourse Learning

IMPORTANT TERMS & CONCEPTS Agents of ProductionPhysical Forces AmenitiesPolitical Forces Business CyclesPrinciple of Anticipation DemandPrinciple of Change DemographyPrinciple of Competition Economic ForcesPrinciple of Conformity Fiscal PolicyPrinciple of Increasing & Decreasing Returns Gross Domestic Product (GNP)Principles of Progression & Regression Monetary PolicyPrinciple of Substitution Monetary TheoryPrinciple of Supply and Demand Over-ImprovementPrinciples of Highest & Best Use and Consistent Use 37 Page 142 © 2015 OnCourse Learning

IMPORTANT TERMS & CONCEPTS Principles of Surplus Productivity, Balance, and Contribution Purchasing Power Real Estate Cycle Scarcity Secondary Markets Social Forces Supply Surplus of Productivity Transferability Utility 38 Page 142 © 2015 OnCourse Learning