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

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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

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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.

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5

THE REAL ESTATE VALUE INFLUENCES

Real Estate has no Intrinsic Value

Value is Derived from Rights and Benefits that Come from:

o Ownershipo Possession ando Use

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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

= Market Value

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BROAD FORCES INFLUENCING VALUE

• Physical Forces

• Social Forces

• Economic Forces

• Political Forces

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PHYSICAL FORCES

Natural Resources

Developed Resources

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SOCIAL FORCES

1. Demographics2. Neighborhood Stability3. Population4. Life Styles5. Attitudes; Behavior6. Attitudes; Development7. Attitudes; Public Education

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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

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POLITICAL FORCES

1. Zoning and Land Use2. Building and Safety3. Environmental Laws4. Endangered Species Act5. Police, Fire, and Health6. Crime Prevention7. Public Works8. Fiscal Policy9. Monetary Policy10. Government Sponsored Programs11. Government Regulations

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HOW ECONOMIC TRENDS AFFECT REAL ESTATE

Economic Trends and the Business Cycle

Real Estate Supply Factors

Real Estate Demand Factors

Federal Government Activity

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ECONOMIC TRENDS AND THE BUSINESS CYCLE

An Economic Trend is a Pattern of Changes

CyclesBusiness cycles

Real Estate Cycles The Cycle of Construction New Home Sales Volume of Sales

Used by Permission of Alma Dizon: www.riverside-real-estate.us

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REAL ESTATE SUPPLY FACTORS

• Housing Supply

• New Construction

• Supply of Vacant Land

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REAL ESTATE DEMAND FACTORS

Population

Purchasing Power

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FEDERAL GOVERNMENT ACTIVITY

• Housing and Urban Development Programs

o FNMA

Federal National Mortgage Association Secondary Market

o FHA Federal Housing Administration

Figure 5.5:

Government Housing Project

under Construction

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FEDERAL GOVERNMENT PROGRAMS

• Energy and the Environmento EPA

Environmental Protection Agency

o FEMA Flood Maps

• Governmental Banking and Monetary Policy

o Federal Reserve Monetary Policy Actions

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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

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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

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PRINCIPLE OF CONFORMITY

Maximum Value

Properties are similaro Sizeo Styleo Qualityo Amenities/Utility

Over-improvement

5 bedroom in a 3 bedroom neighborhood

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PRINCIPLES OF REGRESSION & PROGRESSION

• Progressiono Lower value properties benefit from being close to high

value properties

• Regressiono Higher value properties tend to decrease in value when

close to lower value properties.

• Is This an Illustration of Progression or Regression?

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PRINCIPLE OF CHANGE

Change is Eternalo Physicalo Socialo Economico Political conditions

Neighborhood Changeo Development (growth)o Stabilityo Declineo Renaissance (rebirth)

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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

Price

Quantity

Demand

Supply

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Principle of Competition

Market Demand Generates Profits Profits Generate Competition Excess Profits Usually Generate Ruinous

Competition

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PRINCIPLES OF REAL ESTATE PRODUCTIVITY

1. Agents of Production2. Principles of:

a) Surplus Productivityb) Balancec) Contribution

3. Principle of Increasing and Decreasing Returns

4. Principle of Highest and Best Use5. Principle of Consistent Use6. Principle of Anticipation

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AGENTS OF PRODUCTION

o Labor

o Coordination

o Capitol

o Land

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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

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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

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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.

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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

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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

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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.

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PRINCIPLE OF ANTICIPATION

• Value is the Present Worth of Future Benefits

• The Principle of Anticipation Underlies the Income Approach to Value.

SUMMARY

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Real estate is a basic and fundamental form of wealth, ithas 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 supplyand demand factors in the general economy.