Real Estate Economics: The Economics of Real Property Markets
Objectives addressed by an economic analysis of the property market
to put the operation of land and property markets in the context of economic activity in both the domestic and international economy
explain the structure of land and property markets
identify both the economic problems posed by the operation of land and property markets and the difficulties they themselves pose economic analysis
explain the economic behaviour in land and property markets
Analysis should also consider the following issues:
have regard to the "non-economic" aspects of property market activity
should reflect the contribution of other related disciplines (e.g. finance, property law, appraisal, planning, construction etc.)
reflect the real choices faced by participants in property markets
reflect the legal, social, institutional and historic context of property market activity and how these factors in turn have influence the structure of individual property markets and conditioned market behaviour
the full complexity of property market problems
"It makes little sense for economics to discuss the process of exchange without specifying the institutional setting within which the trading takes place, since this affects the incentives to produce and the costs of transacting" (R.H. Coase, 1992)
Why is this important?
Land has been ascribed a role in economic theory, as one of the 4 factors in production. V. surprising as it's an input into the production process of all firms and consequently the operation of this market has very important implications for individual firms and on aggregate . Furthermore - property market forms one of the principal asset markets of the economy and represents an important asset balance sheets.
The Characteristics of Real Property
- the market participants
- the special characteristics of land and property
- the structure of the market
- the characteristics of the 'goods' being traded in the market
real property is either land or "land plus capital plus labour" i.e. cultivated land or buildings). what is traded in the real property market is not the physical units of land and buildings but the legal rights or interests which exist over them. there exists an infinite variation in property interests, reflecting the infinite scope for variation in the leases which create them.
Legal: Heterogeneous, high transaction costs, extensive government control; attitudes to property;
owner occupiers and users of property; investors in property; producers of property (developers); Agents, advisers, etc. (professional middlemen)
the RPM is a series of related sub-markets (defined in terms of sector, location, type of property interest, etc.)
Problem with the characteristics of RPM
The 'goods' traded in the RPM are the legal rights or interests which exist over physical units of land and buildings. Because there is infinite scope for variation in the lease forms which create them an infinite variety of property interests exist. Therefore the products in the market are not homogeneous.
To Overcome This create a functional division of the sector, where is makes more sense to analyse the principal sub markets than one unrealistic homogeneous entity.
Investor
Occupation
Multiple, integrated sub-markets, which respond to different stimuli.
Development
Extinguishes old property interests and creates new property interests .
Functions of the Real Property Market
the RPM as a mechanism for reconciling demand and supply
differing views about the interests which are served by the market process
The mainstream economic analyses of property markets stress the efficient allocation of resources to secure the "highest and best" use of property (Harvey, 1996). See also Evans 1995 or Gau 1987. Political economy approaches suggest that the property market is itself "unproductive", existing only to serve the interests of particular groups within the economy (Lamarch 1976, and Boddy 1981).
RE is FUNDAMENTAL to economic development
The operation of RE markets underpins the productive economy through the provision of space for economic activities, the social well-being of the population through housing provision and contributes to the wealth creating potential of society through a system of property rights and the potential for capital accumulation.
Physical: a spacial market, indivisible; durable (path dependancy); inelastic supply; heterogeneous; monopoly power; external costs and benefits; imperfect information; high transaction costs
"property development investment equips space and creates physical infrastructure so as to facilitate the circulation of capital in its various forms, the exchange of information, and the physical and legal transactions on which commercial, administrative, governmental and financial functions are predicated"
Property Market Efficiency
Operational
Informational
Allocative
Prop. market efficiency is poorly developed. It is inefficient because of the well known characteristics.
Efficiency is confused with the perfectly competitive market, which focuses on info.-processing efficiency
A knowable and determinate price established in the market - efficient measure of value, capturing all the relevant info. available to the market at a given point in time.
Re-think
Consider efficiency in terms of specific characteristics of property itself and the processes through which it is used and traded.
Replace the the question 'is the property market efficient?' with a more relevant one 'who is the market efficient for?'
Economic Models of the RPM
Simple Model - Keogh (1994) . Key features:
pure-investor interests are in turn divided between user and investor rights
the dynamic change rests on the process of demand supply interaction in the markets for owner-occupied and pure-investor interests
existing stock of property interests is subdivided in terms of owner occupied and pure investor interests
changing conditions in one sub-market prompt changes elsewhere through the links which exist
all 3 interlinked submarkets use investment and development
The Fisher Model
serves to illustrate the complexity of interrelationships which exist within the RPM and between it's principal submarkets of space and capital.
it demonstrates that the relationships which exist between elements like new supply, change in rents and vacancy depend on where the pressure for change have arisen, in the space or capital market and on which set of pressures will have the greatest relative impact at any point in time.
Adjustment in the RPM: A Comparative Static Analysis
Demand and Supply in the RPM
Demand
consumer demand e.g. residential
producer demand (e.g. for commercial property i.e. offices, retail premises and industrial)
Supply
supply of intermediate or final product e.g. provision of factories, offices or residential properties
supply of factors of production e.g. greenfield and other development sites
in general, demand and supply plans are subject to different influences and are therefore independent of each other.
user demand is derived demand reflecting the demand for the goods and services capable of being produced in an individual property
investor demand, amongst other things, reflects the attractiveness of property assets relative to other available asset classes at any point in time.
on the supply side, the development industry's activities are influenced by the system of land use regulation and the availability of dev. finance.
*in the RPM many actors operate both the demand and supply sides e.g. some owner-occupiers may use, invest in and develop their own space requirements
Effective Demand and Supply
are equal to the actual amount of property interests both demanded and supplied in the market at a particular moment in time
therefore market price reflects effective demand and supply
effective demand is only part of the underlying demand or requirement for property
much largerunderlying demand isn't realised because a large proportion of users already have rights to occupation through leases or owner-occupation. Their actual demand for property is not displayed in the market place.
also, many users might be constrained
like demand, effective supply is only part of the underlying supply and again a key difference is that a large proportion of the stock is supplied to users with continuing rights to occupation through lease arrangements or owner-occupation and therefore not expressed in the market place.
It is these factors that determine the respective slopes of the fisher model
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Comparative statistics provide a number of illustrations of both the short and long run adjustment
adjustment across property types
adjustment across locations
adjustment in the configuration of property interests
the dynamic process of market adjustment
User Markets in Real Property
Is the use of property for production or consumption ?
interaction of demand and supply in the user market determines rental values
the use of property is aflow concept, which is important to distinguish the use of the services provided by property either for production or consumption purposes from the stock of property
use, or potential use, underpins the value of property and by implication its investment value
User Rights, take a variety of forms
most user rights have a n investment dimension, specifically owner occupation, where it may be difficult to ascertain which motication, use or investment, for holding the property interest is paramount
pure user rights, which distinguishes a clear separation of user and investor rights
Demand for user rights in real property
Individual user demand
the max rent will depend on the contribution the property makes to utility
(non-resi) demand price offered for a given property will be determined as a surplus after other inputs have been rewarded i.e. its rent as the residual left after all the other factors of production- labour, capital, and entrepreneurship - have been rewarded
demand for non-residential property
the productivity of those inputs when applied to property
the market for the goods or services capable of being produced in that property
the price of non-property inputs used in production
The Theory of the Natural Vacancy Rate
if the marginal cost of holding space is low and current market prices are below developer expectations, then some component of user rights in the new property may not be placed on the letting market
space that landlords are willing to rent only under certain conditions that are not currently met
the amount of this desired space divided by the total amount of space in the market
If the vacancy rate is too low, landlords will hold out for the best possible tenant for their property. If the actual vacancy rate is judged to be too high then landlords are willing to rent the space to first available tenant.
The Investment Market
The Investment Market
Property must have value in use to have value as an asset, i.e. for property to generate a return or income to an investor, a user must be willing to pay a rent for it in the user market. The rent paid in the user market translates into th einvestors income in the investor market
property investment involves the sacrifice of certain cash flows for uncertain cash flows in the future. Risk represents the variation in the expected future benefits from the investment
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