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Summary Lectures Real Estate Principles 2018/2019
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Summary of the lectures of Real Estate Principles 2018/2019. Incl. Guest lectures, graphs and detailed explanations.
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Real Estate PrinciplesTable of Contents
Class 2 – Real Estate Market Principles & Stylized facts I ................................................................................ 2
Class 3 2017 – Guest Lecture - Air Rights & RE-Cycles - Professor Dhr. G. Geurts, FRICS .................................. 6
Class 4 – Guest Lecture – Real Estate Finance and Investment – Dr. Hoesli, University of Geneva ................... 8
Class 5 – Stylized Facts II & Investment Case ................................................................................................ 11
Class 6 – Urban Economics, Planning, Land Use ............................................................................................ 20
Class 8 – Guest Lecture Housing Markets – Arno van der Vlist ...................................................................... 29
Class 9 – Principles of Real Estate Development & Construction ................................................................... 36
Class 10 – RE Development – Dr. Nozeman, RUG, ASRE, ING ........................................................................ 40
Class 11 – Towards understanding the logic of Cost-Benefit Analysis ............................................................ 47
Class 12 – Guest lecture - Retail property investment – Dhr. Vink, Redevco.................................................. 48
Class 13 – Valuation of externalities ............................................................................................................. 53
Class 14 – Sustainability ............................................................................................................................... 56
1
,Class 2 – Real Estate Market Principles & Stylized facts I
What is real estate?
Real Estate: Land and anything fixed/built to/on this land, including:
- Minerals; - Trees and crops (incl. unpicked fruits)
- Windmills; - Sewerage and gutters
- Anything that is sustainably jointed to land/a building (art. 3:3 lid 1 BW)
Are houseboats Real Estate? Only if it is jointed to land or a building.
Practical economic definition is buildings and/or land, usually in an urban context. In practice, real
estate tends to refer to objects that are generated by developers and (owned by) institutional investors.
Why does Real Estate require a distinct field of study?
Real estate has special characteristics: if more is wanted of any good, say shoes, new orders will be
given for it. This will cause the price to rise and more to be produced. Similarly, more is available of a
good like tea than people want, its price will be marked down. At the lower price, people will drink more
tea and producers will produce less. Thus, equilibrium will be restored. This is also true for the markets
for factors of production such as labour, land and capital.
This is incorrect.
What is special about RE?
It has a slow adjustment of demand and supply: It takes a long time to build and the market cannot
response quickly to an increase in demand. Demand may also not response quickly to price.
- The market is not always in equilibrium;
- Equilibrium is not attained quickly
Examples of RE stylized facts/characterization
- Buildings and land are ‘one’: immobile (can’t be moved but can be transformed), bargaining
position;
- Immobile, but function may change;
- Durable (but wear and tear). It last 30-40 years;
- Slow supply adjustment: construction time, limited demolition, long production time;
- Heterogeneous good and thin market segments: tied to its location, properties differ, sales are
infrequent, not always good information on prices;
- Information asymmetry between buyer & seller;
- High transaction costs, capital intensive, and illiquid.
Focus of the field of real estate
Buildings, in the context of activity and location: The distribution of
activity across space is a different field, not necessary about RE but where
firms select to locate, and people desire to live. It is important for
understanding in which locations you need what kind of buildings. The
building has to be suitable for a given activity.
Real estate can be:
- A production factor: for a company to hosts its activity
- A source of income: sell of a building or rent it out.
Two real estate markets
Real estate is essentially traded in two types of markets which differ substantially:
- The space market: where space to live, work, etc, is traded. It’s about the user perspective.
- The market for capital goods/investments: RE is a source of cash flows
As a result, the value of RE is driven by local (space market) as well as non-local factors.
2
,What is a market?
A market: any arrangement by which buyers and sellers are brought together to fix a price in which
goods can be exchanged.
- Pricing is the central issue
- In practice, a limited share of all RE is on the market.
Space market
It is the market for the use of space inside buildings. In this market, rents are determined. The price
for using space in buildings for a specific period, which is subject to specified conditions. Rents are
determined by supply and demand, which are of local scale. People are locally looking for space. Thus,
rents are determined at a local scale. So: In the space market, rents are determined by supply and
demand at a local scale.
Asset market
Real estate is a potential stream of future income (cash flows). Characteristic of cash flows (size, timing,
risk) are mostly determined in the space market. The income stream can be seen as a mere capital
asset (as in: an asset of financial value). The value of receiving the potential cash flows is determined
in the capital market (shaped by financial-economic factors at the global scale). It is about producing
financial value and is less connected to the actual source.
If you are a home owner you are active in both markets: space market because you are living in a house,
but you also want to make profit on it when you sell, you have a cashflow.
Which of the two markets (space market, asset market) tends to dominate where and when real estate
is built? The asset market. You need capital in order to get something built.
Central concept: Interest
Interest is the compensation paid when borrowing money OR compensation received when lending
money. The value of the amount of money today is not the same as the value of the same amount of
money in any future time.
Time value of money – present value
Current value of an amount of cash that is to be received in the future.
PV = FV / (1+R) ^ t
FV = PV * (1+r)^t
So 100€ today, with 4% interest rate, means 104€ next year. It works both ways, also from FV to PV.
Property value
A building will generate cash flow in the years to come. The property value can be approximated by
equating the income it produces (net rent, i.e., rental income minus operating expenses) with the cap
rate.
Cap rate = yield = rent-to-price ratio
= Rent divided by capital value.
Cap rates are determined in the asset market
- Risk free interest rate (10 y government bond yield)
- Expected inflation (+)
- Property-specific risk premium (+)
- Property-specific expected rental growth (-)
(ULE p. 54 for a list that disaggregates these cap rate-determining factors)
3
, Approximating property value
Conventional way to quote property value
Property value = Net Operating Costs (NOI) / Cap rate
12.500.000 = 1.000.%
- This uses the total of the initial years rent
- Cap rates do not cause property values, they reflect it.
DCF valuation procedure
Discounted cash flow: considers individual expected future cash flows. Steps:
1. Forecast the expected future cash flows (net operating income and sell-off value);
2. Ascertain the required rate of (total) return;
3. Discount the cash flow to present value at the required rate of return.
Value = Year rent / cap rate
10.000.000 = 1.000.%
Balancing the two markets
- Equilibrating role of the project developer:
Matches demand and supply for real estate space/assets.
- Compares the value of (existing) real estate with the cost of new production:
If the value > costs then development will be initiated.
- Appears as a self-regulating system. When there is a shortage, a developer will balance supply and
demand by adding products. This is not always so in practice.
So, project development is the equilibrating force.
What can go wrong?
- There might be an asymmetrical reaction: when there is shortage, new supply of buildings is added
to the existing stock of buildings. But when there are too many buildings, they do not remove them
so there is an oversupply. As a result, the market is not in balance.
- Higher rents need not cause higher value. Could be because of a riskier renter. The cap rate
increases, something happens in the financial market. When rents are higher, they might not be
valued higher because they have less appetite for real estate when its more attractive to invest in
another market. It is relative to the performance of other assets.
- Possible risk of developing for investor demand.
Developers often work with borrowed money. Sentiment in the financial sector has a strong influence
on the opportunities for project development.
Intermediate conclusions
- The real estate market ‘system’ considers of three elements:
o The space market
o The asset market
o Real Estate Development
- The mechanism that should bring the markets for space and assets in equilibrium is imperfect.
- In principle, market actors consider the future
o This is mainly so in the asset market;
o Market responses are often delayed: it takes long time to develop building, construction
takes long time. Also, rents might respond slowly to changes in the space market.
The real property market: An abstract term aggregating all transactions in real property throughout
the country.
4
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