2. MIT Center for Real Estate
Week 1: Introduction
• The space versus asset market: 4 Quadrant
math.
• Real Estate Micro Economics: Hedonics,
Location, density, government regulations.
• Real Estate Macro Economics: timing
behavior (search, moving, contracts),
cycles, regional growth.
3. MIT Center for Real Estate
The Role of Real Estate in the
Economy
• Construction [6% of GDP]
• Service flow, “Shelter”, rent plus imputed
rent [20% + of GDP]
• Assets [55-60% of total national wealth]
• Land? Not part of GDP (we don’t make
land), but it is part of wealth.
• Accounting, measurement difficulties [book
versus market value]
4. MIT Center for Real Estate
Value of New Construction Put in Place, 2002
$ (in Billions) % of GDP
Private Construction 650 6.1
Buildings
Residential buildings 422 4.0
Nonresidential buildings 167 1.6
Industrial 17 0.2
Office 38 0.4
Hotels/Motels 10 0.1
Other commercial 56 0.5
All other nonresidential 46 0.4
Nonbuilding construction
Public utilities 54 0.5
All other 7 0.1
Public Construction 210 2.0
Buildings 102 1.0
Housing and development 6 0.1
Industrial 2 0.0
Other 94 0.9
Nonbuilding construction 108 1.0
Infrastructure 97 0.9
All other 11 0.1
Total new construction 861 8.1
Total GDP: 10,624 100.0
Source: Current Construction Reports, Series C30, U.S. Census Bureau. Gross Domestic
Product from Economic Report of the President, 2004
Figure by MIT OpenCourseWare.
5. MIT Center for Real Estate
The Value of US Real Estate Assets (1990)
$, in billions % of Total
Residential 6,122 69.8
Single Family Homes 5,419 61.7
Multifamily 552 6.3
Condominiums/Coops 96 1.1
Mobile Homes 55 0.6
Nonresidential 2,655 30.2
Retail 1,115 12.7
Office 1,009 11.5
Manufacturing 308 3.5
Warehouse 223 2.5
Total U.S. Real Estate 8,777 100.0
Adapted from DiPasquale and Wheaton (1996)
6. MIT Center for Real Estate
U.S. Real Estate
Ownership, 1990
All Real Estate Residential Only Nonresidential Only
$, in billions % $, in billions % $, in billions %
Individuals 5,088 58.0 5,071 82.8 17 0.6
Corporations 1,699 19.4 66 1.1 1,633 61.5
Partnerships 1,011 11.5 673 11.0 338 12.7
Nonprofits 411 4.7 104 1.7 307 11.6
Government 234 2.6 173 2.8 61 2.3
Institutional Investors 128 1.5 14 0.2 114 4.3
Financial Institutions 114 1.3 13 0.2 101 3.8
Other (Including Foreign 92 1.0 8 0.1 84 3.2
Total: 8,777 100.0 6,122 100.0 2,655 100.0
% of All Real Estate 100.0 69.8 30.2
Adapted from DiPasquale and Wheaton (1996)
7. Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…
D
Rent $
Space Market:
Asset Market:
Rent Determination
Valuation
R*
D
Price $ P* Q* Stock (SF)
C*
Asset Market:
Construction Space Market:
Stock Adjustment
Construction (SF)
8. MIT Center for Real Estate
Systems of Economic Equations
• Parameters: Constants that reflect underlying
behavior, α, β, δ.
• Endogenous variables: values that the model
“determines: C, S, R, P.
• Exogenous variables: values that determine the
model’s variables, but which the models variables
in turn do not influence: i, E.
• Equilibrium: Solution to the endogenous variables
given exogenous values and parameters.
• Comparative Statics: How changes in exogenous
variables change equilibrium endogenous ones.
9. MIT Center for Real Estate
1st quadrant
1). Office Demand = α1ER-β1
E= office employment
R = rent per square foot
β1 = rental elasticity of demand, %change
in sqft per worker/% change in rent]
α1 = sqft / E when R=$1
2). Demand = Stock = S
3). Hence: R = (S/α1E)–1/ β1 {downward sloping schedule}
10. MIT Center for Real Estate
2nd and 3rd Quadrants
4). P = R/i
i = all inclusive cap rate
5). Office Construction rate:
C/S = α2Pβ2
P = Asset Price per square foot
[“Q” theory?]
β2 = Price elasticity of supply:
[% change in construction rate/% change
in price]
11. MIT Center for Real Estate
4th Quadrant
6). Replacement version (graph):
E= fixed, δS = building losses
ΔS/S = C/S - δ [Construction rate – loss
rate equals net additions = 0 in equilibrium]
7). Steady Demand growth version:
ΔE/E = δ, no losses
Hence: ΔS/S - ΔE/E = C/S - δ
[what happens to S/E if C/S >< δ ?]
12. Effect of Demand Growth in Space Market: More
MIT Center for Real Estate Jobs
Asset Market: Rent $
Space Market:
Valuation Rent Determination
D0 D1
R*
Price $ P* Q* Stock (SF)
C*
Asset Market:
Construction
Space Market:
Stock Adjustment
Construction (SF)
13. Effect of Demand Growth in Space Market:
First phase…
MIT Center for Real Estate
Rent $ Space Market:
Asset Market: Rent Determination
Valuation
D0 D1
Doesn’t form a
rectangle.
R*
Excess (negative)
vacancy…
Price $ P* Q* Stock (SF)
C*
Asset Market:
Construction
Space Market:
Stock Adjustment
Construction (SF)
14. Effect of Demand Growth in Space Market:
2nd phase…
MIT Center for Real Estate
Asset Market: Rent $ Space Market:
Valuation Rent Determination
D0 D1
R1 Rents spike and get rid of
excess (negative) vacancy
R*
Price $ P1 P* Q* Stock (SF)
Can this be a long-
run equilibrium
result?…
C*
Asset Market: Doesn’t form a
Construction rectangle.
Space Market:
Stock Adjustment
Construction (SF)
15. Effect of Demand Growth in Space Market: LR Equilibrium…
MIT Center for Real Estate
Asset Market: Rent $ Space Market:
Valuation Rent Determination
D0 D1
R1
R**
R*
P**
Price $ P1 P* Q* Q** Stock (SF)
In long run equilibrium
new supply tempers
C* initial rent spike
Asset Market:
Construction
C** Space Market:
Stock Adjustment
Construction (SF)
16. Effect of Demand Growth in Asset Market…
MIT Center for Real Estate
Asset Market: Rent $ Space Market:
Valuation Rent Determination
D0
11% CAP
D1
R*
8%CAP
R**
SR
LR
P1 Q**
P* Q*
Price $ P** Stock (SF)
C*
Asset Market:
Construction
Space Market:
C** Stock Adjustment
Construction (SF)
17. MIT Center for Real Estate
Using the 4-Quadrant Model to
assess the impact of other changes.
• What happens if Construction costs rise or the
supply schedule shifts?
• Suppose depreciation speeds up (functional
obsolescence dictates shorter life spans of
buildings)?
• How to interpret owner occupied space (e.g.
Single Family Housing)?
• EXERCISE #1.
18. MIT Center for Real Estate
Current Issues: using the diagram
• Zero (or negative) population and labor force
growth in: Japan, Germany, Italy, Spain…?
• Increasing use of the Internet for retail
shopping?
• Expanded availability of (subprime) mortgage
credit to households previously ineligible?
• Continued global saving glut from growth in
Asia – where savings rates are 20%+
19. MIT Center for Real Estate
Real Estate Macro-economics: Real
Estate Cycles and Secular Trends
• What are real estate cycles? Truly independent
oscillations or just reactions to the economy.
• Cycles vary with Property type.
• Cycles are related to broader capital markets.
• Secular trend: growth rates of the stock
(construction) slow as economy matures.
• Secular trend: Prices adjusted for inflation rise
over time?
20. MIT Center for Real Estate
Prefect Historic correlation between economic recessions
and Housing Production – except for the last 5 years
5 3.2
Year-over-year change in total
4 2.8
employment, millions
Total housing starts,
3 2.4
millions of units
2 2.0
1 1.6
0 1.2
-1 0.8
-2 0.4
-3 0.0
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
New Jobs (L) Total Housing Starts (R)
Sources: BLS, BOC, TWR.
21. MIT Center for Real Estate
Prefect Historic correlation between economic recessions
and Housing Prices – except for the last 5 years
Housing and U.S. Job Growth
6% 12%
5% 10%
4% 8%
real median home prices
6%
3%
4%
job growth
2%
2%
1%
0%
0%
-2%
-1% -4%
based on 4-qtr
-2% moving averages -6%
-3% -8%
1
20 Q3
20 Q1
20 Q3
19 Q1
19 Q3
19 Q1
20 Q3
20 Q1
19 Q3
19 Q1
19 Q3
19 Q1
19 Q3
19 Q1
19 Q3
19 Q3
19 Q3
19 Q1
19 Q1
19 Q3
19 Q3
19 Q3
19 Q1
19 Q1
19 Q1
Q
04
05
07
95
96
98
99
01
02
87
89
90
92
93
80
81
83
84
86
69
71
72
74
75
77
78
19
Job Grow th Real Median Home Price Grow th (lagged)
22. MIT Center for Real Estate
With offices, building booms follow rents. The booms
then generate falling rents = endogenous cycle?
Office construction and rent growth (TWR sum of markets)
140 15
Forecast
120
Completions - 10
Historical average
100
5
80
60
0
40
-5
20
0 -10
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Completions in msf (L) TWR rent inflation in % (R)
Figure by MIT OpenCourseWare.
23. MIT Center for Real Estate
National Office Market
Completions Rate vs. Real Rent
$ Per Sqft
Forecast
34.00
8.00%
32.00
6.00% 30.00
28.00
4.00%
26.00
2.00%
24.00
0.00%
22.00
-2.00% 20.00
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Total Employment Growth (L) Real Rent (R) Completion Rate (L)
24. MIT Center for Real Estate
Historically: Rents over the “cycle”
mean revert around Development costs
PPI: Construction TWR Rent Index
200 31
190 29
180
27
170
25
160
150 23
140
21
130
19
120
110 17
100 15
20 1
20 1
1
19 1
19 1
20 1
20 1
20 1
20 1
20 1
20 1
20 1
19 1
19 1
19 1
19 1
19 1
19 1
19 1
19 1
19 1
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
06
07
08
99
03
04
05
00
01
02
91
92
93
94
95
96
97
98
88
89
90
19
PPI: Construction Materials and Components TWR Rent Index
Source: BLS, TWR Office Outlook XL, Summer 2008
25. MIT Center for Real Estate
Over the long run there also are:
little cycles and Big cycles Broken
Ground
Projects
Construction as % of Stock
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
-2%
1901 1910 1919 1928 1937 1946 1955 1964 1973 1982 1991 2000
Downtown Suburban
26. Price Index
16
0
50
100
150
200
250
300
350
400
28
16
38
16
48
16
58
16
68
16
78
16
88
16
98
17
08
17
18
17
28
17
38
g
17
48
17
58
17
MIT Center for Real Estate
68
y
17
78
17
88
17
98
18
08
Y ear
18
18
18
28
18
38
18
48
18
58
18
68
(
18
78
18
88
18
98
19
g
08
19
18
19
Amsterdam (Real Guilders)
28
)
19
38
19
48
19
58
Index of Historic Housing Prices in
19
68
27. MIT Center for Real Estate
CPI Apartment Rent Indices for Selected "traditional" Cities: 1918-1999 (constant $)
400
350
300
Apartment Rent
250
200
150
100
50
0
1918
1921
1924
1927
1930
1933
1936
1939
1942
1945
1948
1951
1954
1957
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
Year
NEW YORK BOSTON CHICAGO WASHINGTON D. C. SANFRANCISCO
28. MIT Center for Real Estate
Long run Appreciation? Just inflation (3.5%) for 100 years
in NYC, but lots of decade risk
Price Index 1899 = 1.0
constant dollars/square ft.
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999
Source: MIT 2002 Thesis
29. MIT Center for Real Estate
Real Estate Micro-economics:
Cities and Land Markets
• No two properties are identical [complete product
differentiation]
• Properties are close if not perfect substitutes for
each other – at some price differential.
• Price differentials are extremely large, and very
predictable.
• Price differentials tend to be stable over time:
local neighborhoods do not have independent
cyclic movements.
30. MIT Center for Real Estate
House prices reflect both unit characteristics and
location attributes
17.19
In(sale)
8.52
5.71 In(sqrt) 9.34
Sale amount against square feet, Phoenix
Figure by MIT OpenCourseWare.
31. MIT Center for Real Estate
Repeat-Sale House price indices (CSW) for 15 submarkets
within the greater Boston CMSA: 1982-2002 (current $)
House Price Indexes, Eastern M assachusetts, by City/Tow n Location
300
250
Boston
Southeast
W estern 1
200 Far North Shore
Price Index (1990=100)
495 North
95 South
95 N orth
150 W estern 2
Lowell Area
495 W est
North Shore
100 South Shore
W orcester Area
Cam bridge Area
North Central
50
0
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Year
32. MIT Center for Real Estate
Home Prices within South California
Median Home Price,
Thousands ($ 2002.4)
$400
$350
$300
$250
$200
$150
$100
77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
Los Angeles Orange County Riverside Ventura San Diego
Sources: OFHEO, Torto Wheaton Research
33. MIT Center for Real Estate
Office Rents Move together Cyclically but not
always secularly
TW Rent Index, 2003$ per sqft
40
Forecast
35
30
25
20
15
1980
1981
1982
1983
1985
1986
1987
1988
1990
1991
1992
1993
1995
1996
1997
1998
2000
2001
2002
2003
2005
Los Angeles Orange County Ventura County Riverside San Diego
34. MIT Center for Real Estate
Closely Correlated Industrial Rent
Movements: few secular differences
TW Rent Index, 2003$ per sqft
10.00
Forecast
9.00
8.00
7.00
6.00
5.00
4.00
1980
1981
1983
1984
1986
1987
1989
1990
1992
1993
1995
1996
1998
1999
2001
2002
2004
2005
Los Angeles Orange County Ventura County Riverside San Diego
35. MIT Center for Real Estate
Manhattan Office Rents vs. NJ and
Conn. Suburbs
TW Index, $2002 per sqft
65
60
55
50
45
40
35
30
25
20
1980
1981
1982
1983
1985
1986
1987
1988
1990
1991
1992
1993
1995
1996
1997
1998
2000
2001
Suburban Markets Manhattan
36. MIT Center for Real Estate
Office Suburban Rents in Detail
TW Index, $2002 per sqft
50
45
40
35
30
25
20
15
10
1980
1981
1982
1983
1985
1986
1987
1988
1990
1991
1992
1993
1995
1996
1997
1998
2000
2001
Northern New Jersey Long Island Stamford Westchester
37. MIT Center for Real Estate
Prices and Development
• Prices bring forth development: of any urban land
use..
• Development occurs so as to maximize the
residual value between: Price-capital costs
(construction).
• This residual is “land value”. Development
maximizes land value.
• Land Development is a natural real option: incur
heavy capital costs to realize an income stream –
or- wait (to do the same later) ?
38. MIT Center for Real Estate
What is a real Estate Market?
• Within “markets” all properties should
move together: high substitutability, easy
mobility.
• Between markets there exists frictions,
transportation costs, immobility of
resources and low substitutability.
• MSA as “market”? CMSA?
39. MIT Center for Real Estate
Between Markets – there can be huge differences in
both long term growth and cyclic risk
1 9 8 0 = 1 0 0 (C o n s ta n t $ 2 0 0 5 )
350
300 B o s to n
250 Los
A n g e le
s
200 Ch ic a g
o
150 Na tio n
100 Da lla s
50
0
1980 1985 1990 1995 2000 2005
40. MIT Center for Real Estate
Metropolitan Housing Markets
can even move independently
FIGURE 5. Repeat Sale House Price Indices for Selected "new" Cities: 1975-1999 (constant
$)
250
230
210
190
170
House Price
150
130
110
90
70
50
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
Year
Atlanta Dennver Houston Los Angeles Phoenix
41. MIT Center for Real Estate
Although sometimes they are subject
to a common economy wide Shock
FIGURE 4. Repeat Sale House Price Indices for Selected "Traditional" Cities: 1975-1999 (constant $)
250
230
210
190
170
House Price
150
130
110
90
70
50
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
Year
Boston Chicago New York Sanfrancisco Washington D.C.