Chapter 2 REAL ESTATE MARKET 1st Semester, S.Y 2014-2015
Chapter Outline Market Defined Real Estate Market Market Structure Participants of the Real Estate Market Categories and Sub-markets of Real Estate Market Characteristics of Real Estate Market Factors that determine Real Estate Value Real Estate Cycle
A place where buyers and sellers meet to exchange items of value. The exchange of information between buyers and sellers about factors such as price, quality and quantity. Competition varies directly with: Number of buyers Number of sellers Homogeneity of units available Knowledge by all parties vs. advantage over the other party to distort price or market activity What is a Market?
Real Estate Market? The real estate market is the economic sector that involves the buying and selling of real properties such as buildings either for residential purposes, business premises, and the industry segment. Like any business sector it is susceptible to the economic forces of supply and demand. The main people involved in this field include the owner, renter, developers, renovators, and the facilitators.
Real Estate Market The overall real estate market collectively refers to the pool of all potential buyers and sellers of property at a given time. However, within this overall larger market, there exists different types of real estate markets. There are various categories of property markets and sub-markets. They are segmented based on functional, locational, demographic, socioeconomic, psychological and product-related characteristics as follows
Market Structure For a market to be competitive, there must be more than a single buyer or seller. It has been suggested that two people may trade, but it takes at least three persons to have a market, so that there is competition on at least one of its two sides. However, competitive markets rely on much larger numbers of both buyers and sellers. A market with single seller and multiple buyers is a monopoly. A market with a single buyer and multiple sellers is a monopsony. These are the extremes of imperfect competition.
Functions of the Real Estate Market The operation of the real estate market as an element of market structure is characterized by features that are clearly disclosed by its function. The functions are as follows: Information Pricing Intermediary Regulatory Investment Social function Stimulation Satisfaction
Functions of the Real Estate Market Information. The real estate market provides stakeholders information about the current state of the market (supply and demand, pricing). At the same time in a transition economy is an issue of objectivity, timeliness and completeness of such information, due to delayed development of information infrastructure markets, real estate (specialized media, information-analytical agencies, etc.). Pricing. In the transformation of the economy form the real estate market due to the presence of significant price distortions, whose existence is due to the mismatch volume structure of supply and demand. As the market price distortions begin to level off and the conditions for the "on" the mechanisms of free pricing of real estate.
Functions of the Real Estate Market Intermediary. The real estate market are professional intermediaries - realtors, appraisers, insurers, mortgage lenders and others in transition economies have a situation where the quality and quantity of professional intermediaries do not fully meet the needs of the market, which increases the transaction costs of its participants. Regulatory. The real estate market is actively involved in the redistribution of resources, directing the efforts of its members to comply with an effective structure of the economy and meet the public interest. In the full regulatory function begins to appear on the secondary market.
Functions of the Real Estate Market Investment. The real estate market is an attractive way to preserve and increase capital, contributes to the transfer of savings and savings of the population of the passive form of stocks in real capital, revenue-generating property owner. Social function. Thisis manifested in the growth of the labor activity of the total population, increasing the intensity of the labor of citizens who plan to become owners of apartments, land and other capital and prestigious projects. Function in society contributes to the formation of the middle class, which is the basis of stability. One of the manifestations of the social function of the real estate market appears socialization of capital.
Functions of the Real Estate Market Stimulation.the essence of which - the economic profits encourage the productive use of scientific and technological progress in the development and use of immovable property. Competition promotes high business activity and the search for new possibilities of effective management of capital property. Satisfaction.The real estate market makes it possible to eliminate non-competitive and weaknesses of market participants, contributes to the bankruptcy of inefficient businesses. The market mechanism as the direction of search, but makes no warranties as to the final financial results.
Participants in the Real Estate Market • Owner/User. These people are both owners as well as tenants. They purchase houses or commercial property as an investment and also to live in or utilize as a business. • Owners. These people are the real estate investors. They do the purchase, ownership, management, rental and/or sale of real estate for profit. They do not consume the real estate that they purchase. Typically they rent out or lease the property to someone else for profit. • Renters. These people are pure real estate consumers. They typically also called lessee or tenant who are occupier of a real property (housing or retail space) and pay rent to the landlord or lessor.
Participants in the Real Estate Market • Developers. These people prepare raw land for building which results in new product for the market. It buys land, finance real estate deals, build or have builders build projects, create and control the process of development from beginning to end. • Renovators. These people supply refurbished buildings to the market. They undergo the process of improving a commercial and residential real estate structure. • Facilitators. These include banks, real estate brokers and agents, mortgagers, and others that facilitate the purchase and sale of real estate.
Categories and Sub-Markets of Real Estate Market Categories Residential | Commercial | Industrial | Agricultural | Special Purpose Sub-markets Urban | Suburban | Rural High | Medium | Low-Priced Large/Small | Old/New | Good/Poor Design
Categories of Real Estate Market • Real estate market is also categorized based on the types of buyers and sellers, the process of sale, or particular interests in property. This includes: • Primary Sale Market • Secondary Sale Market • Rental Property Market • Auction Property Market • Real Investment Trust (REIT) Market
Categories of Real Estate Market • Primary Sale Market. Sale of newly launched properties by developers. • Secondary Sale Market. Sub-sale market involving non-developer individual buyers and sellers. • Rental Property Market. All about property rentals involving landlords and tenants.
Categories of Real Estate Market • Auction Property Market. An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder. • Real Estate Investment Trust (REIT) Market. A security that sells like a stock on the major exchanges and invests in real estate directly. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
Characteristics of a Real Estate Market Real estate market is dynamically affected by the attitudes, motivations and interactions of buyers and sellers. The behaviours and decisions of buyers and sellers are influenced by social, economic, governmental and environmental factors.
Characteristics of a Real Estate Market • Each property is unique - heterogeneous. No two properties are exactly identical, they are physically and geographically different. • Only a few buyers and sellers act at any one time, within one price range, at any one location. No one has large enough share in the market to dominate the supply and control the prices. • Prices of properties are relatively high, few pay with cash. Purchase decisions are influenced by the types and amount of financing available, interest rate, down payment required and loan duration. • Investors are more likely to buy a property if the income/cash flow from it exceeds the debt service. • Federal, state, district and local regulations govern the ownership and transfer of properties. There may also be further restrictions on sale
Characteristics of a Real Estate Market • Supply and demand for a certain type of property in a certain location are seldom in equilibrium, or balanced. • Projects take several years to build, and while new units are being built, oversupply may set in. • If demand suddenly increases, existing supply may not be enough to meet it. • Likewise, when demand suddenly drops, existing supply cannot be removed. • Most people rarely buy or sell properties, not familiar with the procedure, and lack knowledge and judgment as pertinent information on transaction prices and details are not readily available.
Characteristics of a Real Estate Market • There is no central market for property, such as the KLSE for stocks. Buyers and sellers are brought together through various communication channels and through estate agents. • The lack of a central market, coupled with incomplete information, property market is known as a market of Imperfect Knowledge, where opportunities and threats abound. • Properties are relatively hard to market and not liquid because they are durable products (unlike perishable consumption goods), expensive, require financing and not movable to where the demand is.
Factors that Determine Real Estate Value in Real Estate Market • When looking at value in real estate, it’s important to consider these principles to see how pricing is determined. A great number of factors establish real estate priceswhich are as follows: • Principle of Change • Principle of Competition • Principle of Conformity • Principles of Progression and Regression • Principle of Substitution • Principle of Supply and Demand
Principle of Change Cities, neighborhoods, and developments experience change, whether it be growth or decay. Nothing really stands still. Economists note that cities and nations alike experience four distinct stages of change, including development, stability, decline, and renaissance. The stage of the city or nation or development for which the subject property lies will have an effect on the value of the property.
Principle of Competition When there is strong demand for real estate, profits rise and competition stirs. With this increased competition and profit comes more home building and development. Unfortunately, when excessive profits are available, a surplus of competition can create an oversupply of housing, and collapse the market.
Principle of Conformity Many real estate markets thrive on conformity. If the properties of a given market are all similar in type, size, style, age, quality, etc., the maximum value is a result. If for example, a non-conforming home, such as 6-bedroom home is situated in a 3-bedroom community, the true value will not be realized.
Principle of Progression and Regression Related to conformity, the principle of regression tells us that high-valued properties tend to suffer when found in close proximity to lower-valued homes. While the principle of progression assumes that lower-valued homes will see increased value if found amongst higher-valued properties. That’s why you always hear people saying, “buy the cheapest property on the block”, as the strength of those around it will make it more valuable. And this explains why homes in good areas are often in bad shape, because they know the value is there regardless. Meanwhile, the newest and fanciest homes are often found in less desirable areas as a means to draw in buyers.
Principle of Substitution When setting a market price for a piece of property, the cost of acquiring or constructing a similar property must be considered. If the asking price of a home is P500,000, but similar homes in the neighborhood sell for P450,000, chances are the home will not sell for the full asking price. Comparable sales come to mind here. The same is true if the cost of constructing a new home (along with lot lost) is less than the asking price of P500,000.
Principle of Demand and Supply When demand is greater than supply, the price of homes and rent go up, and the inverse is true as well. When demand is strong, developers should react by increasing development to meet the demand, and keep prices at bay. However, if the reaction to demand is too strong, overbuilding can occur, leaving a surplus of property and weak demand, followed by lower house values. When supply and demand are a perfect equilibrium, the cost of production (along with the profit) should be reflected in market prices.
Real Estate Cycle A real estate or property cycle can be seen as a logical sequence of recurrent events reflected in demographic and economic factors that affect supply and demand for property subsequently influencing the property market. The first recorded pioneer of studying property cycles was Homer Hoyt (1895–1984) in 100 years of real estate values in Chicago (1933). It is widely recognized that property (along with other forms of investment) follows a predictable cycle.
Real Estate Cycle A real estate cycle or property cycle can be described as a logical sequence of recurrent events reflected in demographic, economic and emotional factors that affect supply and demand for real property subsequently influencing the real estate market.
Phases of Real Estate Cycle • Boom or Expansion • Oversupply • Slump or Recession • Recovery
Real Estate Cycle: Boom or Expansion Boom or Expansion. During the expansion phase, space becomes difficult to find, rents rise rapidly toward new construction levels, and prices continue to increase. Construction activities increase dramatically, but vacancy rates remain at normal levels or lower. This phase may last for a few months or for years, depending on the activity of system components, national economic trends, shifts in basic employment,, or changes in social relationships (such as family size or space needed per worker).
Real Estate Cycle: Expansion • Rents rise to levels which place significant financial pressure on tenants • The time it takes for a property to sell after being listed for sale reduces markedly • Property prices rise • Yields fall as prices rise proportionally more than rents rise • Property finance is easy to obtain and there are a number of new lending products making borrowing easier • People borrow against their increased house values and spend this money on consumer items (TVs, boats, holidays, cars, etc.) • There are many property seminars competing for investor value. • Property is a hot topic in the media. Initially there is much speculation about how price growth will continue, but later in the media turns its attention to the reduced affordability of property
Real Estate Cycle: Oversupply • Oversupply. At some point in the expansion phase, the market may become overbuilt. Builders and lenders may not perceive that the market is saturated. They continue to pump capital and new buildings into the market or an external shock occurs such as an unfavorable tax law or a general economic recession. In this phase, prices begin to drop, sales activity begins to slow, and vacancies begin to increase. As these changes occur, they tend to gather momentum, and prices and sales activity begin to slow even more. New construction continues for a while in this phase for two major reasons: • Builders, developers, or lenders do not detect the change occurring in the market. • Some projects in the pipeline cannot be stopped. When these projects are completed, however, new developments and construction quickly come to a halt.
Real Estate Cycle: Slump or Recession Slump or Recession. In the slump phase, sales activity is very slow, while prices and rents continue to decline. Decreases in property value vary by property type and location. Some areas may be hit severely by an economic downturn while other areas may only be slightly affected. Whatever the impact, the rate of decline begins to decrease and eventually bottoms out. Almost no new construction occurs.
Real Estate Cycle: Recession • What is observed during the recession phase includes: • Increased vacancies of rental properties • Reduced cash flow for investors • Property price growth stagnates and/or property values fall • The length of time to sell a property increases markedly • Increased number of mortgagee/forced sales • Property finance is more difficult to obtain • There is much 'doom and gloom' about property values being too high in the media • Many property investors experience lower cashflow and sell down their property portfolios to some degree, or completely.
Real Estate Cycle: Recovery • Recovery. After a depression, the market stabilizes, prices begin to recover, and excess space begins to be absorbed. This process continues, and the vacancy rate begins to approach equilibrium, where supply equals demand. Recovery is usually caused by one of two factors: • External Shock. A development outside of real estate, such as a revision of tax laws, may cause the recovery. • Passage of Time. The real estate cycle runs its normal course. After a recession or depression, very little or no new construction may occur for several months or years. Eventually, general economic activity begins to increase the demand for space, excess space is absorbed, and financing becomes available on favorable terms.
Real Estate Cycle: Recovery • What is observed during the recovery phase includes: • Increased rents and cash flows • The length of time to sell a property reduces • Property prices begin to increase • Much confusion in the media reigns about whether recent property value growth is sustainable • Many potential property purchasers delay buying because they evidenced value falls or a slow market in the preceding slump