Real Estate Markets

Markets are the means by which buyers and sellers trade goods and services. The real
estate market can be broken down into space markets and asset markets.

Space Markets the mechanism for trading the rights to use land and buildings
1. Demand for space is created by those who are willing to pay for the use of space
2. Supply for space is provided by those willing to sell the rights that they own to the
users

Space markets can be categorized by type of use:

1. Office Space
Class A Superior quality and location that command the highest rents
Class B Highly desirable, but lacking attributes that would otherwise
command top dollar
Class C Buildings with few amenities but are in good condition and are
modestly priced
Class D Buildings with few amenities in poor locations and generally
poor condition

2. Retail Space
Freestanding retail single tenant buildings
Neighborhood center serve a relatively small population within a 1
mile radius often anchored by a supermarket with other stores providing
convenience goods and personal services, such as strip centers (Oak Park
Village on N. New Branfels)
Community center serves a larger trade area within a 3-5 mile radius
with a wider variety of stores often anchored by a department store (De
Zavala/I-10 area or the Colonnade at Wurzbach/I-10)
Regional center serves an area within a 7-12 mile radius often in the
form of enclosed malls and anchored by two or more department stores
(North Star, Windsor malls)
Superregional center serves areas of up to 50 miles in radius with a
tremendous range of products and services (San Marcos outlet)

3. Industrial Space
Warehouse and distribution
Manufacturing and production
Materials processing

4. Agricultural Space
Annual and perennial cropland
Livestock facilities and grazing
 5. Lodging Space
Highway motels Motel 6
Convention/business hotels (have convention space) Marriott
Luxury hotels La Mansion on the Riverwalk
Extended stay hotels/motels (apartments) Warren Inn
Resort or destination hotels Hyatt Hill Country

6. Residential Space
Single family detached homes
Single family attached homes (condos, co-ops and townhouses)
Manufactured homes
Multi-family apartments

The demand for real estate space is represented as are all demand curves a downward
sloping line in which the quantity demanded decreases as price increases. The supply for
real estate space is somewhat different than the typical supply curve in which the supply
increases as the price increases. This is due to the long-term nature of real estate space in
which quantity cannot be quickly adjusted changes in demand (see Figure 8.2 on page
157). Figure 8.3 depicts the short-term nature of changes in demand. A drop in demand
immediately results in a drop in price since the quantity of available real estate is fixed.
An increase in demand will result in an increase in prices (extended the vertical quantity
line up until it intersects with the D1 demand curve to see where the equilibrium price
P** would be). Longer term, the supply curve is upward sloping as older buildings are
replaced with higher density construction.

Asset Markets the market for cash flow rights to real estate ownership (value)

Capital Markets the market for long-term (more than one year) assets. This includes
stocks and bonds as well as real estate.
Public markets
o Publicly traded stocks (equity), bonds and money market (less than one
year) instruments
o REITs (real estate investment trusts) invest in real property
o Mutual Funds invest in stocks and bonds (and other financial assets)

Private markets
o Real property
o Privately-held companies
o Partnerships (oil and gas, leasing)
o Bank loans
o Individual mortgages (as opposed to mortgage backed securities, which
are publicly traded securities backed, or securitized, by mortgages)
o Private (venture) debt
Like all assets, both real and financial, market prices are determined by
1. Cost of capital (an opportunity cost) this refers to the fact that investors have
alternative investment opportunities in which to earn a rate of return on their
invested capital. Thus, investors look at the rates of return that can be earned
elsewhere before making an investment in a specific asset.
2. Expectations of future cash flows (which reflect growth opportunities) how
much an investor is willing to pay for an asset is a function of the future cash
flows that they can anticipate realizing from the investment. This includes both
increases (growth) as well as decreases (decline) in cash flows.
3. Risk the risk related to the investment is an important consideration in order to
compare apples to apples. Clearly, an investment in a government bond has no
risk associated with the payments by the government, whereas investment in
mortgages has default risk and investment in stocks or real property has
uncertainty of cash flows in general due to the residual nature of the ownership
claim. As will be seen later, the higher the risk of an investment, everything else
the same, the lower price that investors are willing to pay since investors are risk-
averse.

The definition of fair market value can be described as

the price at which an asset trades between a willing buyer and a willing seller,
neither of whom is under compulsion to buy or sell, and both of whom are
knowledgeable of the risks and future prospects of the asset

The relationship between the Space Market and the Asset Market in real estate is tied
together through the cash flows. The price at which the use of real estate space is sold is
a function of supply and demand which determines rent. In addition, economic
circumstances beyond the supply and demand for space determine the costs of providing
space. The difference between rents and costs represent the cash flows available to
investors which are valued in the asset market. Economic circumstances in other markets
also impact the opportunity cost of capital and, hence, the value of real estate assets and
the allocation of capital to providing additional space (supply) in the space market.

Real Estate Market Analysis study of the supply and demand sides of a real estate space
market

Revenue Considerations:

o Rents what can be charged to tenants (competitors rents)

o Vacancy rate
o Amount of competing space currently and anticipated
o Rate of absorption of space
o Number of units/floor space on the property
o Location
 o Type of building
o Growth prospects

All of these factors are interrelated. The term months supply of property refers to how
long it will take before demand fills a given supply of real estate space. It can be defined
as

Vacant Space Space under Construction

Months Supply
Net Absorption per Month

This is one measure of the desirability of adding new space since it is directly impacts the
revenue stream that can be anticipated from development.

Important considerations by market segment for revenues:

1. Office Space employment in occupations requiring office space
2. Lodging air passenger volume, highway traffic counts, tourism receipts, number
of visitors
3. Retail per capita income, aggregate income
4. Industrial manufacturing employment, shipping volume
5. Apartments population, household formation, housing affordability,
employment growth
6. Owner-occupied residential population, household formation, interest rates,
employment growth, income growth, apartment rents