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Real Estate and Urban Economic Analysis


... needed given the patterns of growth and the economics forces driving that growth ... Geographic direction of growth. Job growth ... – PowerPoint PPT presentation

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Title: Real Estate and Urban Economic Analysis

Real Estate and Urban Economic Analysis
  • Discussion Outline
  • The Basic Tools for Urban Economic Analysis
  • Theories of city growth and development
  • Economic base theory and the importance of job
    growth to real estate analysis
  • Deriving Land Value
  • Absolute and option value of land
  • Purpose and Value of Market Research
  • Leasing Terminology and Lease Structures

Why Study Urban Economics
  • Understand how cities grow
  • Why, when and how
  • real estate typically refers to urban, not
    rural land
  • Understand what types of real estate are needed
    given the patterns of growth and the economics
    forces driving that growth
  • Determine what land is worth in unique locations
    in an urban setting
  • Land value is a function of a citys growth
  • Location of land and its zoning and perceived
    value to end users determine its value over
  • Urban economics identifies land value as the
    determining factor for new development

Interesting Books on Urban Development
  • The City in History by Lewis Mumford
  • Urban sociology and history from the earliest
  • Measuring America by Andro Linklater
  • History of the origins of the land survey system
    of measurement and its contribution to the
    concept of individual ownership of land and its
  • How Cities Work

Theories of Urban Growth
  • Essentially all are part of location theory ?
    all forms of services and economic activity will
    find their optimal location
  • Central place theory
  • Development around a business, civic, religious
  • Ancient cities of Greece and Italy
  • Driven by transportation or lack thereof and
    the need/ability to reach your customer audience
  • Axial theory
  • Development along topographical and/or
    transportation features
  • my home town of Manchester, NH
  • Concentric circle theory a variation on central
    place theory
  • Development of the CBD
  • Concentric development of other, suburban nodes
  • urban sprawl and edge cities

Drivers of Growth
  • Centralizing forces
  • Economies of scale
  • Taking advantage of positive operating
    leverage/synergy, common physical or natural
  • Decentralizing forces
  • Quality of life issues
  • Pollution, crime, educational system, etc,
  • Cost of transportation
  • Dominance of one over the other is determined by
    the economic functions of an urban area

What are Economic Functions?
  • Economic functions are essentially activities
    that drive the urban economy
  • Centralizing forces government, manufacturing,
  • Growth of the steel belt, industrial northeast
  • Washington, DC., New York City
  • Decentralizing forces light manufacturing, RD
  • Raleigh Durham and the Triangle
  • Is technology centralizing or decentralizing?
  • What about job outsourcing overseas?

Higher and Lower Order Cities
  • Ranking of cities is another way to evaluate land
    use patterns
  • Higher Order cities ? larger populations,
    larger threshold markets to support economic
  • Typically dominated by activities that require
    close proximity of participants
  • Often called primary cities
  • Examples NYC, LA
  • Lower Order cities ? secondary and tertiary
    markets, depend on higher order cities for their
  • Examples Stanford, CT., City of Commerce

The Economic Base, the Base Multiplier, and
Location Quotients
  • A citys economic base is the group of
    functions that account for the export of goods
    and services its core economy
  • Functions that produce a net return on local
    investment capital, both private and public
  • This export base is what contributes to growth in
    urban areas
  • The export base multiplier is the ratio of new
    jobs created in supporting functions for every
    job created in the economic base
  • A citys location quotient is its concentration
    of jobs in a certain function relative to the
    national average

So, Why is All This Interesting?
  • Past and prospective real estate activity is a
    function of
  • Strength of the economic base, and a citys
    ranking as a primary, secondary, or tertiary city
  • Historical reason for a citys growth
  • Geographic direction of growth
  • Job growth
  • The first thing youll find in a commercial real
    estate appraisal, or a market research study, is
    an analysis of the economic activity in the
    region, city, and submarket

How Location Theory Helps Us Think about Real
Estate Value
  • Land has value because
  • it is in limited supply in any given location
  • it is a critical input in economic development
  • Users will pay a location premium for sites
    that meet their specific needs
  • Prestige, image, visibility
  • Ease of access to customers, vendors, airports,
    etc. ? lower cost, maximize productivity
  • Visibility
  • However, users will weigh the cost of all of
    their needs including land cost in the
    resource allocation decision
  • Land is only one of the costs

More About Land Value
  • Land is the basic building block but also the
    residual component of improved real estate
  • Land is the fixed input
  • Everything else the building and the economic
    activity is mobile and can locate anywhere
  • Since the other inputs have a choice, they have
    to earn a market rate of return on investment
    capital in order to attract capital to them and
    their location
  • In order of return
  • Investors in the business activity
  • Investors in the physical improvements on the
  • Land comes last!

Lennies Land Rule
  • If land gets paid last, then
  • Projects are only feasible if and when the
    combined cost of the land and other physical and
    subjective attributes, can command rents which
    are sufficient to achieve a market rate pf return
    on capital
  • The cost of land must be limited as a percent of
    the total project cost

The Bid Rent Curve
  • Explains land value as an allocation of resources
    between location and proximity
  • To employees, customers, vendors, distribution
    points, etc.
  • If location is less important, then more can
    be spent on transportation versus proximity
  • Therefore, uses will move out from the core
  • Land outside the core will be less dense,
    therefore less expensive
  • Companies will buy more of it because its cheaper

The Bid Rent Curve in Action
  • ZONING!!!!
  • Cities codify their development patterns in
    zoning laws that
  • centralize density in the core
  • restrict density in the suburban areas
  • Floor area ratios (FAR), setbacks, height
    restrictions, etc.
  • All keep density down
  • If land is one cost of input, and users have to
    acquire more of it to build in zoning restricted
    areas, they will be willing to pay less for it

Five Rules of Urban Land Valuation
  • Rule 1
  • Larger cities will have higher land prices,
    higher rents ? and higher salaries
  • Greater pressure on the fixed stock of land and
    its use
  • Salaries are higher because the cost of living is
  • The cost of living is higher because the fixed
    input of production land is more expensive

Five Rules of Urban Land Valuation (cont.)
  • Rule 2
  • If a city grows by increasing its available land
    area, the outlying acreage will increase in value
    faster than the CBD
  • more demand at the margin for lower cost

Five Rules of Urban Land Valuation (cont.)
  • Rule 3
  • Declining transportation costs all else being
    equal decreases the absolute value of land near
    the center and increases the relative value of
    the periphery
  • Remote, less dense land becomes more desirable
    because fewer resources are allocated to

Five Rules of Urban Land Valuation (cont.)
  • Rule 4
  • An increase in per capita incomes will cause an
    absolute reduction in CBD land prices
  • People have more money to spend on transportation
    so will move away from density
  • Urban flight

Five Rules of Urban Land Valuation (cont.)
  • Rule 5
  • Faster growth and greater uncertainty about
    future uses will increase land values
  • The option value of land
  • Speculative fever in land

Land as an Option
  • Ownership of land implies a development option
  • What it might be worth in the future at its
    highest and best use
  • Once you put land into development, you have
    defined its use and therefore its value
  • There is option value in the uncertainty of the
    sites prospective use
  • Investors who buy land for investment hold it
    until it is ready for development
  • Ie, when someone will pay them the value of the

The Role of Market Research
  • If land prices reflect patterns of economic
    growth and activity, then research can help to
    define a sites history,and make predictions
    about its future use, and the rents is might
  • The value (i.e., the PV) placed on that site is a
    function of todays rents and your assumptions
    about the future

Primary Forms of Market Research
  • Trend Analysis
  • Extrapolation of recent, past activity
  • Risk of lagging economic forces that can change
    recent trends
  • Structural Analysis
  • More specific, quantitative forecasting of supply
    and demand, such as
  • Retail per capita income, population growth,
    housing starts
  • Office net absorption, market vs. in place
    rents, job growth
  • Single family housing job growth, household
    formation, public investment in infrastructure
  • Most good research incorporates elements of both

Market Research and Leases
  • Use Market Research to evaluate
  • What market trends and conditions tell you about
    current and future lease rates
  • What kind of leasing strategy to employ
  • The probability of achieving your leasing and
    revenue forecasts
  • What return parameters are appropriate for
    investment capital

The Real Estate Leasing Strategy
  • Real estate needs to meet the market
  • Leasing should optimize not necessarily
    maximize a propertys financial performance in
    the context of
  • Market conditions and Investment strategy
  • Leasing is a choice between
  • current and future revenue
  • recurring versus choppy cash flow
  • Revenue concentration or diversification
  • ALWAYS cheaper to keep an existing tenant than to
    get a new one!

Key Conditions to Look For in Setting a Leasing
  • Net new job growth
  • Market rental rates
  • In place versus current asking rents
  • The vacancy rate
  • Physical versus economic vacancy
  • New construction starts and completions
  • Measurement of new supply
  • Absorption
  • net increase in occupied space
  • Comparable leasing and sales transactions

What are Tenants Looking For?
  • Tenants are interested in more than just rent
  • Location, management, space layout and efficiency
  • Things that affect what theyll pay
  • Market conditions
  • Location within the building
  • Size, length of lease
  • Options
  • Miscellaneous lease covenants