Chapter 5 REAL ESTATE ECONOMICS AND VALUE CHAPTER TERMS AND CONCEPTS Agents of production Over-improvement Amenities Physical forces Demand Political forces Demography Principle of anticipation Economic forces Principle of change Fiscal policy Principle of competition Gross domestic product (GDP) Principle of conformity Monetary policy Principle of increasing and Monetary theory decreasing returns 2 CHAPTER TERMS AND CONCEPTS Principle of progression and Purchasing power principle of regression Real estate cycle Principle of substitution Scarcity Principle of supply and demand Secondary market Principles of highest and best use Social forces and consistent use Principles of surplus Supply Surplus of productivity productivity, balance, and Transferability contribution Utility 3 LEARNING OUTCOMES 1. List the four basic elements of value. 2. List and give examples of the broad forces that affect value. 3. Define real estate cycles. 4. Name the major supply and demand factors that cause economic changes affecting real estate. 5. Describe the federal governmentвЂ™s role in the economy. 6. Explain how the principles of value relate to the marketing and productivity of real estate. THE REAL ESTATE VALUE INFLUENCES Real Estate has no Intrinsic Value Value is Derived from Rights and Benefits that Come from: o o o Ownership Possession and Use FOUR ESSENTIALS OF VALUE Utility п‚§ Usefulness; the ability to create a desire for possession Scarcity п‚§ In relatively short supply; a lack of abundance Demand п‚§ The desire to possess plus the ability to buy; effective purchasing power Transferability п‚§ The ability to change the owner or use; marketable title = Market Value BROAD FORCES INFLUENCING VALUE вЂў Physical Forces вЂў Social Forces вЂў Economic Forces вЂў Political Forces PHYSICAL FORCES Natural Resources Developed Resources SOCIAL FORCES 1. 2. 3. 4. 5. 6. 7. Demographics Neighborhood Stability Population Life Styles Attitudes; Behavior Attitudes; Development Attitudes; Public Education ECONOMIC FORCES 1. Income Levels 2. Employment 3. Wages and Jobs 4. Money and Credit 5. Price Levels 6. Personal Savings 7. General Business Activity 8. Supply and Demand for Housing 9. Production of Goods and Services POLITICAL FORCES 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Zoning and Land Use Building and Safety Environmental Laws Endangered Species Act Police, Fire, and Health Crime Prevention Public Works Fiscal Policy Monetary Policy Government Sponsored Programs Government Regulations HOW ECONOMIC TRENDS AFFECT REAL ESTATE пЃ± Economic Trends and the Business Cycle пЃ± Real Estate Supply Factors пЃ± Real Estate Demand Factors пЃ± Federal Government Activity ECONOMIC TRENDS AND THE BUSINESS CYCLE пЃ¶ An Economic Trend is a Pattern of Changes пЃ¶ Cycles пЃ¶Business пЃ¶Real cycles Estate Cycles пЃ¶ The Cycle of Construction пЃ¶ New Home Sales пЃ¶ Volume of Sales Used by Permission of Alma Dizon: www.riverside-real-estate.us REAL ESTATE SUPPLY FACTORS вЂў Housing Supply вЂў New Construction вЂў Supply of Vacant Land REAL ESTATE DEMAND FACTORS пѓ� Population пѓ� Purchasing Power FEDERAL GOVERNMENT ACTIVITY вЂў Housing and Urban Development Programs o FNMA п‚§ п‚§ o Federal National Mortgage Association Secondary Market FHA п‚§ Federal Housing Administration Figure 5.5: Government Housing Project under Construction FEDERAL GOVERNMENT PROGRAMS вЂў Energy and the Environment o EPA п‚§ Environmental Protection Agency o FEMA п‚§ Flood Maps вЂў Governmental Banking and Monetary Policy o Federal п‚§ Reserve Monetary Policy Actions THE ECONOMIC PRINCIPLES OF VALUATION пѓ� пѓ� пѓ� пѓ� пѓ� пѓ� пѓ� Principle of Substitution Principle of Conformity Principle of Progression Principle of regression Principle of Change Principle of Supply and Demand Principle of Competition PRINCIPLE OF SUBSTITUTION вЂў When a Property Easily can be Replaced by Another, the Value of Such a Property Tends to be Set by the Cost of Acquiring an Equally Desirable Substitute вЂў The Principle of Substitution is a Basic Concept Behind Each of the Three Approaches to Value PRINCIPLE OF CONFORMITY Maximum Value п‚§ Properties are similar o Size o Style o Quality o Amenities/Utility Over-improvement п‚§ 5 bedroom in a 3 bedroom neighborhood PRINCIPLES OF REGRESSION & PROGRESSION вЂў Progression o Lower value properties benefit from being close to high value properties вЂў Regression o Higher value properties tend to decrease in value when close to lower value properties. вЂў Is This an Illustration of Progression or Regression? PRINCIPLE OF CHANGE Change is Eternal o Physical o Social o Economic o Political conditions Neighborhood Change o Development (growth) o Stability o Decline o Renaissance (rebirth) PRINCIPLE OF SUPPLY AND DEMAND вЂў Price Goes Up with an Increase in Demand or Decrease in Supply вЂў Price Goes Down with a Decrease in Demand or Increase in Supply вЂў Theoretically, when Supply and Demand are in Balance, Market Prices Reflect the Cost of Production with Reasonable Profit Supply P r i c e Deman d Quantity Principle of Competition пѓ� Market Demand Generates Profits пѓ� Profits Generate Competition пѓ� Excess Profits Usually Generate Ruinous Competition PRINCIPLES OF REAL ESTATE PRODUCTIVITY 1. Agents of Production 2. Principles of: a) Surplus Productivity b) Balance c) Contribution 3. Principle of Increasing and Decreasing Returns 4. Principle of Highest and Best Use 5. Principle of Consistent Use 6. Principle of Anticipation AGENTS OF PRODUCTION o Labor o Coordination o Capitol o Land PRINCIPLE OF SURPLUS PRODUCTIVITY вЂў The Net Income or Other Benefits that Remain after the Cost of Labor, Coordination, and Capital have been satisfied have been described as the вЂњResidualвЂќ Returns to Land. п‚§ Surplus of Productivity вЂў Dollar Amount of Surplus becomes Basis of Land Value PRINCIPLE OF BALANCE вЂў Proper Balance in the Agents of Production is Required if the Maximum Value is to Result from the Costs Invested. п‚§ Consistent with Principle of Conformity PRINCIPLE OF CONTRIBUTION вЂў The Benefit of An Agent of Production Depends Not on Cost But How Much it Contributes to Value п‚§ A pool may cost $25,000 but only contribute $10,000 of value. вЂў Principle of Surplus Productivity is the basis for the Principle of increasing and decreasing returns and the principle of highest and best use. INCREASING & DECREASING RETURNS вЂў Fertilizer Principle! o Added increments of fertilizer and labor do not result in equal increases in crop yield o This principle helps property owners make decisions about adding improvements or remodeling п‚§ What to add and to what degree PRINCIPLE OF HIGHEST AND BEST USE вЂў Highest and Best Use Means the Most Profitable Use вЂў Theoretical Balance Between Land and Improvements п‚§ Helps in estimating land value вЂў Highest and Best Use as: п‚§ п‚§ Vacant Improved PRINCIPLE OF CONSISTENT USE вЂў Corollary to the Principle of Highest and Best Use п‚§ Must appraise land and improvements on the basis of the same use. п‚§ This photo shows that the improvements (house) are a detriment to development of town homes. PRINCIPLE OF ANTICIPATION вЂў Value is the Present Worth of Future Benefits вЂў The Principle of Anticipation Underlies the Income Approach to Value. SUMMARY Real estate is a basic and fundamental form of wealth, it has no intrinsic value. Its market value is a measure of the rights that the owners control, valued at prices set in the market. But in order to enter the market, the rights must have the four elements of utility, scarcity, demand, and transferability. We know that real estate is affected by changing business conditions, such as employment, income and price levels, production volumes, and building construction costs. Thus, it is possible to analyze and better understand real estate by observing key supply and demand factors in the general economy.