SETTING THE STAGE 1. The Nature of Real Estate and Real Estate Markets

We began this chapter by looking at the different uses of the term real estate. This was fol- lowed by a discussion of land use in the United States and the contribution of real estate to U.S. and household wealth, and then a discussion of the real estate market. The term real estate is used in three fundamental ways: (1) to identify the tangible assets of land and buildings; (2) to denote the “bundle” of rights associated with the owner- ship and use of the physical assets; and (3) to refer to the industry, or business activities, related to the acquisition, operation, and disposition of the physical assets. Viewed as a tangible asset, real estate constitutes the physical components of location and space. In this context, real estate is defined as the land and any improvements permanently affixed on, or to, the land. The bundle of intangible rights, or interests, associated with the ownership and use of the physical characteristics of space and location constitutes the services that real estate provides to its users. It is the services/benefits that result from the use of the property that create value. Said differently, tracts of dirt do not have any intrinsic value. It is the uses to which the dirt can be put that create value. Real estate typically generates over 25 percent of U.S. gross domestic product (GDP), creates jobs for nearly 9 million Americans, and is the source of nearly 70 percent of local government revenues. The total contribution of the housing sector alone approaches 20 percent of GDP. Real estate construction, construction permit activity, and real estate sales figures are closely watched by investors on Wall Street and across the world because of the effect real estate has on the nation’s economy. Real estate also represents a signifi- cant share of our accumulated national wealth. The total value of owner-occupied housing and investible commercial real estate in the United States is estimated to be $30.8 trillion. Approximately $22.0 trillion of this represents the value of owner-occupied housing. Hous- ing alone represents approximately 22 percent of U.S. household wealth and is the single largest asset category owned by households. Real estate market activity is influenced by the activities and conditions that take place in three sectors of a market economy: (1) the user market, (2) the financial or capital market, and (3) the government sector. Real estate users compete in the market for location and space. Among the users of space are both renters and owners. The financial resources to acquire real estate assets are allocated in the capital market; hence, equity investors and investors in mort- gage debt (lenders) are capital market participants. Local and state governments, as well as the federal government, influence the activities of each of the participant groups through regulations, provisions of services and infrastructure, taxes, and various subsidies. Two primary characteristics of real estate assets distinguish them from others: heterogene- ity and immobility. Because of these two factors, the market for evaluating, producing, buying, selling, leasing, and managing real estate tends to be illiquid, localized, and highly segmented, and it usually involves privately negotiated transactions with relatively high transaction costs.

Provide three alternative definitions for the term real estate.

1. Tangible Asset: Land and its permanent improvements (e.g., buildings, infrastructure).

2. Bundle of Rights: Legal rights associated with ownership (possession, use, enjoyment, disposition).

3. Industry/Profession: Business activities related to acquiring, managing, and selling real property (e.g., brokerage, development, appraisal).

Discuss the distribution of U.S. land among the various uses to which it is put (e.g., developed land, federal land, forest land).

• Developed Land: ~6% (residential, commercial, industrial, infrastructure).

• Federal Land: ~23% (national parks, forests, military bases).

• Forest Land: ~21%.

• Crop Land: ~19%.

• Range Land: ~21%.

• Other Uses: Pastureland (6%), water areas (23%), and miscellaneous rural land (3%).

Discuss the value and importance of U.S. real estate compared with the values of other asset classes such as stocks and bonds.

• Real estate is the second-largest asset class in the U.S. (~$30.8 trillion), exceeded only by corporate equities (~$35.7 trillion).

• Larger than mortgage debt ($13.8 trillion), government debt ($15.1 trillion), and corporate bonds ($11.7 trillion).

• Represents ~22% of household wealth (primary residences).

Describe the role real estate plays in the portfolios of U.S. households.

• Housing is the largest asset for U.S. households (22% of total wealth).

• Exceeds holdings of stocks, bonds, and other financial assets.

• 65% of household liabilities are home mortgages.

Discuss the primary ways that real estate markets are different from the markets for assets that trade in well-developed public markets.

1. Heterogeneous Products: Each property is unique (location, design, age).

2. Immobile: Land and structures cannot be relocated.

3. Localized Markets: Demand and supply are geographically limited.

4. Segmented: Markets differ by property type (e.g., residential vs. commercial).

5. High Transaction Costs: Privately negotiated deals with fees for agents, appraisers, etc.

A market where tenants negotiate rent and other terms with

property owners or their managers is referred to as a:

a. Property market.

b. User market.

c. Housing market.

d. Capital market.

b. User market

The market in which required rates of return on available

investment opportunities are determined is referred to as the:

a. Property market.

b. User market.

c. Housing market.

d. Capital market.

d. Capital market

The actions of local, state, and federal governments affect

real estate values:

a. Primarily through user markets.

b. Primarily through the capital market.

c. Primarily through their taxation policies.

d. Through all of the above.

d. Through all of the above

What portion of households owns their house?

a. Approximately one-third.

b. Approximately two-thirds.

c. Approximately one-half.

d. Approximately one-quarter.

b. Approximately two-thirds

Of the following asset categories, which has the greatest

aggregate market value?

a. Corporate equities.

b. Mortgage debt.

c. Government debt.

d. Nongovernment real estate.

a. Corporate equities

Storm water drainage systems are best described as:

a. Tangible assets.
b. Improvements to the land.
c. Intangible assets.

d. Improvements on the land.

d. Improvements to the land (part of infrastructure).

What is the single largest asset category in the portfolio of a

typical U.S. household?

a. Housing.
b. Consumer durables.

c. Stocks.

d. Bonds.

a. Housing (22% of household wealth).

Real estate markets differ from other asset classes by having

all of the following characteristics except:

a. Local market.
b. High transaction costs.
c. Segmented market.

d. Homogeneous product.

d. Homogeneous product (real estate is heterogeneous).

Which of the following is not important to the location of

commercial properties?
a. Access to customers.
b. Visibility.
c. Access to schools.
d. Availability of communications infrastructure.

c. Access to schools (less critical than customers, visibility, or infrastructure).

Which of the following attributes of a home are the most difficult to observe and value?

c. Location attributes (external effects like proximity to amenities/noise).

What distinguishes real property from personal property?

A major determinant between real and personal property is whether or not the property is movable or permanently affixed to the land or structure.

What is the difference between tangible and intangible assets? Does the ownership of “real estate” involve tangible assets, intangible assets, or both?

Tangible assets are physical assets such as land, automobiles, and buildings. Intangible assets are nonphysical, including patents, financial claims, or contractual agreements. Real estate is a tangible asset, but a bundle of intangible rights is also associated with the ownership and use of the property.

U.S. households own $16.1 trillion in housing assets. Assume this amount does not include rental real estate. On average, what percent of the value of the U.S. housing stock is financed with home mortgage debt?

About 61 percent of the U.S. housing stock is financed with home mortgage debt. ($9.8 trillion in mortgage debt divided by $16.1 trillion in housing value.)

Investible assets based on real estate are traded in each of the four capital market quadrants. List the four quadrants and at least one real estate asset that trades in each.

The four capital market quadrants include private equity, private debt, public equity, and public debt:

1. Private Equity: Individuals, partnerships, private equity funds.

2. Private Debt: Banks, insurance companies, private lenders.

3. Public Equity: Public REITs, real estate operating companies.

4. Public Debt: Commercial mortgage-backed securities (CMBS), mortgage REITs.

In what market are rental rates for commercial real estate assets determined? In what market are property values determined?

Commercial real estate rental rates are determined in local user (space) markets, while property values are determined largely in the local property market.

Identify four ways in which real estate markets differ from the market for publicly traded stocks.

1. real estate is a heterogeneous product distinguished by its age, building design, and location.

2. real estate is immobile, and therefore location and its accessibility are important.

3. real estate is a localized, segmented market due to local competition and the heterogeneous nature of the product.

4. real estate transactions have high transfer costs, and most deals are privately negotiated.