Real Estate Midterm

endowment effect

occurs when a person values something (e.g. property, asset, etc.) more when they possess it than if they had to purchase it

What is the rationale for RE Regulation

externalities, incomplete information, uncertainty and value stability, natural monopolies, complementarities, underproduction of certain products

What are the two main types of real estate regulation

traditional and modern

What are traditional land use controls?

building codes, zoning, subdivision regulations

building codes

likely the oldest traditional type of land use control, requires certain construction, engineering, design, and safety standards for all building and construction, without such standards it is difficult to ascertain precisely what risks are posed by a particular structure - helps resolve asymmetric information

subdivision regulations

in addition to subdividing land into smaller parcels subdivision regulation often includes: standards for streets, sewers and water systems, adequate water supply for fire safety, adequate drainage and run off retention, open spaces, lot layout, easements for utilities, traffic and pedestrian safety

What are the elements of zoning ordinances

1. use classifications (residential, commercial, etc.)

2. use districts (zoning map)

3. setback requirements

4. building bulk or density limits (heigh restrictions, floor area)

5. minimum lot dimensions

6. special use districts (churches, hospitals, service stations, cemeteries)

7. zoning commission (oversee administration consider rezoning requests, review hardship cases)

what are nonconforming uses?

when zoning is changes some existing land use might fall outside the new classification, can be grandfathered if use is never discontinued, use can be allowed for a period of time (or amortized)

variance in use

if zoning ordinance imposes exceptional hardship owner can apply for a variance in use, must be unique to the parcel, must not materially change character of neighborhood

zoning oversight

1. on top is a planning/zoning commission - appointed by elected officials in advisory capacity

2. second is board of adjustment - appointed by elected officials to review petitions for variance, decisions are final rather than advisory

3. third is site plan review board - open public review process, informal procedures to allow for variety of public voices to be expressed, often the most challenging step in real estate development

what are the types of modern real estate regulation?

planned unit developments, performance standards, impact fees, form-based zoning codes, environmental regulations and controls

traditional vs new urban

traditional - separated uses and uniform density, automobile oriented (priority placed on easy ingress and egress), cul-de-sac hierarchy in heighborhoods

new urban - mixed use and mixed density, public transportation and pedestrian oriented (sidewalks, houses close to street, rear alleys), grid streets with restricted traffic flows

planned unit development (PUD)

involves developing a detailed plan for a community that mixes various land uses and standards in nonuniform ways, often involves mixed land use types, mixed density, no standard setback requirements, open community spaces, community recreation and other facilities

form-based zoning

in contrast to restrictions based on land use, form-based zoning aims to restrict based on structural qualities (i.e. form), based on street character, walkway character, structure shapes and sizes, development density, parking arrangements, foliage character

performance standards

place an underlying requirement on the use of land but do not otherwise provide a restriction on land use, for instance a neighborhood can be redeveloped for any purpose as long as noise and enviornment are not impacted, common performance standards involve noise and emission limits, traffic impact limits, tree removal limits, storm runoff limits

impact fees

favorite tool of economists (in principle) for people to internalize externalities, if a new development imposes external costs on neighborhoods or the community then the developer can pay an impact fee to compensate those affected, to achieve social efficiency the impact fee must be approximately equal to the negative externalities generated

environmental regulations

state and federal regulations concerning land use and environmental hazards: clean air act 1970, clean water act 1977, safe drinking water act 1974, resource conservation and recovery act 1976, toxic substances control act 1976, comprehensive environmental response compensation and liability act (CERCLA) 1980, endangered species act 1973

sales comparison approach 4 big steps

1. identify elements of comparison and value adjustment

2. select comparable sales

3. adjust comparable sale prices to approximate subject

4. reconcile adjusted sale prices and obtain indicated value of subject

identify elements of comparison and value adjustment

first step involves evaluating the subject property to determine which attributes are most important and salient for determining value, i.e. what are the things that most prospective buyers would care about, e.g. location, lot size, house size, building age, # of bathrooms, etc. idiosyncratic attributes or features that are not widely considered important likely won’t affect valuation and could make finding comparison more difficult e.g. attached skating rink

select comparable sales

second step involves finding and selecting properties that are most similar/comparable according to the attributes identified in step 1, this is the step that will most likely determine the accuracy of the valuation, ideal comparable are properties that are good and clear substitutes for the subject property, to most prospective buyers, should ideally reduce the need to make adjustments in the next step, finding good comparable may be challenging especially if property is more atypical or if local property market is small

adjust comparable sale prices to approximate subject

third step involves taking the sales prices of the selected comparable properties and adjusting them, the adjustments should reflect an underlying change to the comparable property to make it more similar to the subject property, estimating how much of an adjustment should be made is more art than science, this is where the knowledge, experience and data of a professional appraiser or agent is especially helpful

reconcile adjusted sale prices; obtain indicated value of subject

fourth step involves taking the adjusted sales prices of the selected comparable properties and deciding how they inform the valuation of the subject property, again there is no objective formula for doing this, while an arithmetic average of the adjusted prices of comparable is often a safe estimate there may be reasons to weight certain comparable properties over others (perhaps one comparable is very similar to the subject, while the others are much less so)

What are the 2 major dimensions for comparison?

transactional dimensions and property dimensions

transactional dimentions

1. property rights conveyed - if a subject property is a fee simple absolute it should be compared to other transactions conveying the same real property interests

2. financing terms - while financing conditions matter in deteriming sales prices such information is often difficult to obtain

3. conditions of sale - if sale was between family members or was a distressed sale (e.g. foreclosure) then sale is not likely comparable, these can sometimes be identified as outliers in transactions data i.e. prices that are unrealistically low

4. expenditures made immediately after purchase - while such purchases can distort observed sales prices (making them too low) such information is often difficult to obtain, sometimes can be determined by general condition of property as presented in MLS listing

5. market conditions - real estate market conditions can change rapidly, it is important to not consider comparable sales that occurred too far in the past, correcting for general changes in property prices is possible but tricky

property dimensions

1. location - arguable the most important factor in real estate, comparable should exist within the same basic location as the subject property

2. physical characteristics - while there are generally too many different physical characteristics to consider, commonly used attributes are: lot size, floor space, # of bedrooms, # of bathrooms, property age, and availability of parking

3. economic characteristics - applies to commercial properties

4. use - comparable properties should ideally have been purchased with the same intended use as the subject property, the best possible use of the real property will provide the best guide to the property value - but making sure projections may be challenging

   1. nonrealty items - if sellers agree to leave valuable personal property - e.g. furniture, equipment, sheds, etc. - this can influence sales prices, as with certain other dimensions obtaining this information for past transactions can be difficult

cost approach

another approach for estimating the value of a property is known as the cost approach, this method attempts to estimate the building costs associated with recreating the subject property from the ground up while making adjustments for depreciation

estimated cost to construct structure today

-estimated accrued depreciation

=depreciated cost of building improvements

+estimated value of land

=indicated market value by the cost approach

construction costs

there are two types of construction estimates: reproduction cost and replacement cost

reproduction cost is the expenditure required to replicate the structure exactly as is - including possibly dated features materials and equipment

replacement cost is the expenditure required to construct a structure of equal utility or usefulness - even if the replacement structure is not identical to the existing structure

certain companies specialize in estimating such building costs in the US

depreciation

depreciation is the loss in value due to deterioration or obsolescence of a structure

physical deterioration - aging and decay of physical structure and its materials e.g. roof, furnace, flooring, etc.

functional obsolescence - changing tastes, new technology, can make older structures less desirable e.g. too many structurally essential walls, no room for 2-car garage, etc.

external obsolescence - neighborhood or location character changes e.g. change in zoning density

comparing approaches to valuation

what are situations where the cost approach is likely preferred?

brand new structures - have never even been sold before (no concerns for depreciation involved

appraisals by insurance companies - the potential expense they face is the cost of rebuilding

specialty buildings - structures for whom there are simply no appropriate sales comparable the construction cost may be the only objective metric e.g. church, lighthouse, etc.

commercial valuation

an income producing property is typically valued by the rental income generated by the property, the income approach aims to estimate the market value of a property based on its expected rental income, works best for valuing properties that are rented out - commercial properties that are owner-occupied may have other factors driving value

income approach

in finance and economics the value of a cash earning asset is typically determined by the present value of its expected future cash flows - discounted cash flow (DCF) approach, the discounted cash flow approach makes conceptual sense but involves a more complicated set of calculations and forecasts about future cash flows, such cash flow calculation are also highly specific to the particular property its owner and their investment horizon

direct capitalization approach

owning in part to its simplicity this approach is more commony referenced in the real estate practice, the approach estimates the market value as a multiple of the property’s net operating income, the net operating income can be estimated by the appraiser which is then multiplied by a comparable capitalization rate, to estimate the market value, this is similar to the price to earnings ration frequently cited in valuing stocks/equity

direct capitalization formula

Market Value = (NOI / Cap Rate) or Cap Rate = (NOI / Market Value)

Net Operating Income calculation

PGI potential gross income

-VC vacancy and collection loss

+MI miscellaneous income

= EGI effective gross income

-OE operating expenses

-CAPX capital expenditures 

=NOI net operating income

estimated for the first year of owning the property

cities

cities are collections clusters or communities of people in close geographic proximity, people typically cluster together for various reasons: - mutual security/protection, economic production, social, political, cities exist because they accomplish things that would be challenging to do for people living in isolation, export is needed primarily as a means of obtaining imports (i.e. things that cannot be produced locally)

location of cities

proximity to economic resources (e.g. natural resources, people, etc.) are important factors determining the location of cities because of the transportation costs, typically people locate close to resources that are difficult transport (e.g. freshwater) but also where there is easier access to other needed resources (e.g. nearby waterways, rail, highway), it is clear that not all cities are the same size, the size of cities isn’t determined simply by the amount of local natural resources or access

what are the four main things that create agglomeration economies?

economies of scale, economies of density, economies of scope, network efficiencies

economies of scale

occurs when the average costs of production fall as more output is produced - e.g. if you produce 1000 pies the average production cost per pie is lower than if you produce only 10 pies, larger scale production can lower costs to the point where they compensate for transport costs

economies of density

occurs when producers can share certain resources or inputs resulting in lower costs for all e.g. universities with libraries, research resources, classrooms etc. e.g. amenities like sports stadiums or facilities (which can be used by multiple sports teams) also occurs with public infrastructure such as energy, utilities, transportation, etc.

economies of scope

occurs when the average costs of production fall as more types of related products are produced e.g. bakery can more efficiently use resources by making a variety of goods - pies, cookies, etc. sometime pure specialization is also helpful but at times a variety of related products can be most efficiently produced in one place

network efficiencies

also known as network externalities or demand side economies of scale, occurs when a product becomes more valuable/useful the more people use it e.g. social networks, LinkedIn, local telephone services, languages, the opposite of the externality of congestions

agglomeration economies

refers to the broad set of benefits and positive spillovers resulting from close geographic proximity, occurs when industries and their specialized labor pools cluster together to capitalize on economies of scale, scope, density, etc. when people/firms are in close proximity they share resources, ideas, knowledge, innovations, which results in greater productivity than the sum of the parts, people in a cluster become a new valuable resource which attracts firms to the cluster

economies of city shape

cities around the world feature a variety of different shapes but are generally affected by similar underlying economic forces, proximity and transportation costs are still important and relevant factors shaping cities in the 21st century, proximity to resources and access still shape modern cities as they did ancient ones, ideally located land is an important scarce resources only 6% of land area of US is developed

economic issues

Furman describes broader economic research on how land use restrictions impede economic growth and development - meaningfully reduced standards of living, a person can be more productive when relocated to region with agglomeration economies, reduced labor mobility can reduce employer-employee match quality, restrictions potentially lead to more volatile housing price downswings - due to exacerbated housing price bubbles

social issues

restrictions can act as an economic barrier to entry to highly productive urban centers - fewer people can afford expensive but necessary housing, only more socioeconomically advantaged can access greater economic opportunities - contributes to income and wealth inequality, lower density can make provision of public goods and services more costly - resulting in less public goods provision

environmental issues

land use restrictions that lead to urban sprawl have adverse environmental consequences, longer commutes or travel distances necessitate greater fossil fuel and resource consumption, more widespread land development encroaches upon ecosystem and natural wildlife, long commutes also carry adverse consequences for human health e.g. car accidents, high-blood pressure, mental health, etc.

challenges of land use regulation

though land use regulations are necessary for addressing important problems (e.g. externalities) they can also create problems, often civic leaders organizations and local government are not following an objective cost-benefit analysis in determining regulation, regulations tend to favor the interest of incumbent property owners but with broader consequences

property taxes

today most property taxes are ad valorem taxes - a tax that is proportionate to the property or transaction value, the tax accessor appraises taxable properties and determines an assessed value, the taxable value of a property deducts any exemptions, e.g. homestead exemption for primary residences, the effective tax rate is the amount of tax owed divided by the market value of the property - can incorporate several separate property taxes

property tax challenges

assessing the value of a property can be challenging as properties may be infrequently sold, since market value reflects both land and its improvements property taxes based on market value can discourage land development and improvements - highly distorts use of land, out of consideration for incumbent residents many municipalities have adopted restrictions on how much property taxes can rise which can create problematic incentives and barriers to selling e.g. California prop 13

alternative property taxes

many alternatives means of raising local tax revenue from properties exist or have existed in the past: taxes on house size (e.g. bricks, bedrooms, windows, etc.), user fees (e.g. gas taxes, tolls, waste collection fees, etc.), local sales taxes, vacancy taxes, non-resident taxes, transaction taxes (e.g. land transfer tax), land value tax

land value tax (LVT)

a land value tax is a property tax based only on the value of the land (without consideration for structures or improvements), taxes based on market value can discourage use and development as improvements are taxes - e.g. it may be more profitable to leave a parcel vacant and speculate on appreciation than to develop land, land value taxes have been advocated by economists as they are less distortionary and promote most valued uses of land

non-explicit property taxes

in some instances property taxes have been effectively disguised, for example HK has some of the most expensive real estate in the world - routinely #1 on many lists of most expensive cities to buy property, Hong Kong is considered a low tax jurisdiction e.g. sales tax, no capital gains, etc. land use is heavily restricted and undeveloped land is government owned new land is only sold occasionally, government artificially restricts land sale to generate revenue from sales - acts as a quota - extremely economically inefficient

ideal public finance

raising funds for necessary public goods, services and infrastructure is an economic reality - there is no such thing as a free lunch, the central question in public finance is: how can revenues be generated in the least inefficient way? i.e. the way that produces the least distortions to behavior decisions or investment, unfortunately mostly commonly used means of public finance do create distortions - like with land use restrictions there is room for improvement and innovation