USB142 Fundamentals of Property Valuation - Week 1: Property and Economy

Foundations of Property Economics and Valuation

  • Economics is formally defined as a social science that investigates the production, distribution, and consumption of goods and services.

  • Robbins (1998) provides a specific definition of economics: the science that studies human behaviour as a relationship between ends and scarce means, which have alternative uses.

  • The practice of economics involves:

    • Analyzing current existing conditions.

    • Proposing what "ought to be" (normative economics).

    • Projecting trends.

    • Formulating recommendations for improvements in future decisions, choices, and resource distribution.

  • Positive Aim: The positive aim of economics is to provide the context and methods required to maximize the efficient and effective use of limited resources to meet the demands of individuals and communities.

  • Core Focus: The various branches of economics emphasize decision-making, setting priorities, and the distribution of resources.

The Discipline of Property Economics

  • Property economics is a specialized branch of economics focusing on the real estate market.

  • Factors influencing buyer and seller behaviour beyond pure economic reasoning or mathematical models (H$\ddot{\text{a}}$ring & Storbeck 2009):

    • Demographic profile (e.g., age, education levels, family structures, cultural and ethnic background).

    • Perceptions of risk.

    • Time preferences.

    • Community sentiment.

  • Understanding buyer and seller behaviour is vital in real estate because transactions are large-scale and carry significant financial consequences, both positive and negative.

Property and Microeconomics

  • Microeconomics is the study of how people make decisions, focusing on individuals, households, firms, and specific markets regarding the allocation of scarce resources.

  • Consumers are influenced by their priority of needs, wants, and income levels.

  • Maslow’s Hierarchy of Needs:

    • A motivational theory in psychology consisting of a five-tier model of human needs, typically depicted as a pyramid.

    • Behaviours are often motivated by multiple needs simultaneously.

    • The hierarchy levels (from base to peak) generally include physiological needs, safety needs, love and belonging, esteem, and self-actualization.

    • A central question in property economics is where property sits within this hierarchy (e.g., shelter as a physiological/safety need versus property as an investment for esteem or self-actualization).

  • Producer/Business Factors: Businesses are influenced by several variables:

    • Understanding of their target market.

    • Scale of production.

    • Available capital.

    • Risk profile.

    • Competition.

    • Time lags.

    • Input costs (both fixed and variable).

  • Market Mobility: Consumers have the ability to withdraw from specific markets and choose other options quickly. This creates a challenge for property and development markets because property assets have long time frames to produce (supply and build).

Property and Macroeconomics

  • Macroeconomics studies the aggregates of the economy and links between high-level variables:

    • Government policy.

    • Regions, industry sectors, and economic variables such as national income and output.

    • The Cash rate, interest rates, and exchange rates.

    • Employment levels.

    • Inflation.

    • Global markets and international trade (Hefferan 2021).

  • Relationship: Macroeconomics and microeconomics are interrelated and both exert impact on the property markets.

  • Complexity: The large size of investments and significant time lags require property economists to be highly skilled in predicting market movements regarding supply and demand impacts.

The Role of Property in the Economy

  • Economic Activity: Real property is a critical component of economic activity alongside capital, labour, and management skills.

  • Wealth Aggregation: Property serves as a basic form of holding and aggregating wealth.

  • Employment: Significant employment is generated through property development, financing, management, and operations.

  • Financial Security: Property provides the collateral (security) upon which most financial sector dealings are based.

  • Economic Theory Definition: In economic theory, "Land" encompasses buildings and other related fixed improvements.

General Economic Characteristics of Property

  • Small Parcels: Property assets are typically held in small parcels with tenure rights reinforced by legislation. Consequently, use decisions are made mostly at the microeconomic level.

  • Finite Resource: Land is fixed in quantity and cannot be recreated, impacting environmental, economic, and community sustainability.

  • Physical Asset: Components are subject to physical deterioration, decay, erosion, and obsolescence, requiring intensive management to maintain functionality.

  • Spatially Fixed: Problems of location and infrastructure are paramount. The positive and negative externalities (effects on surrounding environments) must be considered.

  • Heterogeneous Commodity: No two properties are exactly alike; they differ to varying extents.

  • Sector-Based: Assets exist in distinct sectors (Commercial, retail, industrial, residential, rural, etc.), each with different use capacities and supply/demand determinants.

  • Management Requirement: Value is secured through development and use, making functionality, income generation, and asset-in-use management critical.

  • Investment Intensive: The land component requires capital and other factors of production to reach its "Highest and Best Use." Factors effectively merge with the land and cannot be extracted later.

  • Long Supply Lags: There are considerable time delays in recognizing demand and producing usable property. This can lead to short-term price spikes and windfall profits for current asset holders.

  • High Entry Price: High unit prices create barriers to entry, favouring long-term investments and making buy/sell decisions highly significant.

  • Legislative Control: Extensive regulation dictates development levels, influences value, and sets parameters for ownership and use.

  • Changeable Asset: Property is dynamic, evolving physically, legally, and economically. Strategy must incorporate adaptability and flexibility.

Linkage to Other Economic Sectors

  • Property is integrated with the financial, development, and construction sectors.

  • Economic Cycles: The link between property and the wider economy is defined by economic cycles.

    • Expansion: Increase in production/output, decrease in unemployment, increase in wages, and increase in consumer spending.

    • Contraction: Decrease in production/output, increase in unemployment, decrease in wages, and decrease in consumer spending.

  • Factors impacting investment flow into property:

    • Direction and predisposition of the financial sector.

    • Attractiveness of competing investments (e.g., share market, bond rates).

    • Prevailing interest rates and exchange rates.

Property in the Australian Economy

  • Economic Interest: Australians have direct interests (owning, leasing, working) and indirect interests (investments, superannuation, insurance) in property.

  • Residential Property Statistics (ABS 2026):

    • Total value of dwelling stock: $\$ 12,772.6 \text{ billion}$.

    • Total number of residential dwellings: $11,495,200$.

    • Mean price of residential dwellings: $\$ 1,111,100$.

Detailed Characteristics of Property

Physical Characteristics

Land

  • Individual elements: Shape, size, topography, views, exposure (sunlight, wind), soil quality, and bearing capacity.

  • The impact on value depends on the cost of making the site productive, profitability, and specific use requirements.

Improvements

  • Improvements "TO" the land: Drainage, filling, clearing, levelling, and adding trace elements. These impact the viability of further improvements.

  • Improvements "ON" the land: Structures, fencing, and physical attachments.

  • Considerations for value include:

    • Conformity/compatibility with surrounding uses.

    • Amenities provided (employment, retail, recreation).

    • Positioning to take advantage of natural features or external space relationships.

    • Optimal improvement (Highest and Best Use), which maximizes site value subject to constraints.

    • Property type, building design, geographic location, size, construction type, age, and quality.

Institutional Characteristics

  • Property rights are derived from law.

  • Tenure System: Powers of ownership include the right to use, alienate (transfer ownership), assimilate, pass by succession, and claim title.

  • Crown Rights: The government (The Crown) retains prior rights to resume or acquire land.

  • Legal Restrictions: Rights are curtailed by laws relating to health, town planning, building codes, and heritage preservation.

  • Market Definition: The rights available to be traded in the market equal the tenurial system minus the restrictions imposed by law.

Specific Economic Characteristics

  • Immobility: Creates a localized market with limited transactions to indicate price. Users come from a fixed area, and the property cannot avoid externalities. Leads to inhomogeneity and long transaction times in an opaque market.

  • Large Economic Units: Requires large capital amounts and specialized financing techniques.

  • Durability: Land is indestructible. Improvements have long lives but can be subject to economic obsolescence. Ownership and planning are long-term. Supply is relatively inelastic because stock cannot quickly meet demand surges.

  • Scarcity:

    • Physical Scarcity: Fixed supply of land.

    • Economic Scarcity: Land use cannot be sustained beyond its extensive margin. Competition for sites with specific locational requirements creates value.

  • Unproductivity Alone: Land requires labour, capital, and management to become productive. Land value is often the residual after rewards are paid to these other factors.

Property Sectors and Participants

Sectors

  • Residential: Single lot dwellings, townhouses, units/apartments, aged care, build-to-rent, student accommodation.

  • Commercial:

    • Office: Premium, A-C grade, suburban.

    • Industrial: Logistics, manufacturing, warehousing.

    • Retail: Super regional, neighbourhood, convenience.

    • Hotels/Leisure: Motels, resorts, pubs.

    • Rural: Hobby farms, grazing, cultivation.

    • Specialized: Child care centres, storage units.

  • Infrastructure: Hospitals, schools, stadiums, libraries, toll roads, and dams.

Property Life Cycle

  1. Planning.

  2. Acquisition.

  3. Utilisation.

  4. Asset Management.

  5. Dispose / Redevelop.

Market Participants

  • Direct Participants: Developers, investors, real estate agents, valuers, property managers, facility managers, asset managers, owners, and researchers.

  • Indirect Participants: Financiers/Banks, solicitors, town planners, builders, government bodies, architects, tenants, and service providers.

  • Stakeholder Roles:

    • Space Users: Occupy space based on cost vs. location vs. amenity.

    • Space Producers: Provide skills, trades, and materials; impacted by supply chain costs.

    • Infrastructure Providers: Public works such as roads, water, power, and essential services.

  • Professional Inter-relationships: Valuers work alongside development managers, property analysts, consultants, investment managers, and portfolio managers across the life cycle.

Critical Factors Affecting Value

  • Technology and demographics.

  • Prevailing economic conditions.

  • Social trends.

  • Climate and climate change considerations.

  • Market sentiment and perceptions.

  • Characteristics analysis helps determine saleability, potential buyers, investment potential, rates and taxes, and market demand.