Forecasts

RM/FIN 460 - Real Estate Financial Analysis

Market Forecasts

• Topics Covered:

  1. The Real Estate System

  • Interconnected space and asset markets.

  • Definitions:

    • Space Market: Leasing market; market for the use of real estate.

    • Asset Market: Sales market; market for ownership of real estate.

  1. Space Demand

  2. Space Supply

  3. Asset Supply

  4. Asset Demand

  5. Equilibrium Dynamics

  6. Vacancies

The Real Estate System

• Authors: Geltner and Miller

• The real estate system comprises interconnected space and asset markets. This includes:

  • Space Market:

  • Demand and supply are driven by tenants and landlords

  • Influences: Local and national economic conditions impact rents and occupancy levels.

  • Asset Market:

  • Demand and supply are managed by investors and property owners.

  • Valuation Influences: Cash flow, market-required capitalization rate, and property market value.

Analysis of Two Markets

• Space Market:

  • Quantity measured in space, price measured in rent.

  • Supply from landlords, demand from tenants.

• Asset Market:

  • Quantity measured in construction, price measured in asset price.

  • Supply from developers, demand from investors.

• Dynamics:

  • Rents affect prices, while construction takes time to impact space.

Space Demand

• Key Concepts:

  • Gross Absorption: Total new lease signings.

  • Net Absorption: Net changes in occupied space calculated as gross absorption minus move-outs.

• Demand Influence:

  • Equation: $ext{Net Rent} = a<em>1 + a</em>2 imes ext{Space Demand}, \ a<em>1 > 0, \ a</em>2 < 0$

  • Inverse Demand Function: Based on renters' willingness to pay.

  • Demand Function:

  • Integrated: $ext{Space Demand} = \frac{a<em>1}{a</em>2 - 1} ext{Net Rent}$

Space Demand Shifters

1. Residential/Retail Factors:

   • Number of residents

   • Population growth

   • WTP of residents

   • Employment rate

   • Wage levels

2. Office/Industrial Factors:

   • Number of user firms

   • Employment and economic activity levels

   • Corporate profits and stock prices

   • Space required per worker

Population Changes

• Displays state and county-level changes contributing to shifts in space demand.

• Example: Decrease in space demand metrics observed during downturns, such as those following economic shocks.

Space Supply

• Defined as the stock of rentable space in square feet.

• Change in space supply is calculated using the formula:
  $S<em>{t+1} = S</em>t + \Delta S_t$

• Components of $\Delta S_t$ (Net Supply):

  • Completions

  • Rehabs & Conversions In

  • Demolition

  • Conversions Out

• Supply is generally more flexible in the long-run but constrained in the short-run.

• Short-, Medium-, and Long-Run Supply Characteristics:

  • Short-run is nearly fixed, medium-run is slightly more responsive, and long-run offers flexibility.

Asset Supply

• Driving indicators include:

  • Building Permits: Forward-looking, not entirely reliable.

  • Construction Starts: Can lag by 6 months to 2 years.

  • Completions: Accurate but lagging indicators of market response.

• Mathematical Representation: $Construction = \max(0, a<em>3 + a</em>4 \times Price)$

  • where $a<em>3 < 0$ reflects entry costs, and $a</em>4 > 0$ indicates supply elasticity.

Vacancy Analysis

• Comparison with Unemployment:

  • Similar market dynamics, vacancies are constant like unemployment.

  • Noted that vacancies are counter-cyclical, persisting even in robust economies.

Sources of Vacancy

1. Slow Rent Adjustments:

   • Excess supply can lead to vacancies if rents adjust slowly.

   • Economic downturns highlight this issue, affecting landlord willingness to lower rents.

2. Search Frictions:

   • The time taken to match tenants with landlords leads to inevitable vacancy periods.

   • Introduces a concept of Natural Rate of Vacancy correlating to labor market dynamics.

Historical Examples of Vacancies

• Philadelphia Office Market:

  • Data showing changes in demand, supply, and vacancy rates over defined periods, particularly highlighting shifts during 1997-2016.

• Las Vegas Apartment Market:

  • Insights into delivery rates against vacancy rates and rent growth.

Challenges in Real Estate Forecasting

• Questions for Consideration:

  1. Negative impact of rent controls on market supply and demand.

  2. Drawing and analyzing curves for demand versus supply under rent control conditions.

  3. Assessment of short-run versus long-run market dynamics under regulated conditions.