chapter 2: chapter 2dspace.mit.edu/bitstream/handle/1721.1/41057/11-431jfall... · 2019. 9. 12. ·...

Chapter 2:Chapter 2:

The Real Estate System

The Real Estate SystemThe Real Estate System

1. The development industry

2. Overview of the R.E. “system”

3. The “4-Quadrant” model (4QM)

4. Using the 4QM to understand “boom & bust”cycles in R.E.

2.1 Development IndustryThe Commercial Property 2.1 The Commercial Property Development Industry

Financial Resources

Physical Resources

New Built

Space

Development Industry

The Development IndustryThe Development Industry

Development is a creative, entrepreneurialprocess characterized by…

VisionGreed

CooperationRisk

(All the most entertaining features of American capitalism.)

Development (cont.)…Development (cont.)… Cooperation: • Between public & private sectors;

• Between developers & financiers. Risk: • Even an economy in recession needs anexisting stock of built space.

• New space (need for development) resultsonly from economic growth &/or change.

Development (cont.)…Development (cont.)…

R.E. Development is therefore dealing with the dynamic “cutting edge” of the physical built environment.

This makes development the most cyclical branch of the real estate industry…

2.2 The Real Estate System2.2 The Real Estate System

Exhibit 2-2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development I ustryExhibit 2-2: The “Real Estate System”: Interaction of the Space Market, Asset Market, & Development Indndustry

SPACE MARKET

SUPPLY (Landlords)

DEMAND (Tenants)

RENTS &

OCCUPANCY

LOCAL &

NATIONAL ECONOMY

FORECAST FUTURE

ASSET MARKET

SUPPLY (Owners

Selling)

DEMAND (Investors Buying)

CASH FLOW

MKT REQ’D

CAP RATE

PROPERTY MARKET VALUE

DEVELOPMENT INDUSTRY

IS DEVELPT

PROFITABLE ?

CONSTR COST INCLU LAND

IF YES

ADDS NEW

CAPI TAL MKTS

= Causal flows.

= Information gathering & use.

“Negative feedback loops”…

“Negative feedback loops”…

Mechanisms within a system that tend to dampen the changes in the system, helping to keep it in control, preventing it from spiraling out of control.

Example: Example: A thermostat puts a negative feedback loop into a

heating and cooling (HVAC) system in a building.

• When the temperature in the building getstoo low, the thermostat triggers the heater.

• When the temperature in the building getstoo high, the thermostat triggers the air conditioning.

The result is that the building temperature remains “under control”, within a comfortable temperature range.

Concept check:Concept check:How do the development industry and the real estate

asset market work together to provide a (long-run) negative feedback loop in the Real EstateSystem?…

How can “forward-looking” behavior (goodforecasting of the space market) in thedevelopment industry and R.E. asset market(capital market) improve this negative feedbackloop?…

2.3 The “4-Quadrant Model” (4QM)…2.3 The “4-Quadrant Model” (4QM)…

Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…Quadrant Diagram… Exhibit 2-3: The DiPasquale-Wheaton 4-

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

D

D

2.4 Using the 4QM to help understand “boom & bust” cycles…2.4 Using the 4QM to help understand “boom & bust” cycles…

EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .

EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .

69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0

Price Level Index U.S. Institutional Real Estate

REITs

REIT bust, Recession

ERISA: MPT =>P.F. demand

inflation fears

Boom, Tax incentives S&L Dereg

Overbuilding Tax reform

Disinflation

Recession S&L Crisis: FIRREA

Securitizatn: - REITs - CMBS

Exhibit 2-4a: Demand Growth in Space Market:Effect of Exhibit 2-4a: Effect of Demand Growth in Space Market:

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

D0 D1

Exhibit 2-4a: nd Growth in Space Market: First phase…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Space Market: First phase…

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

D0 D1

R1

P1

Can this be a long-run equilibrium result?…

Doesn’t form a rectangle.

Exhibit 2-4a: nd Growth in Space Market: LR Equilibrium…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium…

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

D0 D1

R1

P1

R**

P**

C**

Q**

Exhibit 2-4a: nd Growth in Space Market: LR Equilibrium…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Space Market: LR Equilibrium…

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

D0 D1

R**

P**

C**

R1

P1

Exhibit 2-4a: nd Growth in Asset Market…Effect of DemaExhibit 2-4a: Effect of Demand Growth in Asset Market…

Rent $

Stock (SF)Price $

Construction (SF)

Space Market: Stock Adjustment

Asset Market: Construction

Space Market: Rent Determination

Asset Market: Valuation

Q*

R*

P*

C*

11% OAR

8% OAR

D0

D1

P1

P**

R**

Q* *

C**

SR

LR

EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .

EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE LAST QUARTER-CENTURY . . .

69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0

Price Level Index U.S. Institutional Real Estate

REITs

REIT bust, Recession

ERISA: MPT =>P.F. demand

inflation fears

Boom, Tax incentives S&L Dereg

Overbuilding Tax reform

Disinflation

Recession S&L Crisis: FIRREA

Securitizatn: - REITs - CMBS

Concept check…Concept check…

1. What does the 4Q Model reveal about the interaction of the space market, the assetmarket, and the development industry incausing “boom & bust” cycles?

2. How can the an understanding of the 4Q Modelhelp participants in the asset market anddevelopment industry to avoid “boom & bust”cycles? [Hint: Can the 4Q Model help with“forward-looking” decision-making?…]