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Essentials of Real Estate Economics,Sixth Edition

Dennis J. McKenzie, Richard M. Betts, andCarol A. Jensen

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Chapter

1IMPORTANT TERMS AND CONCEPTS

EconomicsReal estateReal estate economics

PREVIEW

As you begin reading this textbook, you probably have certain ques-tions in mind: What is economics? What is real estate economics?Why should you study real estate economics? What topics are cov-ered in this book? How is the material organized? This introductorychapter answers these questions; so you will know what to expectfrom this textbook.

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Introduction to RealEstate Economics

WHAT IS ECONOMICS?Economics is a social science that is concerned with how individualsand societies choose to use scarce resources to produce, distribute,and consume goods and services. The demand for goods and servicesfrequently exceeds the supply. How these scarce resources are allo-cated is the main interest of economists.

Economics is not the same as accounting, which only looks at whathas happened in the past. And economics may use numbers and math,but it is much more than just math. It is the study of what causes theeconomy to change, and how it changes.

The study of economics can be broken into two main categories:macroeconomics and microeconomics. Macroeconomics is the studyof the national, regional, or state economy and its various segments,such as national, regional, or state income, output, employment,and growth. Microeconomics is concerned with the individual unitswithin the general economy, such as business firms and households.Whether the focus is macro or micro, the role of the economist is toanalyze how resources are being used. The economist may suggestchanges, or forecast economic trends.

WHAT IS REAL ESTATE?Real estate means land and buildings. The formal definition is land,that which is affixed to the land, that which is appurtenant to theland, and that which is immovable by law. Anything that is not realestate is called personal property. The ownership of real estate carriescertain rights, known as the bundle of rights. The bundle includes theright to use, possess, exclude, and dispose of the property. Land

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includes both the surface, the subsurface (including any minerals),and the air above. However, right to any water, oil, or gas is morelimited. And ownership of the air above is generally limited to onlythat height that can reasonably be used. All of these rights are notabsolute; they can be legally modified by private restrictions and bygovernment regulations and laws. In short, real estate or real propertyis land and improvements, and the rights of use associated with theownership.

WHAT IS REAL ESTATE ECONOMICS?Real estate economics is about people and how their actions affectreal estate use and values. A formal definition would be: Real estateeconomics is a study that uses economic principles, both macro andmicro, to analyze the impact that national, regional, community, andneighborhood changes or trends have on real estate values and uses.

Inour society, our desire for goods and services frequently exceedsthe supply available. When an object is scarce, people will give moneyto obtain it. Scarcity creates value. Real estate economics focuseson the economic principles that create and change real estate values.

WHAT REAL ESTATE ECONOMICS IS NOTReal estate economics is not the study of general economics. Noris it a course in the practice of real estate. Rather, real estate eco-nomics is the link between general economic theory and appliedreal estate practice. A course in general economics concentrateson how society attempts to use limited resources to satisfy thewants of its people. However, such a course does not examinehow this affects local real estate markets. On the other hand, acourse in real estate practice concentrates on the specific knowl-edge and techniques needed to complete a real estate transaction,but spends little time discussing the economic factors that influ-ence whether a home purchase or other real estate investment willbe profitable over the years.

Real estate economics draws principles from both general eco-nomics and real estate practice. It then combines them to studychanges in real estate use, value, andactivity.The focus is on real estatechange. The main reason to study real estate economics is to help un-derstand issues and changes, and the impact these will have on localreal estate use and values.

Figure 1.1 illustrates the relationships among general economics,real estate economics, and real estate practice.

4 Chapter 1 • Introduction to Real Estate Economics

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WHY IS REAL ESTATE ECONOMICSSO INTERESTING?• Everything that we do involves economics! Does the price of

gasoline concern you? What about interest rates on certificates ofdeposit? When corn is used to make ethanol to blend with gaso-line, the price of corn goes up, and then the price of meat follows!This is economics at street level.

• But everything that we do also involves real estate: where we live,where we work, where we play, and more. And every real estatedecision is also an economic decision! The American dream is tobuy a home—but where? And how?

• Today, almost every other newspaper headline involves issues inreal estate economics—mortgage problems, interest rates, theimpact of unemployment, foreclosures, property values—all areissues that are discussed here!

WHY SHOULD YOU STUDY REALESTATE ECONOMICS?Studying real estate economics helps people understand what causesfluctuations in real estate value,use, andactivity.These fluctuations orchanges in turn affect local real estate markets. Everyday, appraisers,investors, real estate agents, real estate lenders, voters, and othersmake real estate decisions that influence the shape, form, and valueof property. In turn, real estate decisions made today will be reflectedin real estate values in the cities and neighborhoods of tomorrow.Studying real estate economics helps people understand the impacttoday’s real estate actions will have on future real estate values. InCalifornia, for instance, real estate economics is considered so impor-tant that state law requires that a course in real estate economics, or itsequivalent, be completed before a person can become a licensed realestate broker. And real estate economics is a required education topicfor everyone seeking a real estate appraisal license.

FIGURE 1.1 The field of real estate economics draws principles from both general economics and real estate practice.

Why Should You Study Real Estate Economics? 5

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A GENERAL OVERVIEWIt is suggested that you review this brief introduction to the text, aswell as the Table of Contents, to understand the relation of each chap-ter to the overall thrust of this book.

The book is divided into four parts, starting with general eco-nomic principles and moving on to applied real estate economics.Part One, “Basic Economic Background for Real Estate Analysis,”contains five chapters, which review the major principles of econom-ics and the reasons these principles are important to real estate stu-dents. Part One then explores the role of government and foreigninterests in the economy, devotes a chapter to monetary policy, anddiscusses the economic characteristics of markets for real estate.

Part Two, “Understanding Real Estate Markets,” devotes sixchapters to regional, community, and neighborhood real estate anal-ysis. The objective is to discuss why local and regional economieschange and how these changes are reflected in the markets for eachmajor type of real estate.

Part Three, “Major Influences on Real Estate Development,”presents four chapters on real property taxation, land-use controls,real estate development procedures, and required government reports.These subjects are among the most controversial issues in the field ofreal estate.

In Part Four, “Real Estate Investment: The Economics of theParcel,” four chapters bring together all the material previously pre-sented to demonstrate how the principles of real estate economicscan be used to analyze a specific property. Topics include investmentprinciples, cash flow analysis, income tax aspects of real estate, andforecasting trends.

Figure 1.2 is the essence of the entire book, and course, con-densed into one illustration. These steps are the building blocksneeded to understand real estate economics, and to apply it to dailyreal estate issues, problems, and decisions. The illustration shows howthis textbook advances from one level of understanding to the next.Every newspaper will have stories, where you will use this knowledgeto help you understand and evaluate what is reported. Some articleswill be about events at the local level, and others will be at the city,county, state, nation, or international level!

CHAPTER OUTLINESEach chapter in this textbook begins with a short preview of the mate-rial, followed by a list of objectives that you should be able to meet bythe end of the chapter. The body of the chapter comes next, dividedinto sections. After each section, there is a series of brief questions to

6 Chapter 1 • Introduction to Real Estate Economics

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check your understanding of the material in that section. You shouldwork methodically through each chapter, taking time to review eachsection for any points you have not understood.

At the end of each chapter, there is a brief summary, a list of theimportant terms and concepts in that chapter, and 25 multiple-choicequestions. Answers are given at the back of the book. Once again, youcan test your understanding of what you have read by studying thechapter summary, reviewing the terms and concepts, and answeringthe multiple-choice questions. This material is a valuable aid in pre-paring for examinations. Finally, a number of figures and otherspecial-interest inserts have been included in each chapter to clarifysome issues and provide variety in your reading.

A FINAL WORDThe study of real estate economics can be approached from the math-ematical view, called econometrics, or from the non-mathematicalperspective, using verbal descriptions. Econometrics combines eco-nomics, mathematics, and statistics, in order to express economicrelationships with mathematical equations. The verbal approach useswords, rather than equations, to describe economic relationships.

This textbook uses the verbal approach wherever possible! Specialemphasis has been placed on a clear and simple explanation of eco-nomic concepts. Students who wish to pursue economic principlesin more detail are encouraged to contact their local college and obtaininformation about course offerings in economics, economic geogra-phy, and urban planning.

FIGURE 1.2 The stairway of real estate economics.

A Final Word 7

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