 REAL ESTATE MARKETS

 Markets are perhaps the most basic of all economic social ph

enomena. In essence, a market is a mechanism through which
goods and services are voluntarily exchanged among different
owners.
 The two major markets that are relevant for analyzing real est
ate finance: the space market and the asset market
 The space market is the market for the usage of (or right to us
e) real property (land and built space). This type of market is a
lso often referred to as the real estate usage market or the ren
tal market.

 On the demand side of this market are individuals, households

, and firms that want to use space for either consumption or pr
oduction purposes. For example, a student renting an apartme
nt is using space for housing consumption. A company rentin
g an office is using space for production. Both these types of u
TWO MAJOR MARKET
 Space market

 Asset market
Space market

 The term “space market” is the market for the usage

of real property.

 In this market, tenants exchange rent with landlords

for the right to use land and built space.

 This market is often called “the rental market.”

Characteristics of the Space
Market
 Demand and Supply

Demand side of this type of market includes individuals,

households, or firms who want to use space for
consumption or production purposes.

Supply side of this type of market includes real estate

owners who “rent” (used as a verb here) space to
tenants
 Rent

Rent” as noun refers to the price of the right to use space

for a period of time.

May be measured in $ per square foot per year (office

space), $ per month per unit (apartments) or various other
methods.

Determined by the interaction of supply and demand forces

 When the quantity of space demanded equals, the
quantity supplied, the market is in equilibrium.

 The observed rent at equilibrium is called market rent

 The principle of supply and demand states that
equilibrium price in a market is directly related to
changes in demand and inversely related to changes
in supply.

 Market rent, therefore, is directly related to changes

in demand and inversely related to changes in supply.
 Segmentation
The real estate space market is highly segmented, meaning
that it tends to be local in nature and specialized by
property usage.

Within each segment, or submarket, the same good may

have a different equilibrium price.

Market rent for office space may differ significantly

between Sinza and Kigamboni.

Market rent for retail space and warehouse space in the

same city may different dramatically.
Why is the Real Estate Space
Market Segmented?
 On the demand side:
 Users require specific types of space
 Users require specific locations

 On the supply side:

 Buildings are built for specific uses
 Buildings are fixed in location

 Thus, we often talk of “geographic” or “property

usage” submarkets.
Space Market: Demand
Curve
 The typical space market (or submarket) has a
“downward sloping” demand curve.
$25

$20
TNER LAER

Real Estate Demand Curve

$15

$10

$5
3.5 4 4.5 5 5.5 6 6.5
QUANTITY OF SPACE (Mil. SF)

10
Space Market: “Kinked”
Supply
 The typical space market (or submarket) has a
“kinked” supply curve.

35 4 5 5.5 6 6.5

11
Exhibit 1-2
 Why does the supply of space market is kinked?

Discuss with your collegue

Real Estate Asset Market
 The term “asset market” refers to the mechanism for
the voluntary exchange of ownership of real property.

 In this market, buyers exchange money with sellers

for ownership rights to land and built space (real
estate).

 This market is often called “the property market.”

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Asset Market:
 “Asset market” refers to the market for the ownership of
real estate assets (land and the buildings on it) rather
than the use of space in real estate assets.

 Buyers in this market purchase real estate in expectation

of receiving future cash flows (rent paid by tenants).

 These buyers could buy other kinds of assets (stocks,

bonds, etc.) that would also produce future earnings.

 In this sense, the real estate asset market is really a part

of the larger capital market.
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Overview of Capital Markets
 Capital markets can be divided into four categories
 Public equity markets
 Private equity markets
 Public debt markets
 Private equity markets

 Where do real estate assets fit?

 In all four categories, in some fashion!

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 Capital markets are financial markets that bring
buyers and sellers together to trade stocks, bonds,
currencies, and other financial assets

 Public equity meaning essentially refers to shares or

ownership of a public company, i.e., a company that
is listed on a public stock exchange like the BSE or
NYSE. When a company goes public it essentially
allows the public to buy ownership rights in their
business.
 Private equity
is an alternative investment class that invests in or
acquires private companies that are not listed on a
public stock exchange.
 Public debt market
bond market—often called the debt market, fixed-
income market, or credit market—is the collective
name given to all trades and issues of debt securities.
Governments typically issue bonds in order to raise
capital to pay down debts or fund infrastructural
improvements.
Markets and Investment
Products
Public Private
Markets Markets

Equity Assets Stocks Real Property

REITS Private firms
Mutual Funds Oil and gas
partnerships

Debt Assets Bonds Bank loans

MBS Whole mortgages
Money Instruments Venture debt

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 Capital asset products based on real estate have been develo
ped for, and are traded in, all four of these branches of the ca
pital markets.

 For example, REITs (Real Estate Investment Trusts) offer publ

icly traded common stock shares in companies that essential
ly do nothing but own (and manage, and buy and sell) income
-producing properties and mortgages.

 Mortgage- backed securities (MBS) are publicly traded bond-l

ike products that are based on underlying pools of mortgage
s, which are real-estate-based debt products. There are both r
esidential MBSs and commercial MBSs (the latter known as
CMBS). On the other hand, many mortgages, especially large
commercial mortgages, are held privately as ‘‘whole loans,’’ a
nd these would be traded privately
 The most fundamental form of real estate is that the direct
ownership of whole properties, is traded in a private market
known as the property market, in which individual commer
cial buildings, single-family homes, and land parcels are bo
ught and sold among parties who have often found each ot
her through the services of real estate brokers.

 Ultimately, all the other forms of real-estate-based capital a

sset products are based on privately traded property as the
underlying assets. Property assets produce the cash flow t
hat is the ultimate source of any income or value for any re
al estate investment products or vehicles, including REITs
and mortgages
 The demand side of the property market is made up of invest
ors wanting to buy property.

 The supply side consists of other investors (or developers or

owner users) who want to sell some or all of the property the
y currently own.

 Investors in the property market fall generally into two main t

ypes: individuals and institutions. The major types of instituti
ons include REITs, pension funds, life insurance companies, a
nd mutual funds or opportunity funds of various types. Privat
e individuals invest in the property market both directly and t
hrough funds or syndications.
Pricing of Real Estate Assets

As noted, the supply side of the property market consists of pr

operty owners wanting to sell or reduce their holdings of real e
state assets, while the demand side of the market consists of
other investors wanting to buy or increase their holdings of re
al estate assets.

The balance between supply and demand determines the over

all level of real estate asset values relative to other forms of p
hysical capital in the country. The specific values of individual
properties or buildings is determined by the perceptions of pot
ential investors regarding the level and riskiness of the cash fl
ows that each individual property can generate in the future.
 current annual net income
Cap Rate 
property price
 The cap rate is like a current yield (the amount of current inc
ome the investor receives per dollar of current value of the in
vestment).

 So while the cap rate is an inverse measure of asset value (p

er dollar of earnings), it may be thought of as a direct measur
e of the current component of the return on the investment.

 Thus, property values can be represented as earnings (i.e., es

sentially, net rents) divided by the cap rate
 Cycles of property and market in real estate investment
 The four phases are recovery, expansion, hyper supply, and rec
ession. As an investor, you should determine if your property is
in the recovery, expansion, hyper-supply, or recession phase of
the real estate cycle.
 Doing so will allow you to make a more accurate assumption f
or the length of time the property must be held and the proper
exit strategy to take
 1. Recovery
 Identifying the recovery phase of the cycle can be tricky. Renta
l growth will remain stagnant, with no signs of new constructi
on. However, this is where real estate investors must keep a cl
ose watch and act quickly at any signs of recovery. At this tim
e, you can add value to these properties so that they are ready
to sell or rent outright as the economy shifts into the expansio
n phase
 2. Expansion
 The general economy is improving, job growth is strong, and th
ere is an increased demand for space and housing. The expansi
on phase is when the general public will start regaining their co
nfidence in the economy. Thus, the real estate market and indivi
dual renters and homebuyers will start generating demand onc
e again. the market is on an upswing

 3. Hyper Supply
 Investors and developers get into a frenzy during the expansion
phase to ensure that supply meets a growing demand. Inevitabl
y, there will come a tipping point at which supply begins to exce
ed demand. As an investor, this is a time to hold strong. Propert
y owners will often liquidate their inventory out of fear that their
properties will go vacant or unsold.
 This is a great time to identify properties that you feel confident
will perform well in the next real estate cycle. Use buy and hold
strategy so that you have promising properties already in stock
when it becomes an ideal time to sell again.

 4. Recession
 Eg. the great financial crisis of the early 2008. During the recess
ion phase, supply exceeds demand by a wide margin, and prope
rty owners suffer from high vacancy rates. Also, some landlords
are forced to offer reduced rental rates to attract renters who ar
e also suffering from the economic downturn.
 As an investor, recession provides the opportunity to purchase
distressed properties at a deep discount. There will be an incre
ase in real-estate owned properties. You can hold these properti
es (or add value if you see fit) so that they are ready to hit the m
arket just as the economy begins to recover
 Factors Affecting the Real Estate Market Cycles

• Demographics: The makeup of the population, and major shifts i

n this population makeup, can drive a market significantly.

• Interest rates: Interest rates greatly influence potential homebuy

ers’ buying power. When interest rates are high, it could serve as
a deterrent for many from buying. Conversely, when interest rate
s are low, it could encourage a buying activity

• General economy: Generally, when the economy is doing well or i

s in upward trend, consumers feel more encouraged to buy resid
ential real estate. So, if the general economy is doing well, the re
al estate market is also doing well. If the economy is sluggish, th
e real estate market also tends to follow suit.
Government policies: The government will occasionally interven
e with policies to help boost a market that is particularly sluggis
h a prolonged recession. Policymakers have the ability to implem
ent tax deductions, subsidies, tax credits, and different h or home
buyer programs to incentivize consumers to purchase real estate
. These types of governance mechanisms can greatly influence t
he housing market cycle
 COMMERCIAL LEASES
 A lease involves a contract between a holder of property right
s and a consumer or user of at least some of those rights, co
vering a specified period of time.
 The property owner or landlord is referred to as the lessor. Th
e tenant is referred to as the lessee.
 Normally, the short-term lease gives possession and usage ri
ghts but not development or redevelopment rights. An excepti
on to this may occur in the case of very long-term leases of la
nd, often referred to as ground leases where development or r
edevelopment is allowed.

 The price of the lease is normally called rent and is typically

paid periodically. In addition to possessory rights, the lease n
ormally specifies other rights and duties on the part of the te
nant as well as the landlord,
 Types of Leases
 1. Gross lease. In a gross lease, the landlord pays the operatin
g expenses. This is also called a full service lease because the
landlord provides such services as electricity, heat, water, clea
ning, maintenance, security, and so on, at no expense to the te
nant. Generally, telecommunications services are not included
even in a full service lease.

 2. Net lease. In a net lease, the tenant is responsible for payin

g the operating expenses of the building. In a pure net lease (s
ometimes referred to as triple net/NNN), all or almost all of the
operating expenses of the building are charged to the tenant, e
ven expenses that are fixed, such as property taxes and insura
nce costs. However, in some cases, the landlord may cover so
me expenses, such as the property manager’s fees and costs s
pecifically associated with leasing activities.
 3. Hybrid lease. A hybrid lease involves some aspects of both
gross and net leases. In other words, the tenant and landlord
share the payment of building operating expenses. This may b
e done in various ways. One common approach is for certain
specific expenses to be designated as the tenants’ responsibil
ity while other expenses are the landlord’s responsibility.

 Eg., the landlord might pay the fixed costs of property taxes a
nd insurance, as well as utilities and services that cannot be
metered separately for each tenant, such as water, building se
curity, and common area costs, while the tenants are responsi
ble for other utility and maintenance costs that can be attribu
ted to each tenant.