Tài liệu Real Estate Economics and Finance pdf

– Develop real estate property as primary or secondary business – Trade mortgage securities – Start/manage REITs – Invest in REITs through their personal portfolio – Invest in residentia

Spring 2005

Real Estate Economics and Finance

Starring Erik Hurst

2

In the Beginning, there was land …

Why Should We Study Real Estate?

– Real estate is an asset

– If we take finance classes, don’t we know how to price this or any asset?

– The answer: Not Exactly

Real Estate is different in many respects from stocks and bonds in regards to its:

– Function

– Size (which creates different financing options)

– The asset structure itself (the real option)

– Institutions

3 Asset:

Real Estate gives expected returns to those who own the assets or liabilities

4

Differences in Magnitudes: Total

Market value (in $ billions) 2002 Q1 2003 Q2

U.S Real Estate 19995.2 21783.7 U.S Corporate Equities 11870.9 15497.9 U.S Government Securities 9135.1 10104.2

Corporate Bonds, Foreign Bonds, and Bank Loans 7530.1 8132.8

Source: U.S Federal Reserve, Flow of Funds, tables B100, B102, and L4

Real Estate Capitalization Comparisons

Source: Federal Reserve, Flow of Funds, Table B100

Distribution of U.S Household Assets 1972-2002

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Differences in Magnitudes: Firms

Distribution of Nonfarm Nonfinancial Corporate

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Differences in Magnitudes: Investors

Value of U.S Commercial Real Estate by Type of Property (end of 1999)

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Differences in Magnitudes: Investors

Annual Returns by Property Type, 1984-2003*

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Differences in Asset Structure

•Real Estate is Inherently A Different Asset

There are, at times, large fixed costs in certain real estate transactions

DevelopingInitiating a MortgageDefaulting

There are, at times, irreversible decisions in real estate

DefaultingRefinancingThese characteristics, as we will see, make investment decisions in real estate inherently different: “Real Option Analysis”

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The Institutions

We will be discussing these throughout the course.

Lenders: Most innovations in lending markets started in the mortgage market

Government:

The government tends to take an interest in ‘housing’ and as a result is active in mortgage markets Something we need to be aware of if we are trading mortgage securities (Also, zoning and taxing play a large role)

Appraisers, Real Estate Brokers, REITS, etc Secondary Markets

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Who Owns Mortgage Debt

Ownership of Mortgage Debt

Mortgage Pools include Ginnie Mae, Fannie Mae, Freddie Mac

All Dollar Amounts in real 2001 dollars (i.e., inflation adjusted).

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Real Estate Goals

Households:

Try to maximize life time utility (consumption flows and wealth)

Corporate Real Estate Investors:

Try to maximize equity cash flows (maximize profits)

In doing so, must forecast the future level and timing of the cash flows

In doing so, mush forecast the likelihood of receiving these flows (Agency problems)

Mortgage Traders/Lenders: Try to invest in NPV > 0 projects.

Maximize likelihood that the loan will be repaid/make money on the investment

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Enough Overview - Who is this course is designed for?

• My goal is to teach a course which focuses on the ECONOMICS of real estate

decisions

– Economics is distinct from finance and accounting

– However, some finance is necessary to study the economics

• What does this entail?

– Studying market equilibrium for property prices

– Studying the foundations of risk based pricing

– Studying how mortgage markets have evolved to manage risk

– Studying optimal default, refinancing, and development models

– Study institutions which comprise mortgage markets (REITs, secondary markets, the government, etc.)

• The goal of this class is to get people to think seriously about the economics of real estate (you will be surprised how many in the profession ignore the economics)

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The constituency for this class is likely to be broad….

• Historically, students in this class have different objectives

– Develop real estate property as primary or secondary business

– Trade mortgage securities

– Start/manage REITs

– Invest in REITs through their personal portfolio

– Invest in residential property (i.e., own a home)

– Manage firm assets (real estate is a major component of firm assets)

– Practice real estate law (law students)

– Engage in urban planning (policy students)

• Different student objective provides a challenge to me when designing the course

– Focus on the aspects of real estate decision that are common across student

goals

– Risk management/Market equilibriums

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What this class is not….

• I will not be focusing on accounting stuff ……

– We will not be focusing on how to fill out income statements and such when we own real estate property

– We will not discuss specific tax rules associated with owning real estate

• Nor, will I be focusing on real estate contracts…

– We will not be distinguishing between net leases and triple net leases when

owning commercial real estate I may touch on broad leasing issues, but not specifics of the contract

• Nor is this an applied finance class…

– There will be lots of finance in the class, but only to the extent that it helps us understand the economics

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Course Structure

• Weekly quizzes (weeks 2, 3, 4, 5, 6, 7, 8, and 9)

– However, there will definitely be one problem set due beginning of week 9

• Only one exam - during week 10 (2-3 hours)

• In order to receive a provincial grade for the course, you need to have a quiz grade of 10/20 by week 8 (assuming a zero on the quiz grade in week 9)

TOPIC 1

Housing Demand, Housing Supply, and Bubbles

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What Determines Real Estate Prices

• This may be the single most important lecture of the entire term (I like starting

big… )

• Most practitioners do not fully understand real estate markets (most forget that the market is comprised of suppliers as well as demanders!)

• This lecture is useful for anyone interested in real estate!

– Developers have to predict future prices

– REIT managers have to predict future prices

– Firm managers have to predict future real estate prices (lease vs buy decisions)– Mortgage bankers have to predict future prices (future prices drive refinancing and default)

– Individual homeowners want to predict future prices!

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A Preliminary: Understanding ‘Real’ House Price Movements

• We care about ‘real’ (or relative) house prices - the price you pay for a house -

adjusted for inflation (purchasing power)

• Just because house prices are increasing, doesn’t mean that housing is becoming more expensive!

If house prices doubled from $100,000 to $200,000 between period 1 and 2 and the price of all other goods increased by a factor of 4 over the same period, the value of the home - relative to other goods will actually fall

• Example: Suppose house prices doubled (as above) and the price of a loaf of bread went from $1 to $4

– In this case, in period 1, a house would buy 100,000 loaves of bread

– In period 2, the same house will only buy 50,000 loaves of bread

– In period 2, houses are less valuable.

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Real vs Nominal House Values

prices).

= 50,000 loaves of bread.

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Real vs Nominal House Values

• In real world, we do not measure prices in loaves of bread

• We use other price indices like the CPI (consumer price index).

• CPI measures relative price of all consumer goods (not just bread).

• Price index is ‘anchored’ at 1.00 in some year (currently 1982) Instead of measuring goods in terms of loaves of bread, we measure them in terms of 1982 prices

• CPI for June 2002 was 1.797 (02 dollar/82 dollar)

• CPI for June 1998 was 1.630 (98 dollar/82 dollar)

• Suppose piece of property was worth $500,000 in June of 1998 (nominal value).

• Suppose piece of property was worth $600,000 in June of 2002 (nominal value)

• What is the real growth in the piece of property between June of 1998 and June of

2002? <<answer 8.85%>>

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An approximation formula

($600,000/$500,000 – 1)

• Read my notes on the web page entitled “Real vs Nominal Variables”

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Fact 1: Average Real Appreciation in Residential Property is Small

Real house prices ( residential property ) appreciated by:

Approximately 0% per year during 60s Approximately 3% per year during 70sApproximately 0% per year during 80sSince 1990, three different house price appreciation regimes:

Note: We will discuss commercial real estate prices/trends in next lecture (Topic 2)

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Fact 2: House Prices Fluctuate Dramatically Across Regions

Changes in Real Housing Prices by Region as of December 2004

All Rates are Annualized Percentage Growth

One Year Five Year Since 1980 1980-2000

West North Central 3.0 3.7 0.5 -0.3

East North Central 2.4 2.5 0.8 0.4

West South Central 1.4 2.0 -1.0 -1.8

East South Central 1.6 1.6 0.2 -0.2

U.S 7.3% 5.0% 1.2% 0.3%

Source: Office of Federal Housing Enterprise Oversight, House Price Index; Bureau of Labor Statistics Classification: Selling Price – Existing Homes Only (Repeat Sales Index)

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Real House Price Appreciation Across States (through 2004Q4)

Real Growth in Median House Price By State: NY, CA, TX

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Real House Price Appreciation Across States (through 2004Q4)

Real Growth in Median House Price By State: WI, MA, IL

Illinois

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Top 20 Hot Residential Property Markets in 2004 (Nominal Values)

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Bottom 20 Residential Property Markets in 2004 (Nominal Values)

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Other Property Markets 2004 (nominal returns)

1-year inflation rate: 3.5%

5-year inflation rate: 12%

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Hot Residential Property Markets in 2003

Top 17 - Highest Rates of Nominal Median Home Price Appreciation

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Hot Residential Property Markets in 1999-2003

MSA Rank* 1-Yr 1-Qtr 5-Yr.

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Real House Price Growth At Local Levels (through 2003Q3)

Real Growth Rate in Median House Prices, by Metropolitan Area

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Summary of Local Housing Markets

• All of the top 50 hottest local markets during the last 5 years come from:

– California (both northern and southern)

• Are these local areas experiencing a ‘housing bubble’?

• We will address this question head on at the end of this lecture!

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House Prices At Local Levels (Other Years)

Nominal House Price Increase (MSA Level)

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Summary I - The Raw Data

• Housing Markets are Local

• Housing Markets are Volatile

• A key feature of real estate: Location, Location, Location.

– A John Deer Tractor Store in Downtown Chicago is NOT the same as a similar size store in Des Moines

– A Store on Michigan Ave is not the same as the same store in Hyde Park

– Growth rate in house prices in Lincoln Park/Lake View not the same as the

growth rate in house prices in Hyde Park or South Loop or around Midway

• When we define property markets, we must make sure that the we define the

appropriate geography

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What Drives Property Prices?

• What Else? Supply and Demand! (For Existing Housing Stock)

• We will start by focusing on residential housing:

• Factors Affecting the Demand for Housing:

– Wealth/Income (Housing is a normal good)

– User Cost of Capital

– Trends/Fads

• Factors Affecting the Supply of Housing

– Construction Costs (raw materials)

– Price of Land

– Regulations

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Demand For Housing

As Real Housing Prices Fall, Demand For Housing Rises!

D H

P H

Q H

Stock vs Flow of Housing Stock

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Supply of Housing: Intermediate Run

As Real Housing Prices Rises, Supply For Housing Rises!

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Supply of Housing: Long Run

(To the extent that housing markets are efficient): In long run, competition will drive the price down to the cost of construction - providing the market with what housing stock is demanded

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An Example: Lincoln Park Becomes Trendy

Short Run Analysis

D H

P H

Q H

S H

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An Example: Lincoln Park Becomes Trendy

Intermediate Run Analysis

D H

P H

Q H

S H

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An Example: Lincoln Park Becomes Trendy

Long Run Analysis

D H

P H

Q H

S H P*

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Expected Time Path of Housing

How Do House Prices in Lincoln Park Respond Over Time When Lincoln Park Becomes More Trendy

P H

Time

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Major Conclusion 1

Profit maximization on the part of housing suppliers (i.e., builders and developers) will

ensure that prices will return to price of construction in the long run

If housing markets are efficient, there is a long run zero profit condition!

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Empirical Validity of Predictions

1 All housing booms will lead to a housing bust, holding construction costs

constant.

See Boston and San Francisco graphs (earlier slides)

2 Given that cost of construction is relatively stable over time, house price

appreciation over long periods of time should be close to zero.

See long run house price appreciations:

1960s/1980s 0% per year1970s - 3% per year1990s - 1% per year

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Construction Costs Over Time

Results from “Why Have Housing Prices Gone Up” (Glaeser, Gyourko, Saks) (NBER

working paper 11129 – see nber.org)

Analyze House Prices in 316 Metro Areas

Change in Mean Change in Mean Real Real House Price Construction Costs

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What Accounts for Price Appreciation in Long Run?

1 Construction cost increases (Explains price movements prior to 1970)

2 Price of land increasing (There is only so much land in a given area – as land

becomes more valuable, all property prices will rise)

3 Regulatory barriers to new constructions

Explanations 2 and 3 are simply fancy explanations for “supply constraints”

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Why would long run price differ from cost of construction?

• Often there are constraints on the extent to which supply can adjust

1 Physical constraints

There are only so many places to build in ManhattanThere are only so many units in a ‘trendy’ neighborhood

2 Zoning restrictions

Legal restrictions preventing supply from adjusting

• If no supply constraints, price will equal cost of construction if housing markets are efficient

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An Example: Lincoln Park Becomes Trendy

Short Run Analysis

D H

P H

Q H

S H

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Expected Time Path of Housing

How Do House Prices in Lincoln Park Respond Over Time When Lincoln Park Becomes More Trendy

P H

Time

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Other than supply constraints, are housing markets efficient???

• An efficient market may be defined as one where prices fully and instantaneously

reflect all available relevant information

• Efficient markets usually have large numbers of buyers and sellers (create a

competitive market)

• Buyers and sellers are knowledgeable and fully informed about market conditions.

• In the short run, real estate markets are (usually) not efficient…… !

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Why are housing markets not efficient in short run?

• Lack of product standardization (this is particularly true for commercial real estate).

– Leads to few buyers and few sellers

– It is costly to acquire information about the ‘non’ standard product

– Homogeneity increases efficiency because it reduces search/information costs.

• Time to build is LONG with real estate

– As a result, supply cannot adjust immediately to a demand shock

– The long build time makes developers extremely cautious.

– Suppose demand increase today (and prices increase today) There is profit to be made from increasing supply today But, if demand increase is only temporary, the profit could be gone in 2-3 years Builders are aware of this, and as a result,

do not build (or build less) today

– Uncertainty about future demand results in builders not building as much today