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Real Estate Market Analysis

R.E. Market Analysis


is a collection of practical analytical tools and
procedures designed to help answer
decision questions, such as:

Decision Questions
Where to locate a branch office?
What size or type of building to develop on a specific site?
What type of tenants to look for in marketing a particular

building?
What the rent and expiration term should be on a given lease?
When to begin construction on a development project?
How many units to build this year?
Which cities and property types to invest in so as to allocate
capital where rents are more likely to grow?
Where to locate new retail outlets and/or which stores should
be closed?

Market Analysis usually


requires quantitative or
qualitative understanding (&
prediction) of:
Demand

Side
Supply Side
Of the Space Usage Market relevant to some

R.E. decision.

Types of Market Analysis:


Specific

micro-level analysis

Applies to single property, site, or user


E.g., feasibility analysis or site analysis for a development

project

Broader, more

market

general characterization of a space

Applies to an entire R.E. space market segment or

submarket
E.g., forecast of supply & demand (&/or rents and vacancy
rates) in Jakarta office market.

Focus on latter type (market supply & demand)

Five major market


indicators:
1.
2.
3.
4.

Vacancy rate
Market Rent
Quantity of new construction starts
Quantity of new construction
completions
5. Absorption of new space

Vacancy Rate:

Percentage of the stock of space that is currently


not occupied
Vac.Rate = (Empty SF)/(Total SF) = 1
Occup.Rate
Watch out for sub-lease space:
o

Space leased but unoccupied is vacant.

Vacancy Rate is an indicator of equilibrium


(balance between supply & demand in the space
market)

Some vacancy is normal and


natural in a market, due to:
o Search time & moving costs :

Dont take first deal


Search for good deal (takes time to find)

o Overbuilding:

Impossible to perfectly predict demand growth


Lumpy supply

The natural vacancy rate:


o Rate around which vacancy tends to cycle
o Rate that indicates supply/demand balance
o Above which rents fall, below which rents
rise
o Tends to be higher in more volatile &
faster-growth markets
o Tends to be lower in more supplyrestricted markets

Rent:

Rent on new leases in the market


Another equilibrium variable
Most important space market variable
Tricky to accurately quantify (private
info,apples vs oranges problems)

Consider real rent


rent adjusted for general inflation (as better
indicator of market trend)

Construction:
Supply side variable
Starts & completions

o
o

Starts Pipeline
Completions Additions to supply side of market

Consider net addition to supply:

Construction Completions Demolition &


Conversion Out
o Include re-habs & conversions in also
o

Absorption:
Change in occupied space
Demand side variable
Gross absorption = Total new lease signings

Includes moves within the market

Net absorption = Net increase in occupied space


Net absorption more relevant for indicating market
demand:

(Vacant SF)t = (Vacant SF)t-1 + (Constr)t (Net


Absorption)t

These market indicator


variables:

Vacancy, Rent, Construction,


Absorption
Can be used to help characterize &
understand the current market, and forecast
how it may change relevant to R.E.
decisions.

e.g., The Months Supply


measure:
Vac Constr
MS
NetAbsorp / 12

MS < Typical Construction Project Duration Tight


Market
Room for new development projects
MS > Typ.Constr.Duration May be some slack
(but consider natural vacancy rate).

Defining the scope of the


market analysis
Geographic/Property type market
segments (or sub-markets)

Time-frame of the study (historical,


forecast to when?)

Example of geographic submarkets: Atlanta office market


Exhibit 6- 2: Atlanta MSA Office Sub-markets, 1998.

(Source: Lend Lease Real Estate Investments, Real Estate Outlook: 1999, based on
data from Jamison Research and Lend Lease Investment Research. Lend Lease,
reproduced by permission. )

Market analysis methodology:

Simple trend extrapolation vs Structural


analysis

Trend extrapolation:
Take advantage of inertia in space
market (past partly predicts the future)

Consider trends and cycles

Potential to use statistical techniques


(time-series analysis: autoregression,
ARIMA, VAR, vector error-correction)

Potential to bring in capital market


factors as predictors

Structural Analysis:
Model the structure of the market
(underlying determinants of supply &
demand, e.g. population growth and
employment growth)
Forecast the underlying determinants
(e.g., economic base analysis like we talked
about in Ch.3), then use model to predict
space market.

Formal analysis requires:


o
o
o

Demand model (including elasticities)


Supply model (including elasticities & lags)
Equilibrium model (including landlord behavior)

Useful for gaining fundamental understanding


of the market, and making long-term forecasts
Used more in academic studies than business
decisions

More widely used in business


decision-making are basic short-term
(1-3 yr) structural market analyses
Exhibit 6-3: Generic framework of a basic short-term structural market analysis for real
estate
SUPPLY SIDE

DEMAND SIDE

Inventory existing supply

Identify sources of space usage


demand

Quantify relationship between


demand sources and quantity of
space usage
Inventory construction pipeline

Forecast of new supply

Forecast demand sources

Forecast of new demand

Forecast space shortfall or surplus

Decision implicatons?

Major drivers of the demand


side of the space market
Exhibit 6-4: Major demand drivers by property type
Property Type

Demand Drivers

Residential single family


(Owner occupied)

Population
Household formation (child rearing
ages)
Interest rates
Employment growth (business &
professional
Population occupations)

Residential multifamily
(Apartment renters)

Retail

Office

Industrial

Hotel & convention

Household formation (non-childrearing ages)


Local housing affordability
Employment growth (blue collar
occupations)
Aggregate disposable income

Aggregate household wealth


Traffic volume (specific sites)

Employment in office occupations:


Finance, Insurance, Real Estate
(FIRE)
Business & professional services
Legal services
Manufacturing employment
Transportation employment
Airfreight volume
Rail & truck volume
Air passenger volume
Tourism receipts or number

Market Dynamics
The

real estate cycle may be different from and partially


independent of the underlying business cycle in the local
economy.
The cycle will be much more exaggerated in the
construction and development industry than in other
aspects of the real estate market, such as rents and
vacancy.
The vacancy cycle tends to slightly lead the rent cycle
(vacancy peaks before rent bottoms).
New construction completions tend to peak when
vacancy peaks.

In the preceding model, were


any of the market participants
forward-looking?

What features of the above


results do you think are due to
myopia or purely adaptive
behavior on the part of the
market participants?

In the real world, what factors


or elements in the real estate
system will tend to be forwardlooking?

In the real world, will it be


possible to perfectly forecast
the future? Will some market
participants likely be
somewhat myopic or adaptive
in their behavior?