Overview of real estate markets

The main participants in real estate markets are:

Owner/User - These people are both owners as well as tenants. They purchase houses or commercial property as an investment and also to live in or utilize as a business. Owner - These people are pure investors. They do not consume the real estate that they purchase. Typically they rent out or lease the property to someone else. Renter - These people are pure consumers. Developers - These people prepare raw land for building which results in new product for the market. Renovators - These people supply refurbished buildings to the market. Facilitators - This includes banks, Real Estate Brokers lawyers, and others that facilitate the purchase and sale of real estate.

The owner/user, owner, and renter comprise the demand side of the market, while the developers and renovators comprise the supply side. In order to apply simple supply and demand analysis to real estate markets a number of modifications need to be made to standard microeconomic assumptions and procedures. In particular, the unique characteristics of the real estate market must be accommodated. These characteristics include:

Durability - Real estate is durable. A building can last for decades or even centuries, and the land underneath it is practically indestructible. Because of this, real estate markets are modeled as a stock/flow market. About 98% of supply consists of the stock of existing houses, while about 2% consists of the flow of new development. The stock of real estate supply in any period is determined by the existing stock in the previous period, the rate of deterioration of the existing stock, the rate of renovation of the existing stock, and the flow of new development in the current period. The effect of real estate market adjustments tend to be mitigated by the relatively large stock of existing buildings. Heterogeneous - Every piece of real estate is unique, in terms of its location, in terms of the building, and in terms of its financing. This makes pricing difficult, increases search costs, creates information asymmetry and greatly restricts substitutability. To get around this problem, economists (beginning with Muth (1960)) define supply in terms of service units, that is, any physical unit can be deconstructed into the services that it provides. Olsen (1969) describes these units of housing services as an unobservable theoretical construct. Housing stock depreciates making it qualitatively different from a new building. The market equilibrating process operates across multiple quality levels. Further, the real estate market is typically divided into residential, commercial, and industrial segments. It can also be further divided into subcategories like recreational, income generating, area, historical/protected, etc. High Transaction costs - Buying and/or moving into a home costs much more than most types of transactions. These costs include search costs, real estate fees, moving costs, legal fees, land transfer taxes, and deed registration fees. Transaction costs for the seller typically range between 1.5 - 6% of the purchase price. In some countries in Continental Europe, transaction costs for both buyer and seller can range between 15 - 20%. Long time delays - The market adjustment process is subject to time delays due to the length of time it takes to finance, design, and construct new supply, and also due to the relatively slow rate of

change of demand. Because of these lags there is a great potential for disequilibrium in the short run. Adjustment mechanisms tend to be slow, relative to more fluid markets. Both an investment good and a consumption good - Real estate can be purchased with the expectation of attaining a return (an investment good), or with the intention of using it (a consumption good), or both. These functions can be separated (with market participants concentrating on one or the other function) or can be combined (in the case of the person that lives in a house that they own). This dual nature of the good means that it is not uncommon for people to over-invest in real estate, that is, to invest more money in an asset than it is worth on the open market. Immobility - Real estate is locationally immobile (save for mobile homes, but the land underneath them is still immobile). Consumers come to the good rather than the good going to the consumer. Because of this, there can be no physical market-place. This spatial fixity means that market adjustment must occur by people moving to dwelling units, rather than the movement of the goods. For example, if tastes change and more people demand suburban houses, people must find housing in the suburbs, because it is impossible to bring their existing house and lot to the suburb (even a mobile home owner, who could move the house, must still find a new lot). Spatial fixity combined with the close proximity of housing units in urban areas suggest the potential for externalities inherent in a given location.

Commercial Property

The term commercial property (also called investment or income property) refers to buildings or land intended to generate a profit, either from capital gain or rental income.[1]

Definition
Commercial property includes office buildings, industrial property, medical centers, hotels, malls, retail stores, shopping centers, farm land, multifamily housing buildings, warehouses, and garages. In many states, residential property containing more than a certain number of units qualifies as commercial property for borrowing and tax purposes. Commercial real estate is commonly divided into four categories:
Categories of Commercial Real Estate Category Examples hotels, public houses[2], restaurants, cafes, sports facilities retail stores, malls, shopping centres, shops office buildings, serviced offices[3] industrial property, office/warehouses, garages, distribution centers

Leisure Retail Office Industrial

Multifamily (apartments) multifamily housing buildings Healthcare medical centres, hospitals, nursing homes

House prices are affected by a combination of supply and demand factors. Demand Side Factors: 1. Economic Growth / Real income. Rising incomes enable people to spend more on buying a house. Traditionally, there was a mortgage ratio of 3 times your salary. Basically if you earnt 20,000 the building society would lead 60,000. Therefore rising incomes enable house prices to rise. However, the ratio of house prices to income can vary considerably. For example, between 1995 and 2007, the ratio of house prices to incomes have increased significantly. If the economy goes into a recession and unemployment rises, the demand for buying houses would fall significantly. 2. Interest rates. Interest rates affect the cost of paying for a mortgage. Interest rates are very important as mortgage repayments are usually the biggest part of a homeowner's monthly spending.

In the UK, the majority of homeowners have a variable mortgage which means an increase in rates will cause the cost of mortgages to rise, deterring people to buy.

People on fixed rate mortgages will be insulated from fluctuating rates for 2-10 years. Therefore changes in interest rates can have a time lag of up to 18 months before there full effect is noted on demand for housing.

It is also important to consider real interest rates (interest rates-inflation) The Bank of England set base rates and these usually affect all commercial rates. However, sometimes the Bank of England cut interest rates, but, commercial banks don't pass these cuts onto consumers. In the first half of 2008, the Bank of England cut rates by 0.5% from 5.5 to 5.0%, but the cost of mortgages is still rising.

3. Consumer confidence During times of high consumer confidence, people are more willing to take out risky mortgages to be able to buy a house. For example, in the period 2001-07 100% mortgages and interest only mortgages were quite common. In the early 00s, people were optimistic about the housing market and so took out mortgages with a higher debt to income ratio.

4. Availability of Mortgage Finance In the 50s, 60s and 70s, there were stringent restrictions about the availability of finance. However, with deregulation of the banking sector increased competition has seen a rise in the number of mortgage products. Products such as interest only, self certification mortgages and mortgages up to six times income have enabled people to get more mortgages, thereby increasing demand for housing. However, during the credit crunch of 2008, the number of mortgage products on offer fell due to a shortage of finance in the money markets. 5. Demographic factors There has been a rising number of households in the UK. The number of households can rise faster than the population if the average family size decline and there are more single people living alone. Demand for housing in the UK has been increasing for various reasons such as:

an increase in divorce rates an increase in net immigration from Eastern Europe. Increase in life expectancy and more old single people Children leaving home early Less marriage

6. Speculation Not everyone buys a house to live in it. An increasing number of property investors buy houses to try and make both capital gains and income from renting. This buy to let investor is typically more volatile, they will buy when house prices are rising and sell when the market appears to turn. This makes house prices more volatile because speculators will buy in a boom and sell in a bust. The number of buy to let investors in the UK has risen in the past decade. However, there are quite high fixed costs in selling a house, such as stamp duty and estate agent fees. It is not like dealing in shares where you can easily buy and sell. Many buy to let investors claim they are in in for the long term. The price of rented accommodation Although UK house prices have increased faster than inflation, renting has also become expensive which is the main substitute to buying a house 7. Inherited wealth. Many people use inherited wealth to buy houses. This might explain why there has been rising ratios of house price to incomes. It is also becoming more common for parents to lend children a deposit to help get their first house. In other words higher house prices are not deterring people from buying a house - people are finding ways around it. 8. Unemployment

Low unemployment is often associated with rising demand for houses. But, rising unemployment discourages many from buying.

Supply side Factors

In the short run Supply of housing is fixed because it takes time to build houses. Therefore in the short run demand affects prices more than supply

However if the supply of housing is inelastic then an increase in demand will lead to a big increase in price.

Long Run Supply In the long Run the supply of housing is affected by many factors:

Availability of planning permission. This is difficult to obtain in rural areas Opportunity cost for builders e.g. are there better returns from other types of investment Existing houses may be knocked down because they are deemed unfit to live in. An increase in the cost of building new houses will shift supply to the left In the UK, it is argued there is a significant shortage of housing is this explains why house prices have risen much faster than inflation and earnings. However, in the US, the supply of housing increased in the period up to 2008 and therefore, the excess supply and falling demand led to a big fall in demand. However, it is important to note that house prices can still fall, even if there is a shortage of supply. In 1992, house prices in London fell over 20%, even though we can say supply is inelastic. A shortage of supply just means they will be on average higher. It doesn't mean they are incapable of falling.

Costs of production for construction Employment costs (including wages, overtime payments and employer contributions Costs of purchasing land for housing Costs of purchasing building components and Costs associated with achieving planning consent from local authorities.

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Approximate percentage costs can be broken down as: acquisition costs 10%, site improvement costs 11%, labour costs 26%, materials costs 31%, finance costs 3%, administrative costs 15%, and marketing costs4%
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