Transcript Chapter 1
Chapter 6: Real Estate Market Analysis © 2014 OnCourse Learning. All Rights Reserved. 1 R.E. “Market Analysis” is a collection of practical analytical tools and procedures designed to help answer decision questions, such as: © 2014 OnCourse Learning. All Rights Reserved. 2 Geltner MIT/CRE Decision Questions 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? © 2014 OnCourse Learning. All Rights Reserved. 3 Geltner MIT/CRE 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. © 2014 OnCourse Learning. All Rights Reserved. 4 Geltner MIT/CRE Two Major Types (levels) 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 “shoe leather…” (also mktg consultants like Claritas) Broader, more general characterization of a space market Applies to an entire R.E. space market segment or submarket E.g., forecast of supply & demand (&/or rents and vacancy rates) in Chicago office market, or Class A office Mkt in downtown Chicago “research shops” (or subscriptions) © 2014 OnCourse Learning. All Rights Reserved. 5 Geltner MIT/CRE General market-level analyses focus on 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 © 2014 OnCourse Learning. All Rights Reserved. 6 Geltner MIT/CRE 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: Space leased but unoccupied is vacant. Vacancy Rate is an indicator of equilibrium (balance between supply & demand in the space market) © 2014 OnCourse Learning. All Rights Reserved. 7 Geltner MIT/CRE Some vacancy is normal and natural in a market, due to: Search time & moving costs (hence LT leases): Don’t take “first deal” Search for “good deal” (takes time to find) More uncertainty LL sets higher reservation rent (but tenant sets lower rent target, so deals tougher). Higher moving costs or search costs LL sets lower reservation rent (& tenant accepts higher rent target, so deals easier, longer term leases). “Overbuilding”: Impossible to perfectly predict demand growth “Lumpy supply” © 2014 OnCourse Learning. All Rights Reserved. 8 Geltner MIT/CRE The “natural vacancy rate”: Rate around which vacancy tends to cycle Rate that indicates supply/demand balance Above which rents fall, below which rents rise Tends to be higher in more volatile & faster-growth markets Tends to be lower in more supply-restricted markets © 2014 OnCourse Learning. All Rights Reserved. 9 Geltner MIT/CRE What does it look like the natural vacancy rate is in the Boston office market? Is it higher in the CBD or the suburbs? Boston Office Sub-Markets Vacancy Rate: 1989-2009 30% 25% 20% 15% 10% 5% Suburban CBD © 2014 OnCourse Learning. All Rights Reserved. 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 0% Cambridge 10 Rent: Rent on new leases in the market Another equilibrium variable (along with vacancy rate) Most important space market variable Tricky to accurately quantify (private info,“apples vs oranges” problems) Watch out for “asking rent” vs. “effective rent” © 2014 OnCourse Learning. All Rights Reserved. 11 Geltner MIT/CRE Example: $10 rent but 1-yr abatement in 5-yr lease: What would you say is the “effective rent”? © 2014 OnCourse Learning. All Rights Reserved. 12 Geltner MIT/CRE Example: $10 rent but 1-yr abatement in 5-yr lease: What would you say is the “effective rent”? 10*(4/5) = $8. Or, more carefully, if tenant can borrow @ 8%: =PMT(0.08,5,NPV(0.08,10,10,10,10)) = $8.30. © 2014 OnCourse Learning. All Rights Reserved. 13 Geltner MIT/CRE Consider “real rent” rent adjusted for general inflation (as better indicator of market trend) © 2014 OnCourse Learning. All Rights Reserved. 14 Geltner MIT/CRE Construction: Supply side variable Starts & completions Starts “Pipeline” Completions Additions to supply side of market Don’t forget projects in permitting & planning stage too Consider net addition to supply: Construction Completions minus Demolition & Conversion Out Include re-habs & conversions in also © 2014 OnCourse Learning. All Rights Reserved. 15 Geltner MIT/CRE 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 © 2014 OnCourse Learning. All Rights Reserved. 16 Geltner MIT/CRE 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. © 2014 OnCourse Learning. All Rights Reserved. 17 Geltner MIT/CRE 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). © 2014 OnCourse Learning. All Rights Reserved. 18 Geltner MIT/CRE Perhaps enhance with a Months Excess Supply measure?... Vac% NatVac%StockSF ConstrSF MES NetAbsorpSF / 12 Compare this to typical construction time and what is in pipeline… © 2014 OnCourse Learning. All Rights Reserved. 19 Geltner MIT/CRE Absorption in Largest U.S. Multi-Tenant Office Markets 1998-2000 ANNUAL AVG HOUSTON CHICAGO BOSTON ATLANTA DALLAS / FORT WORTH SAN FRANCISCO LOS ANGELES NEW YORK 2001-2004F ANNUAL AVG 2.02 2.51 2.86 3.01 4.16 3.32 6.53 4.53 4.82 4.68 5.89 5.57 4.95 6.19 6.29 7.56 10.05 9.28 WASHINGTON DC Source: Torto Wheaton Research. Millions of square feet. Forecast 2001-2004 © 2014 OnCourse Learning. All Rights Reserved. 20 14% 24% 12% 22% 10% 20% 8% 18% 6% 16% 4% 14% 2% 12% Gross Asking Rent ($/SF-YR) 80 Vacancy as Percent of Existing Stock 90 26% 70 60 50 40 30 20 2010Q3 2009Q3 2008Q3 2007Q3 2006Q3 2005Q3 2004Q3 2003Q3 2002Q3 Real Rent (constant 2011 dollars) Vacancy (Right Axis) Avg 11.3% 2001Q3 2000Q3 1999Q3 1998Q3 1997Q3 1996Q3 1995Q3 1994Q3 1993Q3 1992Q3 1991Q3 1990Q3 1989Q3 1988Q3 1987Q3 2011Q1 2010Q1 2009Q1 2008Q1 2007Q1 2006Q1 Absorption (Left Axis) Avg 0.3%/yr 2005Q1 2004Q1 2003Q1 2002Q1 2001Q1 2000Q1 1999Q1 1998Q1 1997Q1 1996Q1 1995Q1 1994Q1 1993Q1 0 1992Q1 0% 1991Q1 -10% 1990Q1 10 2% 1989Q1 4% -8% 1988Q1 -6% 1987Q1 6% 1986Q1 -4% 1985Q1 8% 1984Q1 10% 1983Q1 0% -2% Construction Completions (Left Axis) Avg 0.7%/yr New York 1986Q3 Construction & Absorption As Percent of Existing Stock at Annualized Rate 28% 1982Q1 28% 26% 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Vacancy (Right Axis) 22% 10% 20% 8% 18% 6% 16% 4% 14% 2% 12% 0% 10% -2% 8% -4% 6% 12% 10% 30 8% 20 6% 4% 2% 0% Vacancy (Right Axis) Atlanta 28% 26% 24% 22% 70 Gross Asking Rent ($/SF-YR) Vacancy as Percent of Existing Stock 2010Q3 2009Q3 0% 2008Q3 -10% 2007Q3 2% 2006Q3 -8% 2005Q3 4% 2004Q3 6% -6% 2003Q3 8% -4% 2002Q3 -2% 2001Q3 2000Q3 1999Q3 1998Q3 1997Q3 1996Q3 1995Q3 1994Q3 10% 20% 60 18% 16% 50 14% 40 12% 10% 30 8% 20 6% 4% 10 2% 2010Q3 2009Q3 2008Q3 2007Q3 Vacancy (Right Axis) 2006Q3 2005Q3 2004Q3 2003Q3 2002Q3 2001Q3 2000Q3 Real Rent (constant 2011 dollars) 1999Q3 1998Q3 1997Q3 1996Q3 1995Q3 1994Q3 1993Q3 1992Q3 1991Q3 1990Q3 1989Q3 1988Q3 1987Q3 0 1986Q3 1994Q1 1993Q1 1992Q1 1991Q1 1990Q1 1989Q1 1988Q1 1987Q1 1986Q1 1985Q1 1984Q1 1983Q1 1982Q1 2011Q1 0% 2010Q1 12% 2009Q1 2% 2008Q1 14% 2007Q1 4% 2006Q1 16% 2005Q1 6% 2004Q1 18% 2003Q1 8% 2002Q1 20% 2001Q1 10% 2000Q1 22% 1999Q1 12% 1998Q1 24% 1997Q1 80 14% 1996Q1 90 26% 1995Q1 28% 16% Vacancy (Right Axis) Avg 17.5% 1993Q3 Real Rent (constant 2011 dollars) Vacancy (Right Axis) Avg 13.4% Atlanta 1992Q3 1991Q3 1990Q3 1989Q3 1988Q3 1987Q3 2011Q1 2010Q1 2009Q1 2008Q1 2007Q1 2006Q1 2005Q1 2004Q1 2003Q1 2002Q1 2001Q1 2000Q1 1999Q1 1998Q1 1997Q1 1996Q1 1995Q1 1994Q1 1993Q1 1992Q1 1991Q1 1990Q1 1989Q1 1988Q1 1987Q1 0 1986Q1 0% 1985Q1 2% 1984Q1 Construction & Absorption As Percent of Existing Stock at Annualized Rate 16% 14% -8% Absorption (Left Axis) Avg 3.1%/yr 18% 40 -10% Construction Completions (Left Axis) Avg 4.3%/yr 20% 50 4% 18% 22% 60 -6% Absorption (Left Axis) Avg 1.6%/yr 24% 70 10 Construction Completions (Left Axis) Avg 2.5%/yr 26% 80 (same scale across 3 metros) 12% 28% Vacancy & Rent 24% Gross Asking Rent ($/SF-YR) 26% 14% Vacancy as Percent of Existing Stock 16% San Francisco 90 28% 1986Q3 Construction & Absorption As Percent of Existing Stock at Annualized Rate San Francisco 18% 1983Q1 (same scale across 3 metros) (Note: 2001Q3 is -17% & -19% (ann rate) for construction & absorption due to 9/11 terrorist attack.) 1982Q1 Construction, Absorption, & Vacancy New York 16% 18% 0% 21 Recall from Chapter 1: Space markets are “segmented” – different rents can prevail @ same time in different locations, or for different types of uses. Apartment Market Asking Rents Net of Inflation: 1986-2011, Seven Metros Gross Asking Rent ($/mo/unit, Constant 2010 $) 3,500 3,000 Atl 2,500 Bos Chi 2,000 Dal NY 1,500 SF DC 1,000 500 2010Q3 2009Q3 2008Q3 2007Q3 2006Q3 2005Q3 2004Q3 2003Q3 2002Q3 2001Q3 2000Q3 1999Q3 1998Q3 1997Q3 1996Q3 1995Q3 1994Q3 1993Q3 1992Q3 1991Q3 1990Q3 1989Q3 1988Q3 1987Q3 1986Q3 0 Source: CoStar Group © 2014 OnCourse Learning. All Rights Reserved. 22 Recall from Chapter 1: Space markets are “segmented” – different rents can prevail @ same time in different locations, or for different types of uses. Office Market Asking Rents Net of Inflation: 1986-2011, Seven Metros Gross Asking Rent ($/mo/unit, Constant 2010 $) 90 80 70 Atl 60 Bos Chi 50 Dal NY 40 SF 30 DC 20 10 2010Q3 2009Q3 2008Q3 2007Q3 2006Q3 2005Q3 2004Q3 2003Q3 2002Q3 2001Q3 2000Q3 1999Q3 1998Q3 1997Q3 1996Q3 1995Q3 1994Q3 1993Q3 1992Q3 1991Q3 1990Q3 1989Q3 1988Q3 1987Q3 1986Q3 0 Source: CoStar Group © 2014 OnCourse Learning. All Rights Reserved. 23 Defining the scope of the market analysis… Geographic/Property type market segments (or sub-markets) Time-frame of the study (historical, forecast to when?) © 2014 OnCourse Learning. All Rights Reserved. 24 © 2014 OnCourse Learning. All Rights Reserved. Exh.6-3: Example of geographic sub-markets: Atlanta office market as defined by CoStar (2012)… 25 Exh.6-3: Example of geographic sub-markets: Atlanta office market as defined by CoStar (2012)… 2012 Space Market Data Consolidated Into 10 Major Submarkets: Class A Market Statistics Mid-Year 2012 Market # Blds Vacancy YT D Under Quoted T otal RBA Direct SF T otal SF Absorption Deliveries Const SF Buckhead 46 15,136,275 2,546,080 2,732,620 18.1% 409,649 0 0 $26.14 Central Perimeter 79 20,717,900 3,433,301 3,672,549 17.7% 524,075 300,000 300,000 $21.83 Downtown Atlanta 30 16,428,027 2,960,675 3,269,055 19.9% (212,230) 0 0 $19.44 Midtown Atlanta 40 16,275,244 2,722,405 2,923,162 18.0% 274,272 0 450,000 $26.17 North Fulton 113 16,678,599 2,539,667 2,758,154 16.5% 0 72,310 $19.69 Northeast Atlanta 69 8,386,917 1,434,935 1,459,613 17.4% 67,500 344,476 $19.92 Northlake 23 3,371,463 451,495 454,958 13.5% (75,833) 0 290,000 $20.07 Northwest Atlanta 83 17,949,924 2,758,250 2,846,632 15.9% (122,782) 0 0 $21.57 South Atlanta 22 1,645,906 377,640 411,771 25.0% 15,741 0 0 $20.16 1 71,500 0 0 0.0% 0 0 0 $0.00 W est Atlanta T otals 506 116,661,755 19,224,448 20,528,514 Vac % YT D Net 17.6% (5,149) 116,233 923,976 367,500 1,456,786 Rates $21.97 Source: CoStar Property® Class B Market Statistics Mid-Year 2012 Existing Inventory Market YT D Net YT D Under Quoted Absorption Deliveries Const SF Rates 17.7% 8,050 0 0 $18.92 28.1% 84,617 16,000 0 $18.05 1,250,658 8.3% (38,992) 0 0 $14.46 936,071 14.6% 84,056 0 0 $17.81 2,454,982 2,503,965 17.0% 134,143 2,400 0 $14.73 T otal RBA Direct SF T otal SF 86 4,797,941 820,644 847,587 Central Perimeter 256 9,560,549 2,604,334 2,684,364 Downtown Atlanta 147 15,059,769 1,249,348 Midtown Atlanta 134 6,419,880 885,651 North Fulton 833 14,722,654 Buckhead Northeast Atlanta # Blds Vacancy Vac % 1,374 20,436,802 4,288,304 4,372,377 21.4% 99,853 22,200 23,504 $14.49 Northlake 674 18,646,450 2,081,709 2,136,103 11.5% 11,488 13,822 0 $16.94 Northwest Atlanta 1,113 21,682,629 4,044,095 4,088,813 18.9% 49,508 0 16,650 $15.73 South Atlanta 756 14,138,178 1,719,928 1,779,284 12.6% 59,354 0 41,145 $16.62 11.8% 57,362 40,000 40,000 $15.28 16.3% 549,439 W est Atlanta T otals 191 2,540,934 5,564 128,005,786 300,831 20,449,826 300,831 20,900,053 94,422 121,299 $15.96 © 2014 OnCourse Learning. All Rights Reserved. Existing Inventory 26 Exh.6-3: Example of geographic sub-markets: Atlanta office market as defined by CoStar (2012)… Class C Market Statistics Market # Blds Vacancy T otal RBA Direct SF T otal SF Vac % 7.6% YT D Net YT D Under Quoted Absorption Deliveries Const SF Rates (814) 0 0 $18.01 Buckhead 259 1,849,733 140,517 140,517 Central Perimeter 371 3,242,745 489,551 489,551 15.1% 33,846 0 0 $13.90 Downtown Atlanta 221 4,762,046 885,019 885,019 18.6% 40,760 0 0 $15.42 Midtown Atlanta 232 1,722,184 141,457 152,881 8.9% (4,861) 0 0 $15.72 North Fulton 852 4,315,854 466,578 468,743 10.9% 98,111 0 0 $12.88 Northeast Atlanta 1,634 8,417,983 1,100,365 1,103,960 13.1% (3,853) 0 0 $13.08 Northlake 1,603 9,065,346 698,939 701,635 7.7% 79,970 0 0 $13.44 Northwest Atlanta 1,748 9,303,317 983,138 987,399 10.6% 83,859 0 0 $13.69 South Atlanta 1,650 8,575,900 1,007,506 1,007,506 11.7% 39,149 0 0 $13.71 0 0 $11.89 W est Atlanta 475 3,201,587 928,581 928,581 29.0% 27,561 T otals 9,045 54,456,695 6,841,651 6,865,792 12.6% 393,728 0 0 $13.68 Source: CoStar Property® Total Office Market Statistics Existing Inventory Market # Blds Mid-Year 2012 Vacancy T otal RBA Direct SF T otal SF Vac % YT D Net YT D Under Quoted Absorption Deliveries Const SF Rates Buckhead 391 21,783,949 3,507,241 3,720,724 17.1% 416,885 0 0 $24.32 Central Perimeter 706 33,521,194 6,527,186 6,846,464 20.4% 642,538 316,000 300,000 $19.95 Downtown Atlanta 398 36,249,842 5,095,042 5,404,732 14.9% (210,462) 0 0 $17.99 Midtown Atlanta 406 24,417,308 3,749,513 4,012,114 16.4% 353,467 0 450,000 $24.10 North Fulton 1,798 35,717,107 5,461,227 5,730,862 16.0% 227,105 2,400 72,310 $17.15 Northeast Atlanta 3,077 37,241,702 6,823,604 6,935,950 18.6% 212,233 89,700 367,980 $15.75 Northlake 2,300 31,083,259 3,232,143 3,292,696 10.6% 15,625 13,822 290,000 $16.49 Northwest Atlanta 2,944 48,935,870 7,785,483 7,922,844 16.2% 10,585 0 16,650 $17.75 South Atlanta 2,428 24,359,984 3,105,074 3,198,561 13.1% 114,244 0 41,145 $16.27 W est Atlanta 667 5,814,021 1,229,412 1,229,412 21.1% 84,923 40,000 40,000 $13.52 T otals 15,115 299,124,236 46,515,925 48,294,359 16.1% 1,867,143 461,922 1,578,085 $18.47 © 2014 OnCourse Learning. All Rights Reserved. Mid-Year 2012 Existing Inventory 27 Market analysis methodology: Simple trend extrapolation vs Structural analysis © 2014 OnCourse Learning. All Rights Reserved. 28 Trend extrapolation: Take advantage of inertia in space market (past partly predicts the future) Consider trends and cycles Potential to use statistical techniques (timeseries analysis: autoregression, ARIMA, VAR, vector error-correction) Potential to bring in capital market factors as predictors © 2014 OnCourse Learning. All Rights Reserved. 29 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. © 2014 OnCourse Learning. All Rights Reserved. 30 Formal analysis requires: 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 primarily in consultants reports and academic studies © 2014 OnCourse Learning. All Rights Reserved. 31 Exh.6-4: Widely used decision-making tool: Basic short-term (1-3 yr) structural market analysis: 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 demand sources Forecast of new supply Forecast of new demand Forecast space shortfall or surplus Decision implicatons? © 2014 OnCourse Learning. All Rights Reserved. 32 Property Type Demand Drivers Residential single family (Owner occupied) Population Household formation (child rearing ages) Interest rates Employment growth (business & professional occupations) Residential multifamily (Apartment renters) Population Household formation (non-childrearing ages) Local housing affordability Employment growth (blue collar occupations) Retail Office Employment in office occupations: Finance, Insurance, Real Estate (FIRE) Business & professional services Legal services Industrial Aggregate disposable income Aggregate household wealth Traffic volume (specific sites) © 2014 OnCourse Learning. All Rights Reserved. Exh.6-5: Major drivers of the demand side of the space market: Manufacturing employment Transportation employment Airfreight volume Rail & truck volume Air passenger volume Tourism receipts or number visitors © 2014 OnCourse Learning. All Rights Reserved. Hotel & convention 33 A simple formal structural model of a space market: Supply side . . . Construction (developer behavior): C (t ) ( R(t L) K ), if R(t L) K , (1) 0, otherwise R(t) = Rent at time t ($/SF). L = Construction lag (yrs). K = Replacement cost rent level. ε = Price elasticity of supply (responsivenesss) Stock (aggreg.supply) response: S (t ) S (t 1) C (t ) © 2014 OnCourse Learning. All Rights Reserved. (2) 34 Geltner MIT/CRE A simple formal structural model of a space market: Demand side . . . Tenant demand: D(t ) R(t ) N (t ) (3) N = Underlying “need” (e.g., employment) η = Price elasticity of demand τ = Technology parameter (e.g. SF/employee) Occupied space: (lag to implement demand reflects search & move time) OS (t ) D(t 1) © 2014 OnCourse Learning. All Rights Reserved. (4) 35 Geltner MIT/CRE A simple formal structural model of a space market: Supply & demand sides (equilibrium) . . . Rent adjustment (landlord & potential tenant behavior): R(t ) R(t 1)(1 ((v(t ) V ) / V )) (6) v(t) = Vacancy rate at time t. V = “Natural” vacancy rate for the mkt. Vacancy rate “physics” (definition): v(t ) (S (t ) OS (t )) / S (t ) © 2014 OnCourse Learning. All Rights Reserved. (5) 36 Geltner MIT/CRE Put these six equations together . . . Numerical example typical parameters: Supply sensitivity = 0.3 Demand sensitivity = 0.3 Technology = 200 SF/employee Demand intercept = 10 million SF Rent sensitivity = 0.3 Construction lag L = 3 years © 2014 OnCourse Learning. All Rights Reserved. 37 Geltner MIT/CRE Exh.6-6 Simulated Space Mkt Dynamics 100 0.7 90 0.6 60 0.4 50 0.3 40 30 0.2 20 0.1 10 0 © 2014 OnCourse Learning. All Rights Reserved. 0.5 70 Constr. MSF Vac, Rent, Empl. 80 0.0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 Year Employment(000s) Rent($/SF/YR) Vacancy(%) Construction Completions(MSF/YR) 11-year cycle, even though no business cycle! 38 Rent & Vacancy Alone Vac, Rent 20.0 15.0 Vac quartercycle lead ahead of rent. Vacancy peaks just before rent troughs 10.0 5.0 0.0 Year VAC% RENT Devlpt cycle exagerates rent&vac cycle. New supply enters just as vacancy peaks Employment & Construction Alone 0.700 120 Empl. 000s 0.800 0.600 100 0.500 80 0.400 60 0.300 40 0.200 20 0.100 0 0.000 Constr. MSF 140 RE mkt cyclical even when underl demand not © 2014 OnCourse Learning. All Rights Reserved. 25.0 Year EMPL CONST 39 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. Specifics depend on the parameter values. (& CAVEAT: This is a simple model, ignores forward-looking behavior.) © 2014 OnCourse Learning. All Rights Reserved. 40 Geltner MIT/CRE Market Dynamics 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 forward-looking? 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? © 2014 OnCourse Learning. All Rights Reserved. 41 Geltner MIT/CRE Forward-looking decisions & negative feedback equilibrates the system… SPACE MARKET Exhibit 2-2 SUPPLY (Landlords) ADDS NEW Rising supply Falling cash flow Falling asset prices Less dvlpt… LOCAL & NATIONAL ECONOMY DEMAND (Tenants) RENTS & OCCUPANCY FORECAST FUTURE DEVELOPMENT INDUSTRY Consider constr pipeline, underl demand evolution… ASSET MARKET IF YES IS DEVELPT PROFITABLE ? CONSTR COST INCLU LAND SUPPLY (Owners Selling) CASH FLOW PROPERTY MARKET VALUE MKT REQ’D CAP RATE CAPI TAL MKTS DEMAND (Investors Buying) = Causal flows. = Information gathering & use. © 2014 OnCourse Learning. All Rights Reserved. 42 Geltner MIT/CRE But positive feedback can cause spirals that result in cycles… SPACE MARKET Exhibit 2-2 SUPPLY (Landlords) ADDS NEW Rising prices Increased demand More dvlpt… LOCAL & NATIONAL ECONOMY DEMAND (Tenants) RENTS & OCCUPANCY FORECAST FUTURE DEVELOPMENT INDUSTRY ASSET MARKET IF YES IS DEVELPT PROFITABLE ? CONSTR COST INCLU LAND SUPPLY (Owners Selling) CASH FLOW PROPERTY MARKET VALUE MKT REQ’D CAP RATE DEMAND (Investors Buying) = Causal flows. CAPI TAL MKTS Rising prices Increased demand Rising prices… = Information gathering & use. © 2014 OnCourse Learning. All Rights Reserved. 43 Geltner MIT/CRE Both the space market & the asset market can tend to be cyclical, but the cycle is not necessarily the same… Exhibit 2-5. Example Space Market Rents & Asset Market Prices (adjusted for inflation): 1986-2011* 120 Indexed to 1986Q4 = 100 110 100 90 80 70 60 50 2010Q4 2009Q4 2008Q4 2007Q4 2006Q4 2005Q4 2004Q4 2003Q4 2002Q4 2001Q4 2000Q4 1999Q4 Rent 1998Q4 1997Q4 1996Q4 1995Q4 1994Q4 1993Q4 1992Q4 1991Q4 1990Q4 1989Q4 1988Q4 1987Q4 1986Q4 40 Price *The lines depicted here are illustrative examples typical of the US commercial real estate markets, but not exact correlates of the same markets. The rent line is based on asking rents for office space in seven major metro areas (source: CoStar); the asset price line isthe NCREIF-based TBI (source: MIT) transaction price index for institutional investment property. Both the rent line and the asset price line are net of CPI inflation. Source: CoStar Group, NCREIF, MIT © 2014 OnCourse Learning. All Rights Reserved. 44 Geltner MIT/CRE Both the space market & the asset market can tend to be cyclical, but the cycle is not necessarily the same… Exhibit 2-5. Example Space Market Rents & Asset Market Prices (adjusted for Asset mkt inflation): 1986-2011* 120 cycle Indexed to 1986Q4 = 100 110 Space mkt cycle 100 Both mkts cycle together 90 80 70 60 50 40 2010Q4 2009Q4 2008Q4 2007Q4 2006Q4 2005Q4 2004Q4 2003Q4 2002Q4 2001Q4 2000Q4 1999Q4 1998Q4 1997Q4 1996Q4 1995Q4 1994Q4 1993Q4 1992Q4 1991Q4 1990Q4 1989Q4 1988Q4 1987Q4 1986Q4 Rent Price *The lines depicted here are illustrative examples typical of the US commercial real estate markets, but not exact correlates of the same markets. The rent line is based on asking rents for office space in seven major metro areas (source: CoStar); the asset price line isthe NCREIF-based TBI (source: MIT) transaction price index for institutional investment property. Both the rent line and the asset price line are net of CPI inflation. Source: CoStar Group, NCREIF, MIT © 2014 OnCourse Learning. All Rights Reserved. 45 Geltner MIT/CRE