Essentials of Real Estate Economics SIXTH EDITION, Dennis J. McKenzie Richard M. Betts MAI, SRA, ASA (Real Estate) Property Analyst Carol A. Jensen Cabrillo College, Aptos and City College of San Francisco ^CENGAGE QC3 Learning Australia Brazil Japan Korea Mexico Singapore Spain United Kingdom United States
Brief Contents Preface xiv Acknowledgments About the Authors Dedication xxii xix xx PART I BASIC ECONOMIC BACKGROUND FOR REAL ESTATE ANALYSIS I 1 INTRODUCTION TO REAL ESTATE ECONOMICS 2 2 REVIEW OF THE ECONOMIC PRINCIPLES OF CAPITALISM 3 GOVERNMENT'S ROLE IN THE ECONOMY 3 4 MONEY, CREDIT, AND REAL ESTATE 76 5 IMPORTANT ECONOMIC FEATURES OF REAL ESTATE 116 PART II UNDERSTANDING REAL ESTATE MARKETS 149 6 REGIONAL AND COMMUNITY ANALYSIS 150 7 COMMUNITY GROWTH PATTERNS 176 NEIGHBORHOODS: CLUSTERS OF LAND USE AND VALUE 204 9 HOUSING MARKETS 230 10 COMMERCIAL AND INDUSTRIAL MARKETS 266 I I RURAL AND RECREATIONAL REAL ESTATE MARKETS 300 iii
Brief Contents PART IB MAJOR INFLUENCES ON REAL ESTATE 12 THE ECONOMICS OF REAL PROPERTY TAXATION 334 13 LAND-USE CONTROLS 360 14 REAL ESTATE DEVELOPMENT 3 15 REQUIRED GOVERNMENT REPORTS 410 PART IV REAL ESTATE INVESTMENT 427 16 SUMMARY OF REAL ESTATE INVESTMENT PRINCIPLES 42 17 INCOME TAX ASPECTS OF INVESTMENT REAL ESTATE 454 1 APPLIED REAL ESTATE ECONOMICS 47 19 ANTICIPATING CHANGE 496 Answers to the Reviewing Your Understanding Questions 529 Glossary 534 Index 543
Preface xiv Acknowledgments About the Authors Dedication xxii xix xx PART I BASIC ECONOMIC BACKGROUND FOR REAL ESTATE ANALYSIS I I INTRODUCTION TO REAL ESTATE ECONOMICS 2 WHAT IS ECONOMICS? 3 WHAT IS REAL ESTATE? 3 WHAT IS REAL ESTATE ECONOMICS? 4 WHAT REAL ESTATE ECONOMICS IS NOT 4 WHY IS REAL ESTATE ECONOMICS SO INTERESTING? 5 WHY SHOULD YOU STUDY REAL ESTATE ECONOMICS? 5 A GENERAL OVERVIEW 6 CHAPTER OUTLINES 6 h A FINAL WORD 7
vi Contents REVIEW OF THE ECONOMIC PRINCIPLES OF CAPITALISM 2.1 BASIC ECONOMIC CONCEPTS 9 Economics Revisited Choice and Opportunity Cost: No Free Lunch Economics Is an Inexact Science Economic Solutions May Contain Value Judgments The Different Economic Systems Real World Economies No Economic System Is Perfect Basic Principles of Pure Capitalism How Pure Capitalism Answers the Questions What, How, and for Whom Modern Mixed Capitalism in the United States 2.2 ECONOMIC PRINCIPLES IN ACTION 17 The Factors of Production Rent, Wages, Interest, Profit, and Income a The Circular Flow of the Economy 2.3 MARKETS AND PRICES 21 What Determines Prices and Output? Perfect versus Imperfect Markets Demand and Supply: The Classic Answer to Price Determination Demand Supply Supply and Demand Together Determine Output and Price Levels Elasticity The Flow of the Economy Revisited Impact of International Trade International Trade Concepts International Trade: Is Self-Sufficiency Better? The Economic Theory Sounds Good, But... CASE & POINT ADAM SMITH, ECONOMIC PHILOSOPHER 34 GOVERNMENT'S ROLE IN THE ECONOMY 3 3.1 THE REAL WORLD OF MARKETS AND GOVERNMENT 39 Government Intervention in the Economy How Government Economic Intervention Changed Flow of the Economy The Government Included 3.2 MEASURING THE PERFORMANCE OF THE ECONOMY 43 National Income Accounting The Details Behind the GDP Totals Other Income Measurements Keeping Up with National Income The Importance of Employment Data Other Economic Data Foreign Ownership of U.S. Businesses and Real Estate Composition of Foreign Investment 3.3 CHANGES IN ECONOMIC ACTIVITY 55 The Phases of the Business Cycle Causes of Business Cycles Real Estate Cycles Using Economic Indicators Forecasting Changes in Economic Activity
vii 3.4 GOVERNMENT TOOLS TO FIGHT ECONOMIC PROBLEMS 61 Fiscal Policy Monetary Policy The Theory Sounds Good, but There Are Some Problems Automatic Stabilizers The Measurement Problems CASE & POINT LAFFER CURVE 74 4 MONEY, CREDIT, AND REAL ESTATE 76 4.1 THE SUPPLY OF MONEY 77 What is Money? What Makes "Good" Money? Money Today Credit Cards Are Not Money Depository Institutions Create Money How Fractional Reserves Create Money a Federal Deposit Insurance Too Much Money Can Cause Inflation and Cause Harm Real Estate Markets and Inflation The Importance of Controlling the Supply of Money 4.2 THE FEDERAL RESERVE SYSTEM Purpose and Structure of the Federal Reserve System How the Federal Reserve Attempts to Control the Money Supply Major Tools of the Federal Reserve Federal Funds Rate The LIBOR Rate A Review of the Major Federal Reserve Tools 4.3 HOW THE ACTIONS OF THE FEDERAL RESERVE AFFECT REAL ESTATE 96 Tight-Money Policies and Real Estate Does the Fed Discriminate Against Housing When It Tightens Money? Easy-Money Policies and Real Estate Recovery in the Real Estate Market Normally Precedes a Recovery in the National Economy Mortgage Market Reforms 4.4 THE FED'S EMERGENCY POWERS 100 Trust and Counter-Party Risk The Panic and the Fed's Response CASE & POINT THE SAVINGS AND LOAN CRISIS OF THE 190s AND ITS SUCCESSOR, THE MORTGAGE SECURITIES COLLAPSE OF 2007 112 5 IMPORTANT ECONOMIC FEATURES OF REAL ESTATE 116 5.1 ECONOMIC CHARACTERISTICS OF REAL ESTATE MARKETS 117 Does This Mean That the Principles of Supply and Demand Do Not Work in Real Estate Markets? 5.2 HOW REAL ESTATE MARKETS REACT TO CHANGES IN DEMAND 122 What Causes Supply and Demand for Real Estate to Change? Foreign Ownership of U.S. Real Estate Why Have Real Estate Professionals Impact of the Internet
5.3 ANALYZING DEMAND AND SUPPLY USING GRAPHS 130 Demand Supply Equilibrium Why Use Demand and Supply Graphs? CASE & POINT TAKING DEMAND AND SUPPLY GRAPHS ANOTHER STEP 140 PART II UNDERSTANDING REAL ESTATE MARKETS 149 6 REGIONAL AND COMMUNITY ANALYSIS 150 6.1 WHY AND WHERE COMMUNITIES FORM 151 The History of Communities What Determines Community Location? Reasons for American City Locations How the City's Origin Fits In 6.2 WHY THE COMMUNITY GROWS 156 The Community as an Economy Setting Community Goals 6.3 HOW TO STUDY A COMMUNITY 163 Traditional Community Analysis Basic Employment Reviewed Regional Economic Studies The Gatekeeping Syndrome Sources of Data CASE & POINT "WHERE ARE WE MOVING TO?" 173 COMMUNITY GROWTH PATTERNS 176 7.1 LAND-USE PATTERNS 177 How Economics Determines Land Use Why Patterns? What Are the Rules? The Noneconomic Factors in Land Use 7.2 LOOKING AT THE STRUCTURE OF COMMUNITIES 10 Why Study Community Land-Use Patterns? Viewing the Small Community Simple Circles Accessibility The Importance of Topography Transportation The Existing City: Origins 7.3 MODERN CITY GROWTH PATTERNS 16 Proximity Versus Accessibility The Complex City Enter the Wedge Political and Social Factors Community Attitudes The Results Other Views The Effects of Transportation Change Adding in Technology CASE & POINT FUTURE ISSUES IN CITY LAYOUT 202
ix NEIGHBORHOODS: CLUSTERS OF LAND USE AND VALUE 204.1 THE NEIGHBORHOOD AS THE BASIS OF VALUE 205 What Is a Neighborhood? Neighborhood, Location, and Property Values Neighborhood Boundaries.2 NEIGHBORHOODS AS BAROMETERS OF CHANGE 20 Forces for Change Signs of Neighborhood Change The Meaning of It All.3 AS NEIGHBORHOODS AGE 216 Progressive Decay > Wow! What Happened? The Rehabilitation Cycle Learning to Fight Decay CASE & POINT NEIGHBORHOOD PRESERVATION: TWO VIEWPOINTS 22 9 HOUSING MARKETS 230 Housing Markets 9.1 THE DEMAND FOR HOUSING 231 Population Income and Financing Changes in Taste 9.2 THE SUPPLY OF RESIDENTIAL HOUSING 244 Evaluation of Supply Is the Housing Suitable? Available Supply The Future of Construction 9.3 THE GOVERNMENT AND HOUSING 255 Regulating Housing Markets Encouraging Housing Production CASE & POINT GATED COMMUNITIES AMERICAN APARTHEID? 265 I 0 COMMERCIAL AND INDUSTRIAL MARKETS 266 10.1 BUSINESS REAL ESTATE 267 Investors versus Users The User Viewpoint The Investor Viewpoint 10.2 MAJOR VALUE INFLUENCES 271 The Economic Issues The Governmental Issues Special Issues 10.3 COMMERCIAL PROPERTY 277 What Are the Major Forces? What Are the Patterns of Commercial Land Use? Interesting Changes Is Your Local Commercial Area Changing? Making a Simple Market Survey
10.4 INDUSTRIAL PROPERTY 29 Theory of Industrial Location The Changing Pattern of Industrial Locations The Industrial Market Study CASE & POINT THE REVOLUTION IN RETAILING 297 I I RURAL AND RECREATIONAL REAL ESTATE MARKETS 300 I I.I FARMLAND MARKETS 301 Key Factors Major Trends I 1.2 RURAL HOMES 315 The New Subdivision The Older Home 11.3 TIMBER AND OTHER RESOURCE LANDS 321 Key Factors Major Trends CASE & POINT SHOULD THE GOVERNMENT SUBSIDIZE RESOURCE DEVELOPMENT? 330 PART III MAJOR INFLUENCES ON REAL ESTATE 12 THE ECONOMICS OF REAL PROPERTY 12.1 THE PRINCIPLES OF TAXATION 335 Taxes Can Be Used to Redistribute Wealth The Theory of Taxation Major Taxes and Expenditures Is the Tax Progressive, Proportional, or Regressive? 12.2 EVALUATING THE PROPERTY TAX 343 Local Government and the Property Tax Who Really Pays the Property Tax: Owners, Tenants, or Consumers? Property Taxes and Capitalized Real Estate Values Is the Property Tax Regressive? Property Taxes and Land Usage 12.3 PROPERTY TAX REFORM 350 Political Realities Current Reforms Possible Future Reforms Other Taxes Affecting Real Estate CASE & POINT TAX TALK... SAY WHAT YOU MEAN! 35
xi I 3 LAND-USE CONTROLS 360 13.1 TYPES OF LAND-USE CONTROLS 361 Private Land-Use Controls Easements Public Land-Use Controls Police Power Eminent Domain Government Spending as an Influence on Land Use 13.2 PRINCIPLES OF URBAN PLANNING 36 Definition of Urban Planning Creation and Implementation of Urban Planning The Need for Regional Planning 13.3 RECENT TRENDS IN LAND-USE CONTROLS 374 Preventing Premature Subdividing Pollution and Environmental Regulations Slow-Growth and No-Growth Policies The Creation of New Towns State and Federal Intervention in Land-Use Controls Inclusionary Zoning Land-Use Controls and the Real Estate Industry CASE & POINT PROPERTY RIGHTS: TWO VIEWPOINTS 35 I 4 REAL ESTATE DEVELOPMENT 3 14.1 REAL ESTATE CONSTRUCTION 39 Construction Activity Characteristics of the Homebuilding Industry 14.2 THE DEVELOPMENT AND BUILDING PROCESS 394 Land Development and Construction When This Process Is Ignored, Overbuilding Can Occur Steps in Construction Green Building The Cost of Construction Delays and Impact Fees CASE & POINT REAL ESTATE ECONOMIC HISTORY: CALIFORNIA IN THE 190S: "THE BUILD-AND-THEY-SHALL-COME SYNDROME," FOLLOWED BY A DECLINE IN THE I990S-2000S 406 15 REQUIRED GOVERNMENT REPORTS 410 15.1 TYPES OF REQUIRED GOVERNMENT REPORTS 411 Federal Legislation State Legislation Local Legislation 15.2 COSTS VERSUS BENEFITS 417 Defining Costs and Benefits Analyzing the Costs Analyzing the Benefits The Trend CASE & POINT HOW WET IS WET? 425
xii Contents PART IV REAL ESTATE INVESTMENT 427 I 6 SUMMARY OF REAL ESTATE INVESTMENT PRINCIPLES 42 16.1 BASIC INVESTMENT PRINCIPLES 429 The Key Investment Factors The Investment Decision 16.2 REAL ESTATE CASH FLOW ANALYSIS 434 The Steps in Annual Cash Flow Analysis Before-Tax Cash Flow Tax Benefit Analysis Net Spendable Income Multi-year Analysis Summing Up Cash Flow Analysis 16.3 ESTIMATING PRICE AND RATES OF RETURN 441 The Offering Price Amount of the Cash Investment Computing Rates of Return CASE & POINT CASE STUDY OLDER 10-UNIT APARTMENT BUILDING 452 I 7 INCOME TAX ASPECTS OF INVESTMENT REAL ESTATE 454 17.1 MAJOR INCOME TAX ADVANTAGES 455 Investor versus Dealer 17.2 BASIS AND DEPRECIATION 457 How Much Is Deductible? How Does It Work? 17.3 PASSIVE LOSS RULES 460 Passive Income/Loss Offset Rules $25,000 Exception to the Passive Loss Rules 17.4 CALCULATING AND DEFERRING GAIN 464 A. Calculating Gain and Taxes Owed on Income Property B. Use of an Installment Sale to Spread Out Taxable Gain C. Use of a Like-Kind, Section 1031 Exchange to Defer Gain CASE & POINT WHY SHOULD INTEREST ON HOME LOANS BE DEDUCTIBLE? 474 I APPLIED REAL ESTATE ECONOMICS 47 1.1 REAL ESTATE INVESTMENT VARIABLES 479 Expectations Multiple Choices Determining Investment Characteristics Fancy Footwork 1.2 STEPS IN REAL ESTATE DECISION MAKING 43 Steps in Analyzing an Improved Property Steps in Analyzing Alternatives for Unimproved Real Estate Parcels CASE & POINT WHERE ARE WE IN THE REAL ESTATE CYCLE? 494
xiii I 9 ANTICIPATING CHANGE 496 19.1 THE MAJOR ECONOMIC ISSUES 497 Recovery from the Financial Collapse of 2007 The Consequences of the Financial Collapse of 2007 19.2 NATIONAL CHANGES 509 Demographic Issues Political/Legal Issues 19.3 THE UNCERTAIN FUTURE 519 Telemobility Population Growth» Where Does This Situation Leave The Real Estate Industry? Answers to the Reviewing Your Understanding Questions 529 Glossary 534 Index 543