sign in sign up
<<
Home , Real estate economics

Essentials of Economics SIXTH EDITION

, Dennis J. McKenzie Richard M. Betts MAI, SRA, ASA (Real Estate) 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 xix About the Authors xx Dedication xxii

PART I BASIC ECONOMIC BACKGROUND FOR REAL ESTATE ANALYSIS I

1 INTRODUCTION TO 2

2 REVIEW OF THE ECONOMIC PRINCIPLES OF CAPITALISM 8

3 GOVERNMENT'S ROLE IN THE ECONOMY 38

4 MONEY, , 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

8 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 I8B MAJOR INFLUENCES ON REAL ESTATE

12 THE ECONOMICS OF TAXATION 334

13 LAND-USE CONTROLS 360

14 388

15 REQUIRED GOVERNMENT REPORTS 410

PART IV REAL ESTATE INVESTMENT 427

16 SUMMARY OF REAL ESTATE INVESTMENT PRINCIPLES 428

17 INCOME TAX ASPECTS OF INVESTMENT REAL ESTATE 454

18 APPLIED REAL ESTATE ECONOMICS 478

19 ANTICIPATING CHANGE 496

Answers to the Reviewing Your Understanding Questions 529 Glossary 534 Index 543 Contents

Preface xiv Acknowledgments xix About the Authors xx Dedication xxii

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 8 2.1 BASIC ECONOMIC CONCEPTS 9 Economics Revisited 8 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 • 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 38 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 8 Real Estate Cycles ° Using Economic Indicators • Forecasting Changes in Economic Activity Contents vii

3.4 GOVERNMENT TOOLS TO FIGHT ECONOMIC PROBLEMS 61 Fiscal Policy • Monetary Policy 8 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 • 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 88 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 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 1980s 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 Contents

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 8 What Determines Community Location? 8 Reasons for American City Locations • How the City's Origin Fits In 6.2 WHY THE COMMUNITY GROWS 156 The Community as an Economy 8 Setting Community Goals 6.3 HOW TO STUDY A COMMUNITY 163 Traditional Community Analysis • Basic Employment Reviewed 8 Regional Economic Studies 8 The Gatekeeping Syndrome 8 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 8 Why Patterns? 8 What Are the Rules? • The Noneconomic Factors in Land Use 7.2 LOOKING AT THE STRUCTURE OF COMMUNITIES 180 Why Study Community Land-Use Patterns? 8 Viewing the Small Community 8 Simple Circles—Accessibility 8 The Importance of Topography • Transportation 8 The Existing City: Origins 7.3 MODERN CITY GROWTH PATTERNS 186 Proximity Versus Accessibility 8 The Complex City 8 Enter the Wedge 8 Political and Social Factors 8 Community Attitudes 8 The Results 8 Other Views 8 The Effects of Transportation Change 8 Adding in Technology CASE & POINT—FUTURE ISSUES IN CITY LAYOUT 202 Contents ix

8 NEIGHBORHOODS: CLUSTERS OF LAND USE AND VALUE 204 8.1 THE NEIGHBORHOOD AS THE BASIS OF VALUE 205 What Is a Neighborhood? • Neighborhood, Location, and Property Values 8 Neighborhood Boundaries 8.2 NEIGHBORHOODS AS BAROMETERS OF CHANGE 208 Forces for Change 8 Signs of Neighborhood Change • The Meaning of It All 8.3 AS NEIGHBORHOODS AGE 216 Progressive Decay •> Wow! What Happened? 8 The Rehabilitation Cycle 8 Learning to Fight Decay CASE & POINT—NEIGHBORHOOD PRESERVATION: TWO VIEWPOINTS 228

9 HOUSING MARKETS 230 Housing Markets 9.1 THE DEMAND FOR HOUSING 231 Population 8 Income and Financing ° Changes in Taste 9.2 THE SUPPLY OF RESIDENTIAL HOUSING 244 Evaluation of Supply 8 Is the Housing Suitable? 8 Available Supply 8 The Future of Construction 9.3 THE GOVERNMENT AND HOUSING 255 Regulating Housing Markets 8 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 8 The Investor Viewpoint 10.2 MAJOR VALUE INFLUENCES 271 The Economic Issues 8 The Governmental Issues 8 Special Issues 10.3 277 What Are the Major Forces? 8 What Are the Patterns of Commercial Land Use? 8 Interesting Changes • Is Your Local Commercial Area Changing? 8 Making a Simple Market Survey Contents

10.4 INDUSTRIAL PROPERTY 289 Theory of Industrial Location ° The Changing Pattern of Industrial Locations 8 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 315 The New Subdivision • The Older 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 8 Major Taxes and Expenditures • Is the Tax Progressive, Proportional, or Regressive? 12.2 EVALUATING THE 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 8 Possible Future Reforms 8 Other Taxes Affecting Real Estate CASE & POINT—TAX TALK ... SAY WHAT YOU MEAN! 358 Contents xi

I 3 LAND-USE CONTROLS 360 13.1 TYPES OF LAND-USE CONTROLS 361 Private Land-Use Controls 8 Easements Public Land-Use Controls 8 Police Power 8 8 Government Spending as an Influence on Land Use 13.2 PRINCIPLES OF 368 Definition of Urban Planning 8 Creation and Implementation of Urban Planning 8 The Need for Regional Planning 13.3 RECENT TRENDS IN LAND-USE CONTROLS 374 Preventing Premature Subdividing 8 Pollution and Environmental Regulations 8 Slow-Growth and No-Growth Policies 8 The Creation of New Towns • State and Federal Intervention in Land-Use Controls 8 Inclusionary • Land-Use Controls and the Real Estate CASE & POINT—PROPERTY RIGHTS: TWO VIEWPOINTS 385

I 4 REAL ESTATE DEVELOPMENT 388 14.1 REAL ESTATE CONSTRUCTION 389 Construction Activity 8 Characteristics of the Homebuilding Industry 14.2 THE DEVELOPMENT AND BUILDING PROCESS 394 Land Development and Construction 8 When This Process Is Ignored, Overbuilding Can Occur 8 Steps in Construction 8 Green Building 8 The Cost of Construction Delays and Impact Fees CASE & POINT—REAL ESTATE ECONOMIC HISTORY: CALIFORNIA IN THE 1980S: "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 8 Analyzing the Costs 8 Analyzing the Benefits 8 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 428 16.1 BASIC INVESTMENT PRINCIPLES 429 The Key Investment Factors 8 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 8 Net Spendable Income 8 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 8 Computing Rates of Return CASE & POINT—CASE STUDY—OLDER 10-UNIT 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 8 B. Use of an Installment Sale to Spread Out Taxable Gain 8 C. Use of a Like-Kind, Section 1031 Exchange to Defer Gain CASE & POINT—WHY SHOULD INTEREST ON HOME LOANS BE DEDUCTIBLE? 474

I 8 APPLIED REAL ESTATE ECONOMICS 478 18.1 REAL ESTATE INVESTMENT VARIABLES 479 Expectations • Multiple Choices • Determining Investment Characteristics 8 Fancy Footwork 18.2 STEPS IN REAL ESTATE DECISION MAKING 483 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 Contents xiii I 9 ANTICIPATING CHANGE 496 19.1 THE MAJOR ECONOMIC ISSUES 497 Recovery from the Financial Collapse of 2007 8 The Consequences of the Financial Collapse of 2007 19.2 NATIONAL CHANGES 509 Demographic Issues 8 Political/Legal Issues 19.3 THE UNCERTAIN FUTURE 519 Telemobility 8 Population Growth » Where Does This Situation Leave The Real Estate Industry?

Answers to the Reviewing Your Understanding Questions 529 Glossary 534 Index 543