The Main Features of Real Estate Economics - Coursework Example

Real E Economics Table of Contents Real E Economics Table of Contents 2 Introduction 3 The UK Housing Market 3 Housing and the Macro economy and nature of the Housing Market 4 Determining Demand and Supply in Real Estate 4 Lease Structure Change in the UK 5 Report on the European Office Market 7 Report on European Retail Market 7 Report on European Industrial Market 8 Decelerating Rental Decline 10 Conclusion 11 References 11 Introduction This project explains the dynamics of the real estate market and the application of economic techniques which determines varying demand and supply of the market and the generation of cycles of booms and depressions. It also explains why the rents keep varying between sectors. It explains other relevant factors which determine investment decisions of consumers across various sectors. As the real estate market is becoming increasingly international, it is important to understand the operations in national markets and their interrelationships. This project tries to identify and find similarities and differences across different markets and provides a framework to explain how these national markets converge. Recently, there has been extensive study using empirical and theoretical research on real estate using methodologies of economics and finance. This research includes the market structure and its workings, the role of institutional arrangements, risk management and valuation, public policy and regulations by the Government. The UK Housing Market UK’s housing market witnessed a dramatic downfall in the 1990s. But now it has shown remarkable recovery. Currently the average price of houses stands at £163,000 as presented by the HBOS index. House prices had reached its peak in 1989, in comparison to household incomes. Researches now suggest that presently house prices gave surpassed that level. The nation’s economic performance gets reflected in the performance of the housing market (Cameron, 2005, p.1) Housing and the Macro economy and nature of the Housing Market The housing market behaves in a peculiar way owing to certain reasons. Firstly, it is seen that since take a lot of time to get built, when demand increases, its supply responds with a lag. The short run supply of houses remains fixed. Secondly, houses are able to generate an implicit income. It saves the rent that the owner is supposed to pay. Thus value of houses reflects future expectations of rents. Change in prices of houses affects the economy indirectly. The most important way is by their effects on the households. A fall in the price of houses gives them a feel of less wealth and so their household consumption falls. Secondly, price fall for houses reduces household’s borrowing capacity, thus they cannot remortgage to finance holidays and other expenses. Researchers have suggested that the effects are strongest for the UK economy compared to other developing nations. I% decline in housing wealth, results in 0.07% reduction in spending of consumers (Cameron, 2005, p.4). Determining Demand and Supply in Real Estate The supply and demand in real estate are determined by market fluctuations. It is seen that the tendency of losing money remains high during the short term. Usually the supply of real estate grows faster than the demand. When the demand is higher than the supply real estate value begins to depreciate. Housing supply determines the condition of the real estate market. “A nine month supply of housing” (Yaerd.org, 2008) does not reveal if there is excess supply of houses in the real estate, or whether consumers should invest at that time. But the trend in housing supply is noted for the previous years and is seen that it was 10 moths supply, and the year prior to that, it was 11 months supply, it reveals that the excess supply was being consumed. It reveals that the market demand was absorbing the extra supply of houses. Lease Structure Change in the UK UK’s real estate market is characterised by long leases. This characteristic, however, has changed over the last few years. On an average the average length of lease is much shorter in 2005 in comparison to that in 1990. The change in lease structure affects investments on real estate properties. The central government in UK implemented a new lease regulation. It was seen that sectors with volatile rents, had to suffer income penalties, low returns. The sector themselves suffered high volatility. The office market in London was greatly affected by this regime. This reduced allocations in real estate (IPF, 2005, p.6). Figure 1: Showing Prime Rents (BNP Paribas, 2010, p.5) Figure 2: Showing Prime Rents Change – Q1 2010 vs. Q1 2009 (BNP Paribas, 2010, p.5) From the above figure it is seen that prime rent decreased slowly, with a general to stabilize in all parts of Europe. Buildings located in favourable places are expected to remain stable. It is a general tendency of tenants to look for secure places in this segment. Paris registered an increase in prime rents which was almost the same before the recessions. Prime rents in London have remained stable over the year. Rents are on the rise because of the scarcity of spaces and floor spaces that are required by the offices. On the contrary in the western countries rent free periods are increasing, which indirectly implies a rise in rents. In Madrid, prime rents continued to decline. It is now at the level that it was in the year 2006. It is now expected to come at a stable condition. Landlords seem to have stopped adjusting their rents and the demand is also on the rise. Rent has almost stabilised in Milan, and in parts in the centre, but is decreasing in the outskirts. Companies still prefer buildings which are newly formed even if they are located in distant places. Thus, rents are undergoing both upward and downward pressure. The general tendency in European cities is decline in the level of rents because of the availability of second hand offices premises. On the other hand rents are expected to remain in stable conditions in case of establishment of new offices. Report on the European Office Market The sub-prime mortgage crisis in the US led to the financial crisis across the world in the year 2007. Bankruptcy of Lehman Brothers proved to be the turning point of the crisis. The European market was hit by this recession for the very first time in its history. Consequently the real estate was also hit by the crisis. Reduction in employment lessened office take-ups and other real estate investments (BNP Paribas, 2009,). The Office take up index fell by 19% after reaching the maximum in 2007. The market in London improved by 30%, whereas Paris and Amsterdam market fell by 12%. Hague and Madrid witnessed decline by 66% and 49% respectively. Report on European Retail Market The financial crisis affected the European market significantly. Investment dropped greatly in 2008 and resumed its activity by 2009. Situations further improved by the first quarter of 2010. Investment in all real estate sectors reached €53 billion, which was drop of 31% from the previous year. Commercial investment activity fell in all major countries of Europe. Spain and Germany reduced by 56% and 49% respectively. But the retail sector showed improvement for these two countries. The shopping centres remained attractive only if they were located at favourable places and were rented fully. Germany witnessed a drop of 88% in its portfolio deals. During 2010, German investment in real estate recovered significantly. UK’s real estate investment in the commercial sector was 52%, Germany attracted 20% and Spain 11%. Yields from the retail sector usually remain lower than yields from the offices. Commercial premises and competition among the investors leads in rise in rents and lowers yield. The retail sector in UK accounts for one third of the total investment in real estate. It also represents 52% of the total investment in retail in Europe. (BNP Paribas, 2010, p.3) Report on European Industrial Market Industrial yield began to stabilize across the countries of Europe by the end of 2009. Investments began to accelerate during the latter half of the year 2009. This year saw an increase in industrial real estate by almost 60%. Total amount of investment in the year 2009 amounted to about €6.2 billion. This decline was compensated by growing investment in countries like France and UK, which grew by 42% and 7% respectively. As a result of pre-pricing from the year 2007, UK’s yield looked more attractive than the rest of the European countries in 2009. Thus UK drew about 42% of the investment in Europe. 2010 is expected to establish more number of prime assets in markets in Western Europe in countries like France, UK, Netherlands and Germany. But it is apprehended that due to lack of suitable opportunities, it may result in further decline of prime yields. In this situation, investors will be extremely careful and look for the best opportunities to select the right kind of assets. Further investors who are risk averse will resist high prices which will result in compressing yields in short terms (JLL, 2010, p.4). Figure: 3 Sowing net sellers and purchasers of industrial properties in 2009 (JLL, 2010, p.4) As in earlier years, unlisted investors comprised of 40% of the total volume of investments in 2009. Institutional investors comprising of insurance companies and pension funds represented 21%, which was a 40% rise from the year 2008. The financial crisis had taken a toll primarily on the unlisted investors consequently declining investments by 64% in 2008. The supply automatically declined by 57%. In 2009, most of the markets in Europe saw a decline in occupier demand. Total take-up in the warehousing market in Europe accounted for 10.1 million m2. . This implies a decline of 27% annually. Growth remained significantly low for countries like UK, Spain and Belgium, whereas the only market recording growth in take up volumes was Russia (JLL, 2010, p.6). Decelerating Rental Decline Figure: 4 Showing Prime Rental Change Q4 2009 vs. Q4 2008 (JLL, 2010, p.4) The warehouse rental declined 0.8% in 2009. Rents were declining at a decelerating rate for most of the countries. But for countries like Amsterdam, Rotterdam, Antwerp and Hamburg, rents declined for the first time in their history. These markets had remained extremely resilient to rent decline for years. Increase in supply and existence of stiff competition in markets to attract and retain tenants have exerted pressure to bring down rents (JLL, 2010, p.7). Overall, rents are expected to remain at a stable position in 2010. However, rental pressures persist in those markets where supply remains high. Rental declines are expected to exist across Spain and the CEE. The stability and decline in the level of rents in most markets resulted because of the increase in incentive packages. According to the length of the leases, occupiers can presently avail reduction in rents. This ranges from 10% to 20% generally during the time lease renewal or negotiating for new leases. Conclusion Economic reports show that although a number of real estate markets are struggling across the world, there are some countries that have shown significant growth after the recession. America was strongly hit by the recession. A number of cities were severely affected especially those which had major job opportunities in the manufacturing and the housing sector. But the situation is slightly different foe the European countries. It was strongly hit by the recession in the real estate sector, but the now the situation has been on the path of recovery. The market has almost stabilized in most parts of Europe. The countries have been showing stable growth rates. Industrial development across the globe expands the growth of real estate. It is expected that the total volume will increase significantly this year and for the years ahead. However, it would depend on the pace and strength of the economic recovery. There exists tremendous potential in this sector which can bring surprises in the real estate world. This was unthinkable a few years ago, when the entire world was hit by the recession. International rents have shrunk throughout the world. It will take another one or two years to stabilize. Landlords are expected to continue gaining profits and there will also exist stiff competition between them. Overall, the recovery might be disparate but the global real estate picture is sure to improve in the next few years. References BNP Paribas. April, 2009. Atisreal’s “European Office Market, 2009”. [Online]. Available at: http://www.bnpparibas.com/en/expertises/expertises.asp?cat=H. [Accessed on July 22, 2010]. BNP Paribas, 2010. Property Report, Retail in Europe. [Pdf]. Available at: http://www.realestate.bnpparibas.com/pages/etudes_sectorielles/resultrecherche.php?alias=com_etude_recherche_eu&ctx=1&p=eu&s_wbg_menu=117&l=en. [Accessed on July 22, 2010]. Cameron, G. April, 2005. Housing Market Trends. The UK Housing Market Economic Review. [Pdf]. Available at: http://hicks.nuff.ox.ac.uk/users/cameron/papers/ukhousingmarket.pdf. [Accessed on July 22, 2010]. IPF, July 2005. Investment Performance and Lease Structure Change in the UK. [Pdf]. Available at: https://members.ipf.org.uk/membersarealive/downloads/download.asp?ref=65&hash=92bf3072cc3a74090996a1ab58b8d573 [Accessed on July 22, 2010]. JLL. 2010. European Industrial Markets: On the move again. On.Point. [Pdf]. Available at: http://www.joneslanglasalle.com/MediaResources/EU/Marketing/EMEA%20Capital%20Markets/JLL_EMEA_European_Industrial_Markets_Report_Spring_2010.pdf. [Accessed on July 23, 2010]. Yaerd.org. 2008. Determining Supply and Demand in Real Estate. [Online]. Available at : http://yaerd.org/articles/Determining-Supply-and-Demand-in-Real-Estate.html. [Accessed on July 22, 2010]. Read More