Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
Rays of Research on
Real Estate Development
Jaime Luque
Dedication
This book would not have been possible without the numerous contributions
of students who took my Regional and urban economics course at the
University of Wisconsin, Madison. I dedicate this book to them.
Abstract
Real estate development accounts for one of the major economic sectors
in most countries, yet during the last two decades research on this
important topic has been scattered. This textbook brings together some
of the most important results on this subject. The book is written in a
pedagogical way and covers crucial aspects of this industry such as growth
management and real options, land use regulations, mixed housing developments, taxes, externalities, housing affordability problems, land prices
and uncertainty, public infrastructures, and housing supply.
This textbook is an excellent source for an advance course in real estate
development that attempts to cover important contributions in this area.
The book is accompanied with multiple choice questions to test students
assimilation of the material.
Keywords
externalities, growth management and real options, housing supply, land
use regulations, housing affordability problems, land prices and uncertainty, mixed housing developments, public infrastructures, real estate
development, taxes
Contents
Preface...................................................................................................xi
Part I
Growth Management and Real Options.......................... 1
Chapter 1 Volatility, Competition, and Investments...........................3
Chapter 2 Growth Management.......................................................13
Part II
Chapter 3
Chapter 4
Chapter 5
Part III
Chapter 6
Chapter 7
Chapter 8
Part IV
Taxes............................................................................. 67
Chapter 9 Impact Fees......................................................................69
Chapter 10 Property Taxation.............................................................77
Chapter 11 Two-Rate Property Taxes on Construction.......................85
Part V
Chapter 12
Chapter 13
Chapter 14
Chapter 15
Housing Supply............................................................. 91
Construction Cycles.........................................................93
Reinvestment in the Housing Stock...............................101
Estimating the Housing Supply......................................109
Movements in Office-Commercial Construction............115
Part VI
Chapter 16
Chapter 17
Chapter 18
Chapter 19
Bibliography........................................................................................151
Index..................................................................................................155
Preface
In collaboration with Eduardo De La Torre
The process of real estate development in an urban landscape is multifaceted and multidisciplinary in nature for a variety of reasons. Although
there is often the misconception that real estate development is an endeavor pursued and managed purely by the private interests of firms and
actors, this couldnt be further from the truth. If this were the case, profitmaximizing principles would dictate the development and layouts of our
cities, natural resources would be exploited whenever net economic benefit could be extracted, urban landscapes would not take into account the
welfare of its populace, and vulnerable communities would be subject to
the predatory nature of the free market.
Although real estate development does respond to market forces of
supply and demand, it is subject to certain restrictions imposed by government actors who act in the interest of creating sustainable cities that
both encourage productivity, mobility, and economic growth, but that
also consider the benefits of creating communities that are walkable, enjoyable, and safe. The goal is to create a prudent development strategy
that encompasses interests that benefit the private and public sectors.
An important aspect of this strategy is compact development that
repurposes land within existing infrastructure. This means redeveloping
existing land with a current use that no longer meets the goals of both private and public actors with the goal of creating net benefit for both. This
concept is beneficial to real estate developers and investors that represent
private interests because this reduces the costs for land and infrastructure
development. Instead of creating a project beyond the limits of the city,
and having to start from scratch in terms of infrastructure, it is cheaper to
develop within the city and revitalize land and structures. This concept is
also beneficial to the private interests of businesses because the increased
economic activity that ensues attracts additional investment and spending power. It is also in the best interest of public interests such as local
xii PREFACE
PREFACE
xiii
xiv PREFACE
PART I
CHAPTER 1
with capital asset pricing model (CAPM). Bulan, Mayer, and Somerville
(2009) attempt to show that competition within development reduces
the impact of return volatility on investment. They seek to establish that
competition is a driver for investment and that delays in investment tend
to occur during a market downturn in which competition is reduced. The
authors analyze data collected between 1979 and 1998 and compare their
results to existing literature specific to competition and the real options
framework.
The data that the authors analyze was collected from 1,214 strata projects built between January 1979 and February 1998 in Vancouver, Canada. This nearly twenty-year period exhibited four boom-and-bust cycles
(1982, 1986, 1991, and 1996) during which the growth of strata projects
consistently surpassed the growth of single-family developments. The authors provide information about the number of projects in a given calendar
year and the average size of the projects for that year in units per project.
Using the sale prices of all strata transactions between 1979 and 1998
obtained from the British Columbia Assessment Authority (BCAA)the
authors compile a repeat sales index for each of the seven sections of the
citythree unique and four consolidations on the basis of similarities.
Using a combination of autoregressive models and GARCH models, the
authors compute expected price appreciation, project-specific discount
rates, systematic risk, return volatility, and the magnitude of competition.
The authors primary model for analysis is the real options model. The
theory supporting the model is that firms should apply a higher user cost
to new investments in real estate when returns are volatile, reflecting the
option to delay that is lost when investment occurs. The authors believe
that this model is valid because the traditional CAPM model already predicts lower investments in volatile markets. Higher volatility is linked to
greater nondiversifiable risk and thus a higher required rate of return from
investors. Thus, the authors find clear support for the negative relationship between investment and idiosyncratic risk in existing models and
intuition. The second component of the real options model is the effect
of competition on investment. Local competition posed by proximate
potential developments can erode the value of the option to delay irreversible investment and make firms more likely to develop by lowering
the cost of forfeiting their option.
quantifies the values of said options based on a portfolio view to complement the real options model (see Baldi 2013). Baldi identifies real options
as a combination of timingimmediate and deferrableand scaling
up and downstrategies. This flexibility is extremely important to real
estate development as unforeseen circumstances may derail the progress
of an investment; real options help developers adjust to these new conditions so that they can maximize and retain projected profits. The valuation framework that Baldi proposes consists of binomial treesbottom,
intermediate, and upperthat represent the three stages of development,
respectively, preconstruction, completion of the first stage, and the final
completion of the project. The valuebased on expected land appraisal
of a real option varies depending on whenduring which of the aforementioned stagesthe decision is made. Flexibility and the availability
of real options are especially favorable to developers as market volatility
increases; changes to the itinerary may be crucial for profit maximization.
All in all, real options are best taken into consideration through a thorough portfolio approach when appraising a development. An extensive
analysis of market conditions, development progress, and expected property values can ensure that investors will receive a desirable payoff.
Bulan, Mayer, and Somervile (2009) identify several weaknesses in
their analysis. The first arises from strata data, which is filed when a building is very close to completion. Therefore, there is no reliable start date for
construction which is relevant when evaluating option exercise, or when
the choice whether or not to invest occurs. To compensate, the authors
added a lag time of 1 year to the date indicated on the strata plan. This
lag time is an estimation based on an observation that 59 percent of new
multifamily projects are completed within 1 year from the construction
start date. A second weakness is found within the project-specific discount
rate. The model used to find the rate makes the assumption that real estate
market is in perpetual equilibrium. The authors believe that this model
is inconsistent with the market history marked by periods of disequilibrium. Instead of using the project-specific discount rate, a substitute is
implemented from the CAPM model in which the project-specific rate is
estimated by simply adding a market risk premium to the risk-free rate. A
third weakness is the existence of dual options inherent in the sequential
nature of real estate development. Developers can invest and disinvest by
See Mian and Sufi (2014) for an economic analysis of the recent subprime mortgage
crisis and its consequences.
10
11
References
Baldi, F. (2013), Valuing a Greenfield Real Estate Property Development Project: A Real Options Approach, Journal of European Real Estate Research 6,
186217.
Bulan, L., C. Mayer and C. T. Somerville (2009), Irreversible Investment, Real
Options, and Competition: Evidence from Real Estate Development, Journal of Urban Economics 65, 247251.
Mian, A. and A. Sufi (2014), House of Debt, University of Chicago Press:
Chicago, USA.
Novy-Marx, R. (2005), An Equilibrium Model of Investment Under Uncertainty, Working paper. University of Chicago: Chicago, USA.
Index
Affordable housing, 137142
construction, 70
Agricultural land, 13, 3135
property tax assessment of, 32
values for, 33
Airports, 145146
activity, 148149
growth of, 148
ALTIKA database, 78
American Housing Survey (AHS),
102, 130
Asset investment, irreversible, 3
Association of Finnish Local and
Regional Authorities, 78
Baldi, Francesco, 67
Beachfront property values, 25
Beta coefficients, effectiveness of, 117
Bid Rent Curve, 33
Binomial trees, 7
Biodiversity, 34
Boom-and-bust cycles, 4
British Columbia Assessment
Authority (BCAA), 10
Budgetary framework, Solomons, 40
Builders delay development, 6
Building
descriptions of, 14
tax rate, 78
Bureau of Economic Analysis
(BEA), 133
Burge and Ihlanfeldts model of
housing, 71
Business fixed investments (BFIs), 94
Capital asset pricing model (CAPM),
34
traditional, 4
Capital costs, 124
Capital investment, realms of, 3
CAPM mode, 7
156 INDEX
GARCH models, 4
GDP, 39, 129
George, Henry, 77
Green, Richard K., 145
Greens model, 146148
Gross national product (GNP) cycles,
9394
macroeconomic variable of, 96
Growth boundary, 14
Growth management, 1317
boundary and price uncertainty, 14
and real options, 14
urban planners, 13
Growth Management Acts (GMAs),
1316
Habitats
conservation, 3136
subsequent destruction of, 31
Hazard rate, competition vs., 6
Hedonic analysis, 63
Hedonic model, 33, 36, 138
effectiveness in long run, 36
Hedonic price model, 62
Hedonic regression, 33
Heterogeneity of industry, 94
Homebuyers, 63
Homeless, 139
probability of, 139140
risk of, 140
without housing, 141
Homelessness, 137, 139
causes of, 137
determinants of, 137
NSHAPC gathered data on, 141
one-point prevalence of, 141
INDEX
157
low-cost, 140
model for, 110
property tax incentives on, 7778
renting, 138
slums or dilapidated, 43
supply of, 77, 110
Housing and Mortgage Credit
Programs, 42
Housing Assistance Programs, 42
Housing development
budgetary framework for, 3944
tool on, 56
Housing market, 101
scholarship, 62
Housing prices, 55
on labor migration, 55
rise in, 57
Housing programs, 141
Housing stock, 71
reinvestment in, 101106
Housing supply, 109113
Idiosyncratic risk, 3
Impact fees, 6973
benefits of, 73
data types, 70
stipulation of, 69
study of, 73
view of, 72
Impact of New Housing Construction
on Racial Patterns, 49
Incentives, tax, 78
Income eligibility, 140
Inequality, stage of, 77
Infrastructures, public, 145149
Interest rate
changes in, 111
risk-free, 5
International City Managers
Association, 56
Investment, 38
behavior, 115
capital, 3
delays in, 4
vs. idiosyncratic risk, 4
irreversibility in, 3, 117
real estate development and, 67
in volatile markets, 4
158 INDEX
INDEX
159
160 INDEX
Sales index, 4
Single-family developments, 4
Single-family homebuyers, 6162
Single-family homes, 80
nonurbanist, 62
prices of, 63
value, 129
Somerville, Tsuriel, 109
Standard Metropolitan Statistical
Areas (SMSAs), 50
Standard regression techniques, 87
States Beach and Shore Preservation
Act, 23
Strata development in Vancouver, 4,
7, 910
Structural contamination, 123
Suburban development projects, 69
Survey compliance tests, Erbers
review of, 52
Sustainable neighborhoods
development of, 4243
Tax
on construction, 8588
expenditure, 42
incentives, 78
Taxation
power of, 77
reform, 81
Taxpayers, extra charge on, 34
Theoretical mathematical model, 78
Three-rate tax system, 79
implementation of, 78
for single-family homes, 80
Tobit model, 102
Traditional neighborhood
development (TNDs), 6164
attributes and benefits of, 64
prices for homes in, 63
value of homes in, 64
Transit-oriented neighborhood design
principles, 61
Transportation Security
Administration (TSA)
regulations, 149
Two-rate property taxes on
construction, 8588
used standard regression
techniques, 87
Two-rate property tax system, 79
United States
budget, 39
economy, 39
GDP for, 39
Urban Consumer Price Index
(CPI-U), 102
Urban development, 123
projects, 69
Urban growth boundaries (UGBs),
1317
defined, 14
description of, 13
implementation of, 1315
Seattle areas enactment of, 16
timing inside and outside of, 15
Urban housing markets, 101, 102
deterioration of, 104
Urbanism, 63
planning, 63
Urbanist community, 63
price premium, 63
Urbanist developments, 62
Urbanist home prices, 64
Urbanization process, 13, 31, 51
Urban land, 33
Urban market, construction
cost for, 105
Urban-oriented development, 15
Urban planners, 16
Urban rent prices, 78
U.S. Department of Housing and
Urban Development, 137
U.S. Geological survey (USGS)
topography maps, 32
Vital protection dune systems, 23
Volatility, 38, 117
vs. competition, 6
of condo, 5
demand, 116
hazard rate of construction, 6
market, 3
source of, 95
Wages, 57
Water/sewer impact fees
(WSIF), 71
Wharton Urban Decentralization
Project, 56
Williamson Act, 34
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