chapter 1 introduction to real estate economics 1 st semester, s.y 2014-2015

BACHELOR OF ARTS IN ECONOMICS Econ 127 – REAL ESTATE ECONOMICS

Pangasinan State UniversitySocial Science – PSU Lingayen

Chapter 1INTRODUCTION TO REAL ESTATE ECONOMICS1st Semester, S.Y 2014-2015



A. Definition of Real Estate EconomicsB. Importance of Real Estate EconomicsC. Microeconomics vs. MacroeconomicsD. Land as an Economic ResourceE. Renewable and Nonrenewable ResourcesF. EstateG. Categories of EstatesH. Land: Surface and Subsurface RightsI. Real EstateJ. Economic and Physical Characteristics of Land / Real EstateK. Real PropertyL. Bundle of RightsM. Real Property vs. Personal PropertyN. Fixtures O. Trade Fixtures

Chapter Outline



What is Real Estate Economics?

A study of people & how their actions affect property values.

Application of economic principles and techniques to the real estate market.

Develops theories and models that help people think through the complicated dynamics of property, value and exchange.



Real EstateEconomics

What is Real Estate Economics?

General EconomicsPrinciples

and Theory

Real EstatePrinciples

and Practice

Real estate economics draws principles from both general economics and real estate practice. It then combines them to study changes in real estate use, value, and activity. The focus is on real estate change. The main reason to study real estate economics is to help understand issues and changes, and the impact these will have on local real estate use and values.



Real Estate Defined

Land and attachments (buildings).

This refers to land or land improvements, and the rights of use associated with the ownership.

Property, land or fixtures whose nature is definable and whose ownership rights are specifiable through law.



Economics Defined

Economics deals with how individuals and societies choose to allocate and use scarce resources to produce, distribute, and consume goods and services.

The study of choices The study of scarcity The study of resource allocation The study of production and consumption



Two Categories of Economics

Macroeconomics. It is concerned with the economy as a whole and issues affecting it, including unemployment, inflation, economic growth, fiscal and monetary policy.

Microeconomics. This analyzes the behavior of the individual units in the economy such as households and firms, markets, and their interactions.



Let’s Check Your Understanding!

Determine whether each of the following cases on real estate economics is a concern of microeconomics or macroeconomics.

1. The percentage contribution of real estate segment in the increase of GDP

2. Mr. Cruz’s decision whether to rent an apartment or buy a housing unit

3. Occurrence of real estate bubble in recent years 4. The determinants that affect the supply of retail spaces

in SM Malls5. The price to be charged for a three-night stay in a

luxurious resort



Why Study Real Estate Economics?

Understand value fluctuations Estimate real estate values Solve real estate problems Understand fluctuations & changes to local real estate

markets. Personal reasons

To best understand owning v. renting, buying v. investing, when to buy, what to buy, how to buy, where to buy.

Professional reasons To best serve customers in their real estate transactions—

property or financing or investment advice.



Everything that we do also involves real estate: where we live, where we work, where we play, and more. And every real estate decision is also an economic decision! One dream of a Filipino is to buy a home—but where? And how?

Today, almost every other newspaper headline involves issues in real estate economics—mortgage problems, interest rates, the impact of real estate employment, foreclosures, property values—all are issues that are discussed here!

Why is Real Estate Economics so Interesting?



Economic Resources in Real estate

Economic resources in real estate are inputs used by developers in the building or construction process. These may include the following:

1. Land2. Labor3. Capital4. Entrepreneurial skills



Economic Resources in Real Estate

Land includes all the natural resources found in nature a country possesses, such as water, minerals, animals, and forests.

Labor is the work time and work effort that people devote to producing goods and services.Capital refers to produced goods that can be used as resources for further production.

Entrepreneurship is the human resource that com bines the factors of production creatively and efficiently.




Determine what category of resources in real estate sector does each of the following belong.

1. Cement and bricks 2. Heavy-duty trucks 3. Civil engineer 4. Water system 5. Construction site 6. Construction workers



Land as an Economic Resource

The category of resources that we call ‘‘land’’ refers not just to the land surface, but to everything associated with the land—the natural resources. Rent is considered the resource payment for land.Natural resources are the nonproduced resources with which a society is endowed. Natural resources are categorized as renewable and nonrenewable resources.



Nonrenewable resources (also known as exhaustible resources) have a fixed supply that is depleted as the resource is consumed .Examples include coal, natural gas, and oil. The market for nonrenewable natural resources consists of the demand for and supply of these resources. Supply depends on the amount of the resource, and the supply curve is perfectly inelastic.

Renewable resources are nonexhaustible resources which can be used repeatedly without depleting the amount available for future use.

Renewable vs. Nonrenewable Resources



Definition of Estate

The term estate means “all that a person owns.” The term real estate means all realty owned as a part of an individual’s estate. The term estates in real property is used to describe the extent to which rights and interests in real estate are owned. A system of modifiers has evolved, based on English property law, that describes the nature or collection of rights and interests being described as a part of a transaction.



Estates in Possession vs. Estates not In Position (Future Possession)

An estate in possession (a present estate in land) entitles its owner to immediate enjoyment of the rights to that estate. An estate not in possession (a future estate in land), on the other hand, does not convey the rights of the estate until some time in the future, if at all. An estate not in possession, in other words, represents a future possessory interest in property. Generally, it does not convert to an estate in possession until the occurrence of a particular event. Estates in possession are by far the more common. When most people think of estates, they ordinarily have in mind estates in possession. Obviously, lenders and investors are very interested in the nature of the estate possessed by the owner when considering the purchase or financing of a particular estate in property



Two Types of Future Estates

1. Reversion

2. Remainder



Reversion

A reversion exists when the holder of an estate in land (the grantor) conveys to another person (a grantee) a present estate in the property that has fewer ownership rights than the grantor’s own estate and retains for the grantor or the grantor’s heirs the right to take back, at some time in the future, the full estate that the grantor enjoyed before the conveyance. In this case, the grantor is said to have a reversionary fee interest in the property held by the grantee. A reversionary interest can be sold or mortgaged because it is an actual interest in the property.



Reversion

A remainder exists when the grantor of a present estate with fewer ownership rights than the grantor’s own estate conveys to a third person the reversionary interest the grantor or the grantor’s heirs would otherwise have in the property upon termination of the grantee’s estate. A remainder is the future estate for the third person. Like a reversion, a remainder is a mortgageable interest in property.



Freehold vs. Leasehold Estates

Estates in possession are of two general types: freehold estates and leasehold estates. These types of estates are technically distinguished on the basis of the definiteness or certainty of their duration. A freehold estate lasts for an indefinite period of time; that is, there is no definitely ascertainable date on which the estate ends. A leasehold estate, on the other hand, expires on a definite date. Aside from this technical distinction, a freehold estate connotes ownership of the property by the estate holder, whereas a leasehold estate implies only the right to possess and use the property owned by another for a period of time.



Examples of Freehold Estates

A fee simple estate, also known as a fee simple absolute estate, is the freehold estate that represents the most complete form of ownership of real estate. A holder of a fee simple estate is free to divide up the fee into lesser estates and sell, lease, or borrow against them as he or she wishes, subject to the laws of the state in which the property is located.

Life estate, which is a freehold estate that lasts only as long as the life of the owner of the estate or the life of some other person. Upon the death of that person, the property reverts back to the original grantor (transferor of property), his or herheirs, or any other designated person.



Two Types of Leasehold Estates

An estate for years is the type of leasehold estate investors and lenders are most likely to encounter. It is created by a lease that specifies an exact duration for the tenancy. The period of tenancy may be less than one year and still be an estate for years as long as the lease agreement specifies the termination date.

An estate from year to year (also known as an estate from period to period, or simply as a periodic tenancy) continues for successive periods until either party gives proper notice of its intent to terminate at the end of one or more subsequent periods. A “period” usually corresponds to the rent-paying period. Thus, such a tenancy commonly runs from month to month, although it can run for any period up to one year.



Two General Classifications of Estates

1. Based on Rights: Estates in Possession versus Estates Not in Possession (Future Possession)

2. Based on Possession and Use: Freehold versus Leasehold Estates



Land, Real Estate and Real Property



Land is defined as the earth's surface extending downward to the center of the earth and upward into space, including permanent natural objects such as trees and water.

Land includes not only the surface of the earth but also the underlying soil. It refers to things that are naturally attached to the land, such as boulders and plants. It includes minerals and substances that lie far below the earth's surface. Land even includes the air above the earth, all the way into space. These are known respectively as the subsurface and the airspace. Most of the surface of the earth, of course, is water. Special state and local laws govern the ownership of these parts of the earth, including lakes and rivers.

Land



Real estate is defined as land at, above, and below the earth's surface, and all things permanently attached to it, whether natural or artificial.

The term real estate is somewhat broader than the term land; it includes not only the natural components of the land but also permanent man-made improvements on and to the land. An improvement is any artificial thing attached to land, such as a building or fence, or improvements such as streets, utilities, and sewers.

Real Estate



Real property includes both land and real estate. It is defined as the interests, benefits and rights that are automatically included in the ownership of the land and real estate.

Real property includes the earth surface, subsurface, and airspace, including all things permanently attached to it by nature or people, and the legal rights innate to the ownership of a parcel of real estate.

Real Property



Traditionally, ownership rights of real property are described as a bundle of legal rights. These rights include the

The rights of possession Right to control the property within the framework of the

law Right of enjoyment (to use the property in any legal

manner) Right of exclusion (to keep others from entering or using

property Right of disposition (to sell, will, transfer, or otherwise

dispose of or encumber the property

Bundle of Legal Rights



Bundle of Legal Rights



Surface Rights are the rights to use the surface of the earth.

Subsurface rights are the rights to natural resources lying below the earth’s surface. An owner may transfer rights without transferring the subsurface rights.

Surface and Subsurface Rights



Air rights. The rights to use the space above the earth may be sold or leased independently, provided the rights have not been preempted by law. Air rights can be an important part ofa real estate, particularly in cases where the air rights must be purchased to construct large office buildings. To construct such a building, the developer must purchase not only the rights but also numerous small portions of the land’s surface for the building’s foundation supports

Air Rights



Water rights are special common-law rights held by owners of land adjacent to rivers, lakes, or oceans and are restrictions on the rights of land ownership. Water rights are particularly important rights in drier western states, where water is a scarce and valuable public commodity

Water Rights



Economic Characteristics Scarcity Improvements Permanence of Investment Location or Area Preference

Physical Characteristics Immobility Indestructibility Uniqueness

Characteristics of Land / Real Estate



Land isn't generally considered a rare commodity, but only about a quarter of the earth's surface is dry land; the rest is water. The total supply of land is not limitless. Even though a considerable amount of land remains unused or uninhabited, the availability of land in a given location or of a particular quality is limited.

Scarcity



Building an improvement on one parcel of land also can affect the land’s value as well as the use of neighboring tracts and whole communities. For example, improving a parcel of real estate by building a shopping center or selecting a site for a nuclear power plant or toxic waste dump can dramatically change the value of land in a large area.

Improvements



The capital and labor used to build the improve ment represent a large fixed investment. Although even a well-built structure can be razed to make way for a newer building, improvements such as drainage, electricity, water, and sewerage remain. The return on such investments tends to be long-term and relatively stable.

Permanence of Investment



Area preference or situs ("to place") refers not only to geography but also to people's preference for a specific area. Area prefer ence is based on several factors, such as convenience, reputation, and history. It is the unique quality of these preferences that results in the different price points for similar properties. Location is often considered the single most important eco nomic characteristic of land

Location or Area Preference



Although some of the substances of land are removable an topography can be changed, the geographic location of any given parcel of land can never be changed. Its location is fixed – immobile.

Immobility



Land is also indestructible. This permanence of land, coupled with the long-term nature of improvements, tends to stabilize investments in real property.

The fact that land is indestructible does not, however, change the fact that the improvements depreciate and can become obsolete, which may dramatically reduce the land's value. This gradual depreciation should not be confused with the fact that the economic desirability of a given location can change.

Indestructibility



Uniqueness

Uniqueness, or nonhomogeneity, is the concept that no two parcels of property are exactly the same or in the same location. The characteristics of each property, no matter how small, differ from those of every other. An individual parcel has no substitute because each is unique.



1. Real Property

2. Personal Property

Two Categories of Property



Real property (Realty) refers to land and things permanently attached to it. pertains to land improvements, and the rights of

use associated with the ownership.

Personal property (Chattels or Personalty) all property that can be owned and does not fit the

defini tion of real property. generally refers to everything else: the items which

are movable and not part of the land. Examples: chairs, tables, computer, clothing,

money, bonds, and bank accounts.

Real Property vs. Personal Property



Tangible personal property Refers to any type of property that can generally be

moved (i.e., it is not attached to real property or land), touched or felt. These generally include items such as furniture, clothing, jewelry, art, writings, or household goods.

Intangible personal property Called "intangibles“. This refers to personal property that

cannot actually be moved, touched or felt, but instead represents something of value such as negotiable instruments, stocks, bonds, securities, patents, service assets.

Tangible vs. Intagible Personal Property




To which category of properties does each of the following belong?

1. Clothing2. Motor vehicles3. Office building4. Negotiable instruments5. Parking lot6. Shopping mall



Tress and crops (plants) generally fall into two classes:

Fructus Naturales. These are trees, perennial bushes, and grasses that do

not require annual cultivation. These items are considered real estate.

Fructus Industriales Annual cultivated crops of fruit, vegetables, and grain

which are known as emblements. These things are generally considered real estate property.

Fructus Naturales vs. Fructos Industriales



An item of real property can become personal property by severance. For exam ple, a growing tree is real estate until the owner cuts it down, literally severing it from the real estate. Similarly, an apple becomes personal property once it is picked from a tree.

It is also possible to change personal property into real property through the process known as annexation. For example, if a landowner buys cement, stones, and sand and then mixes them into concrete and construct a sidewalk, the landowner has converted personal property (cement, stones, and sand) into real property (a sidewalk).

Severance and Annexation



Fixture is personal property that has been so affixed to the land or a building that, by law, it becomes part of the real property.

Examples of fixtures are heating plants, elevator equipment in highrise buildings, radiators, kitchen cabinets, light fixtures, and plumbing.

Almost any item that has been added as a permanent part of a building is considered a fixture.

Fixtures



Personal property is converted into a fixture by the process of attachment. For example, if a piece of lumber sits in a lumber yard it is a chattel. If the same lumber is used to build a fence on the land it becomes a fixture to that real property. In many cases, the determination of whether property is a fixture or a chattel turns on the degree to which the property is attached to the land. For example, this problem arises in the case of a trailer home. In this case the characterization of the home as chattel or realty will depend on how permanently it is attached--such as whether the trailer has a foundation.

Attachment



1. Method of annexation. How permanent is the method of attachment? Can the item be removed without causing damage to the surrounding property?

2. Adaptation to real estate. Is the item being used as real property or personal property? For example, a refrigerator is usually considered personal property. However, if a refrigerator has been adapted to match the kitchen cabinetry, it becomes a fixture.

3. Agreement. Have the parties agreed to treat an item as though it is real or personal property?

Legal Tests of a Fixture



Trade fixture is a special category of fixtures which includes property used in the course of business. An article owned by a tenant and attached to a rented space or building or used in conducting a business is a trade fixture, or a chattel fixture.

Some examples of trade fixtures are bowling alleys, store shelves, and barroom and restaurant equipment. Agricultural fixtures, such as chicken coops and tool sheds, are also included in this category. Trade fixtures must be removed on or before the last day the property is rented. The tenant is responsible for any damage caused by the removal of a fixture. Trade fixtures that are not removed become the real property of the landlord.

Trade Fixtures



Trade fixture differ from fixtures generally in these ways:

Fixtures belong to the owner of the real estate, but trade fixtures are usually owned and installed by a tenant for the tenant’s use.

Fixtures are considered a permanent part of a building, but trade fixtures are removable. Trade fixtures may be affixed to a building so as to appear to be fixtures, but the tenant has the right to remove them on or before the last day of the lease.

Legally fixtures are real property so they are included in any sale or mortgage. Trade fixtures, however, are considered personal property and are not included in the sale or mortgage of real estate.

Trade Fixtures vs. Fixtures

chapter 1 introduction to real estate economics 1 st semester, s.y 2014-2015

Documents

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