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Profit from Real Estate No Money Down


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									End of Chapter 2 Discussion Questions and Answers

   1. Define a submarket. How does an office submarket differ from a residential

Answer: The market in which the property of interest (the „subject‟ property) competes
is called a submarket. Submarkets are arbitrary but should be based on properties that
compete in the mind of the typical buyer or tenant for such property, thus they tend to
have a geographic component, a price or rental range, and some form of quality range.
For example with office property we have class A, B, and C. For residential properties
we may have neighborhoods for the geographic component and size and price range as
important submarket parameters. Submarkets could be based on zip codes or census
tracts or counties depending on the size of the relevant market in which the subject
property competes.

   2. Why is the supply of real estate considered inelastic in the short run? What are the
      implications of changes in demand if supply is held fixed?

Answer: The supply of real estate is considered inelastic in the short run because of the
inability of the market to add real estate in the near to intermediate term. It often takes
years to conceive, design, permit and build a new property. Graphically a short term
supply curve is a vertical line at one point on the supply side.
Due to the inelasticity of supply in the short run any changes in demand have a direct
impact on vacancy, rents and prices. An increase in demand instantly causes an
increase/decrease in vacancy, rents or prices.

   3. What is the implication of the kink in a kinked supply curve? What level of price is
      necessary in the market before new supply would be added?
Answer: The kink (or corner) in the supply function occurs at the economically feasible
rent level that equates (on a present value basis) to the long-run marginal cost of
supplying additional space into the market.

When prices are below the kink the current value of real estate is below replacement cost
(including acquisition, construction costs and normal profit) and no new space will be
built. When prices are above the kink, new supply will begin.

   4. List the primary attributes of real estate markets compared to perfectly
      competitive markets. What are the implications of each attribute on the markets
      ability to respond to changes in demand?
        1) Homogeneity: Real estate markets are often heterogeneous with unique
           locations and customization so property comparison is more difficult and
           uncertain. Comparison is more difficult and price dispersion a trait of the
        2) Large numbers of buyers and sellers: Real estate markets are often thin with
           few buyers and sellers so it takes more time to sell real estate adding to
           liquidity risk.
        3) Low transactions costs: Real estate market transactions costs are high
           making speculation more difficult and short term ownership non-economic.
        4) Full information: Real estate market decision makers often rely on less then
           full information using samples or observations. This adds to price and value
           uncertainty and requires more research prior to contracting.

        5) Similar expectations: At the margin real estate is no different then perfectly
           competitive markets however a real estate property price must be further
           from equilibrium in order to induce new buying or selling then in the case of
           markets with low transactions costs. The high transactions costs means that
           real estate prices must appear well below fair market value in order to take
           advantage of this difference.

   5. Why is it difficult to speculate in the real estate market in response to probable
      market trends or increasing prices? Why is it difficult to take advantage of a
      downward price trend in the real estate market?

Answer: The high transactions cost (brokerage and other costs) make it difficult to buy
real estate if it appears to be slightly below market value and make any return from this
apparently good deal. Assume a property is worth 1 million but is available for
$950,000. The costs to sell and time value of money make short term ownership
uneconomic. Also the large size of the economic unit means that debt is usually
necessary and this adds to the transaction costs and slows down the ability to respond
quickly. Last, there is no “short” market available in real estate so downward price
expectations do not create profit opportunities.

   6. How efficient do you believe real estate markets are? Can you describe some
      types of markets likely to be more or less efficient?
Answer: In the real estate market, most participants are working with less than full
information, as it is costly to collect and analyze data. This is changing over time with
improvements in communication technology and better and more standardized data
storage and retrieval. In some cases, inside information may also come into play
allowing some participants to profit at the expense of others, otherwise known as excess
profits. Thus real estate markets are not as efficient as perfectly competitive markets and
each of us will have a different belief on the degree of efficiency. In large higher price
property markets, say $10 million and up, the players are fairly sophisticated and
knowledgeable and the markets are likely to be efficient in the sense of reflecting all
available information.
Competitive markets like commodities (oil, pork, corn) where the cost of substitution and
information are negligible are much more efficient than Real Estate Markets.
Thin markets for unique items like old stamps and old art or old jewelry and antiques
may be less efficient than Real Estate Markets as comparative information may be
difficult to obtain.

   7. What drives the housing market in the short run (less than one year)? When do
      you think the nest time to buy might be? When do you think the best time to sell
      might be? Why is it difficult to do both at the best time of year?

Answer: Interest rates and seasonal patterns (holidays and weather induced) are
significant drivers in the short run. Once in a while extreme movements in the stock
market could influence the real estate market. For example, in 2001 and 2002 home
ownership seemed less risky than stocks and many people reallocated wealth towards
personal housing helping to create a brisk and increasing housing market. The best time
to buy a house might be winter or during holidays when markets are slow, but these are
often double transactions as some buyers must also sell their existing home, so it is
difficult to pick the best time to buy when you are also selling.

   8. Employment can be described as related to the export or service sector of the local
      economy. Define each. Which is more important for driving employment and
      population growth?
Answer: Employment that brings revenues into the region is called the "export sector".
Employment geared towards serving the local population is called the "service” sector.
The export sector is more important for driving long term employment and population
growth as the service sector is dependent on the export sector. As workers become more
independent of location the quality of life may start to be more important for driving
population growth and as more people retire stored wealth may also be an important
factor giving seniors the ability to choose quality of life and lower cost and tax

   9. Why are cycles inevitable for real estate markets?

Answer: Cycles are inevitable for a variety of reasons including the lumpy nature of real
estate, the fact that developers must jump into the market before the demand has actually
materialized and in the absence of collusion such increases in supply often exceeds actual
demand leading to market adjustments. Lease terms also have historically been less than
perfectly proportional in terms of expiration patterns so some years see a greater
proportion of expirations and new lease negotiations and adjustments.

   10. Describe the impact of the Internet on one type of property: residential, office,
    retail or industrial properties? Which property types will likely be redesigned?
    Which will grow larger or smaller?
Answer: Increased usage of Internet has enabled people to do knowledge work from their
homes. There is no geographic restriction on these workers with respect to the distance
from their offices, as they do not have to commute regularly. This may impact residential
properties. Residential properties will see growth in areas with a better quality of life.
Office usage could decrease and could be redesigned to suit the needs of the lives of
telecommuters who occasionally go to the office. We should see more office sharing and
we will also need offices at home. Warehouses that can ship small orders will see
increasing demand while traditional format warehouses will see less growth as a result of
more e-commerce. Hence the supply of smaller package warehouses will increase.

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