; End of Chapter 6 ... - Real Estate Principles for the New Economy
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End of Chapter 6 ... - Real Estate Principles for the New Economy


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									End of Chapter 6 Questions and Answers

1. What were the primary reasons for over building in the late 1980’s and early 1990’s?

Answer: Over supply in the mid 1980’s to mid 1990’s was induced by the additional
factors of tax law changes and deregulation of savings associations. Accelerated
depreciation rules permitted until the Tax Reform Act of 1986 increased the early year
returns possible from tax-sheltered income. At the same time, deregulated federally
chartered savings and loan associations were permitted for the first time in 1982 to lend
on commercial real estate. Many inexperienced lenders provided such loans far too
aggressively. The 1980’s excess supply was supply induced. By contrast the early
2000’s excess supply was demand induced as demand cut back with the economic slow

2. Define Class A, B and C space. Name three buildings that fit these definitions in
   your local market.

Class A: Excellent location and accessibility; high quality structure and management;
new or competitive with new buildings; minimum size 100,000 square feet if located in
the Central Business District, CBD, or 50,000 square feet if suburban; rent rates in the
upper 33% of the total office market range. Separate foyers and security. Example: The
AON Building in Chicago

Class B: Good location and access; structure showing very little obsolescence or
deterioration; minimum size 50,000 square feet (CBD) or 25,000 square feet (Suburban);
rent rates in the upper 60% of the market sector's range. Example: The Empire State
Building in New York because of age may be a Class B but as it is so famous it may be
considered an A. Class B Buildings tend to be buildings that were once built as Class A
but are slightly dated.

Class C: Buildings generally more than 15 years old, with rent rates in the lower 40% of
the market sector's range, in less desirable areas with little if any common space.
Example: Almost any older (20 years or more) suburban office building will be Class C.

3. What is the efficiency ratio? Why is it important?

Answer: The percentage of total useable space to the total gross space in the building is
called the efficiency ratio. It will be a percentage under 100%. The greater the efficiency
ratio the higher will be the rental return per square foot of total building.

4. What are the leading causes of real estate cycles?

Answer: The nature of real estate like: lumpy supply, long lead times, huge investment
and long leases are the basic characteristics that cause cycles because of following
          Competition and need to anticipate the market. If a developer waited until
           there was sufficient demand for a new project they would never be able to
           beat out the competition who will take on the risk of anticipating future
           demand. There is no choice but to start a project before the demand has fully
          The time factor in developing a large durable asset like real estate. Larger
           projects like high rise office buildings take anywhere from two to five years to
           conceive, design, build and lease. With a minimum of two to three years
           before completion of a new idea, it is necessary to jump into the market before
           you will actually need the project. In the absence of collusion it is easy for
           more then one developer to try and fill the perceived market demand. When
           multiple projects come on line in the same period it is easy to have some extra
           vacant space waiting for the market to catch up. Extra space may be leased at
           more attractive rates in turn affecting the rents vacancy of lower quality
          Capital flows are not consistent. There are periods when lenders and equity
           investors are eager to move more money into the real estate market and other
           times when other opportunities seem more attractive.
          Lease terms create delays in rent adjustments and help to induce cycles

5. Why is it easy to make money at the bottom of a cycle but hard to do in practice?

Answer: One never knows when it is the bottom of the cycle when the market is going
down. It’s easy to say that those who invest at the bottom of a cycle will make more
money. However in practice it takes real guts to start a project when you are near the
bottom of the cycle, because you are not sure you are really at the bottom. Yet, for those
who are lucky enough to jump into the market when few other firms are willing to
commit and just before an upturn, most of the deals turn out much better then expected.

6. Why do developers keep building when we are at the top of a cycle?

Answer: One ever knows exactly if you are at the top and by the time you find out you
have committed to several projects already that are often better completed than left
unfinished. When the market is going up everyone is optimistic and keeps on investing
but stopping the capital and building flow is not that easy to do quickly.

7. What drives new office demand? How does the space required per person influence
   the demand and what is likely to happen over time to this figure?

Answer: New employment of office workers is the prime driver of new office demand.
The office space demand is estimated by multiplying the number of new office workers
by the average space requirement per office worker. The higher the space requirement per
worker more will be the total space requirement. With increasing trends of “office
hotelling” and “telecommuting” the average space requirement per office worker is
decreasing from over 200 square feet per worker in the early 1990s to about 175 or
maybe less in the year 2002 for new tenants.
8. Why is it better to use specific SIC employment projections instead of gross
   employment in estimating future demand?

Answer: Standard Industrial Classification (SIC) business analysis often reveals that
certain businesses require more space per worker than other businesses. The reason such
relationships are important is because not all businesses in the local area are growing at
the same rate, nor does general employment growth tell us how much office space will be
required except with a crude projection. Employment projection based on each SIC
group, along with the percentage of employment in each sector requiring office space and
the average amount of space per worker in each SIC group will result in a much more
precise future demand estimate.

9. What share of office space demand is being captured by the CBD in most cities? Call
   some leasing agents and see if this holds true in your area?

Answer: The CBD in most cities captures approximately 25% of office space demand. In
some cities with few land constraints or regulatory boundaries much less and in
constrained markets, (physically by lakes or mountains or by growth boundaries and
regulation) central city demand has run higher.

10. The rent at which the project just induces new supply is known as the kink in the
    supply curve. Using the example of the 100,000 square foot office building what is
    the minimum rent at 94% occupancy that would induce new supply in this example?
    Where is the kink?

Answer: We must see the text example to derive the costs of $16 million and the needed
value of $18 million. The kink is at the rent level necessary to support $18 million in
value. We need a cost of capital to derive the kink as well as occupancy. If the cost of
capital from recent cap rates is 9% simple (covering both equity and debt) then we need
net rents of:

$18,000,000 times .09 = $1,620,000 and if we expect 94% occupancy divide this by .94
to get the gross rent required of $1,723,404 per year or $17.23 per square foot of building
11. Which type of property tends to be more owner-occupied, manufacturing or
    warehouse space? Can you explain why manufacturing space tends to be owner

Answer: Manufacturing property tends to be more owner-occupied because it is primarily
a “built-to-suit” asset. Most manufacturing firms’ need highly customized space and
arrange for this space to be custom built according to exacting standards.

12. You are opening a call center for the support of new software products delivered over
    the internet. You will need on line technicians and on line phone operators. Where
   might you open such a support facility? What factors would be important to you in
   deciding upon a location?

Answer: The call location is an industry where people are the principal resource; hence
availability of skilled manpower will be the deciding criteria for the location. The
geographical location based on its closeness to customers is not important as the service
is provided either digitally or through voice chat, which is carried to customers
instantaneously through telecommunication facilities. Quality of life will be an important
factor in deciding a location. The cost of operations like local income taxes, rent rates and
salary rates will be other factors that need to be considered when deciding between the
short listed locations.

13. What is an SPW and HTD warehouse? Why does it need more parking then other
    bulk warehouses?

Answer: HTD: High throughput distribution center. These are the types of distribution
warehouses that are facilitate small package handling primarily on e-commerce generated
business. SPW are small package warehouses. SPW’s and HTD’s involve a fairly high
ratio of labor input based on picking and packaging small packages, hence required more
cars parking than the traditional bulk warehouse where a forklift picks up and ships an
entire pallet of goods that might be sent off to a retail store.

14. Why are warehouses becoming obsolete faster then ever? What do you consider the
    economic life of an SPW or HTD?

Answer: Continuously changing business models and technology demand different kind
of services from warehouses and hence render them obsolete in much shorter time than
their physical life. The most recent developments of warehouse formats is the SPW or
HTD, which came in demand due to the B2B and B2C e-business models. The longevity
of these new age warehouses will depend on the acceptance of these business models by
increasing number of the population. Their reliance of increased manpower may render
these warehouses obsolete in 10-15 years when technology will provide mechanized and
computer driven systems to handle small packages efficiently.

15. Is your city a regional distribution center or merely a local market warehouse center?
    What criteria might you use to figure out if the local warehouses serve the larger
    region or just the local community?

Answer: The average urban area has about 50 square feet of warehouse space per capita
as of the year 2000. Much of this space is for local consumption and local business
needs. If a local market, say Indianapolis has 85 square feet, then clearly they have 85/50
or 170% of the normal amount of space and we can conclude that the extra 70% must
relate to being a true regional distribution center. Local city answers will vary and the
data may not be that easy to collect.
16. What is a call center? Do you think we will see more call centers in the future or will
    people be able to work from home and simply be wired together?

Answer: Call centers are offices located in a warehouse setting where rents are cheaper.
The typical call center is filled with cubicles of workers that staff phone lines answering
questions, taking orders, providing on line support. Call centers are becoming
increasingly important in the new economy. Call centers require very secure computer
systems with power redundancy and back up which makes it difficult for people to work
from home and simply be wired together. Thus call centers are expected to increase in
number in the future but we may also see more at home call center workers if the systems
can be reliably connected.

17. Describe the factors that might influence a soft drink manufacturing plant location

Answer: A soft drink plant is a we ight gaining industry where the drink is bottled after
adding water to the concentrate and hence needs to locate near the consumption centers.
Factors influencing location decision would be:
  Proximity to large consumption centers (big city, town)
  Proximity to national highways (strategic intersections)
  Real estate costs
  Local taxes

18. What is an eco-industrial park? Are there any in your area? Do you think this is a
    trend that will increase in the future?

Answer: Eco- industrial parks are those manufacturing locations symbiotic relationships
are planned between various industries such that waste of one becomes raw material of
other. They are still fairly new. Increased environmental awareness, negative public
opinion and job creation benefits give a bright forecast for eco- industrial parks.

19. How is e-commerce influencing the distribution of services like music and books?
    What types of services and goods can you think of that are likely to be distributed
    electronically in the future?

Answer: Due to e-commerce music and books are sold online with direct business to
consumer delivery through efficient logistics. These are small products with a wide
geographic market and hence it has influenced the way inventories are maintained and
the mode of delivery. The handling of small packages make the warehouse labor
intensive and the need of speedy delivery has caused more reliance on air transport.
Music, books, computers and software will be sold online and customers will pay to
download or ship them. Ticket services for air travel, reservations for cars and hotels and
restaurants will increase, stocks trading and insurance are obvious services adaptable to
on line ordering and sometimes delivery. It is unclear how deep the market will go for
other consumer goods. Business to business commerce is the largest growth area for on
line ordering of supplies, inventory and support.
20. What is a telcom hotel? Will demand for such properties continue to increase in the

Answer: A telecom hotel is a large room filled with stacks of server computers each
connected to power and communication wires through hubs with millions of electronic
signals surging into and out of the building through conduit tubes in the ground. Old
manufacturing buildings close into urban markets with strong floors often can be retrofit
into telcom hotels. These rooms do not have human presence except for maintenance. As
the demand of telecommunications and computing increases the demand for these
telecom hotels will keep on increasing. However, as of late 2002 this market was
overbuilt in most US markets.

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