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

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

2. Chapter Outline Definition of Real Estate Economics Importance of Real Estate Economics Microeconomics vs. Macroeconomics Land as an Economic Resource Renewable and Nonrenewable Resources Estate Categories of Estates Land: Surface and Subsurface Rights Real Estate Economic and Physical Characteristics of Land / Real Estate Real Property Bundle of Rights Real Property vs. Personal Property Fixtures Trade Fixtures

3. 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.

4. What is Real Estate Economics? Real Estate Principles and Practice General Economics Principles and Theory Real Estate Economics 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.

5. 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.

6. 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

7. 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.

8. Let’s Check Your Understanding! Determine whether each of the following cases on real estate economics is a concern of microeconomics or macroeconomics. • The percentage contribution of real estate segment in the increase of GDP • Mr. Cruz’s decision whether to rent an apartment or buy a housing unit • Occurrence of real estate bubble in recent years • The determinants that affect the supply of retail spaces in SM Malls • The price to be charged for a three-night stay in a luxurious resort

9. 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.

10. Why is Real Estate Economics so Interesting? • 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!

11. 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: Land Labor Capital Entrepreneurial skills

12. Economic Resources in Real Estate • Landincludes all the natural resources found in nature a country possesses, such as water, minerals, animals, and forests. • Labor isthe work time and work effort that people devote to producing goods and services. • Capitalrefers to produced goods that can be used as resources for further production. • Entrepreneurshipis the human resource that com­bines the factors of production creatively and efficiently.

13. Let’s Check Your Understanding! Determine what category of resources in real estate sector does each of the following belong. Cement and bricks Heavy-duty trucks Civil engineer Water system Construction site Construction workers

14. 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 nonproducedresources with which a society is endowed. Natural resources are categorized as renewable and nonrenewable resources.

15. Renewable vs. 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.

16. Definition of Estate The term estatemeans “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 propertyis used to describe the extent to which rights and interests in real estate are owned. A system of modifiershas evolved, based on English property law, that describes the nature or collection of rights and interests being described as a part of a transaction.

17. 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

18. Two Types of Future Estates Reversion Remainder

19. 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.

20. 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.

21. 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.

22. 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 her heirs, or any other designated person.

23. 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.

24. Two General Classifications of Estates Based on Rights: Estates in Possession versus Estates Not in Possession (Future Possession) Based on Possession and Use: Freehold versus Leasehold Estates

25. Land, Real Estate and Real Property

26. Land • 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 airabove the earth, all the way into space. These are knownrespectively as the subsurface and the airspace. Most of the surface of the earth, of course, is water. Specialstate and local laws govern theownership of these parts of the earth, including lakes and rivers.

27. Real Estate 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.

28. Real Property 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.

29. Bundle of Legal Rights • 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

30. Bundle of Legal Rights

31. Surface and Subsurface 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.

32. Air 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 bean 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

33. Water 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

34. Characteristics of Land / Real Estate • Economic Characteristics • Scarcity • Improvements • Permanence of Investment • Location or Area Preference • Physical Characteristics • Immobility • Indestructibility • Uniqueness

35. Scarcity 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 remainsunused or uninhabited, the availability of land in a given location or of a particular qualityis limited.

36. Improvements 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 s hopping center or selecting a site for a nuclear power plant or toxic waste dump can dramaticallychange the value of land in a large area.

37. Permanence of Investment The capital and labor used to build the improve­ment 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.

38. Location or Area Preference Area preference or situs ("to place") refers not only to geography but also to people's preference for a specific area. Area prefer­ence 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 eco­nomic characteristic of land

39. Immobility 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.

40. Indestructibility 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.

41. 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.

42. Two Categories of Property Real Property Personal Property

43. Real Property vs. Personal 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 defini­tion 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.

44. Tangible vs. Intagible 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.

45. Let’s Check Your Understanding! To which category of properties does each of the following belong? Clothing Motor vehicles Office building Negotiable instruments Parking lot Shopping mall

46. FructusNaturales vs. FructosIndustriales • Tress and crops (plants) generally fall into two classes: • FructusNaturales. • These are trees, perennial bushes, and grasses that do not require annual cultivation. These items are considered real estate. • FructusIndustriales • Annual cultivated crops of fruit, vegetables, and grain which are known as emblements. These things are generally considered real estate property.

47. Severance and Annexation An item of real property can become personal property by severance. For exam­ple, 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).

48. Fixtures Fixtureis 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.

49. Attachment 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.

50. Legal Tests of a Fixture Method of annexation. How permanent is the method of attachment? Can the item be removed without causing damage to the surrounding property? 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. Agreement. Have the parties agreed to treat an item as though it is real or personal property?