Chapter 5: Location

1. Chapter 5: Location Real Estate Principles: A Value Approach Ling and Archer

2. Outline • Horse vs. Jockey • The life of a city • The shape of a city • Location patterns

3. Horse vs. Jockey • In many areas of investments, it is often asked whether choosing a promising investment sector (horse) or a particular investment (jockey) within a given sector is more important. • For stock investing and venture capital investing, choosing a right horse is more important than choosing a good jockey.

4. RE: horse vs. jockey • The textbook authors make a similar argument (p. 120) that “many developers have learned that …… if the market they had counted on is not there when their projects are completed, it is beyond their power to create it.” • Implications: (1) market judgments (choosing horses) are important, (2) controlling horse-risk (market sector and timing risk) is important. • To make better market judgments, one needs to study urban economics (this chapter).

5. Ways to controlling horse-risk, if so desired • You many want to avoid RE investments that have a high market risk, e.g., land development where the end user is not already locked in. • Invest in a city with greater diversity of economic activities and greater capacity to withstand the downturn of one particular industry in that city. • Diversify RE investments across geographic areas and property types.

6. America's Most Miserable Cities, 2011 • California's troubles helped it land eight of the 20 spots with Stockton ranking first for the second time in three years. • The median price is forecast to be $142,000 this year, a decline of 67% from 2005. • Stockton's violent crime and unemployment rates also rank among the 10 worst in the country. • Source: Forbes.

7. How about jockey-risk? • For traditional investments, jockey-risk is related to security selection. • How about the jockey-risk in RE? • Is it relatively more (or less) important than that of traditional investment? • Hint: location.

8. City: why live close? • Why people tend to live together to form a city? • Reason: the demand for proximity; access (i.e., location) to economic activities, such as production and exchange. • If one lives far away from a city, this person needs to travel. Traveling is costly and time consuming, which is typically not optimal.

9. The location of a city • The intersections of different modes of transportation. Example: NYC (Hudson River transit intersected with the Atlantic Ocean). • Mining and resource extraction. Example: Fairbanks, AK (gold and oil). • High quality of living. Example: Sedona, AZ.

10. The growth of a city • The study on the growth of a city is approached from two aspects: (1) the demand side, and (2) the supply side.

11. The demand side • For the demand side, we ask the question of what the external world wants from the city (external demand). • External demand is related to the notion of economic base. • The economic base is the set of economic activities that a city provides for the world beyond its boundaries. Thus, economic base is also called export base. • Stronger economic bases are associated with urban growth and higher RE values.

12. Location quotient • One indicator of a community’s economic base is called a location quotient: the ratio between the percentage of employees in a certain type of work or job classification in a community and the percentage of employees in that same type of work or job classification nationally. • If the ratio exceeds 1, it indicates that the activity is a base economic activity. • U.S. Census provides data for the calculation of location quotients: http://www.census.gov.

13. Multiplier • Different cities have different economic (export) bases. Some types of economic bases have stronger positive impacts on local developments, i.e., higher economic base multipliers, than the others. • The economic base multiplier is higher if the cash flow brought by export activity circulates and re-spends within the community more frequently and for a longer time period.

14. An example of higher multiplier • Many cities promote leisure activities and tourism. • This economic base has a high multiplier. A large share of cash flows brought into a community through tourism goes to food and hospitality services that must be locally produced (local jobs). The cash flows earned by local labor tend to be re-spent through grocery shopping, rent, etc., within the community for a long period of time. • See what happened to the median housing prices in Las Vegas from 2002 ($147K) – 2006 ($318K).

15. The supply side • For the supply side, we ask the question of what a city can offer to the world. • The usual list of offers: (1) skilled labor, (2) universities, (3) quality of life, (3) local government (tax) support and leadership, (4) industry economics of scale, e.g., Silicon Valley, (5) agglomeration economics (big enough?): the emergence of specialized resources, e.g., shipping terminals and specialized financial services (example: NYC and LA).

16. A model for the shape of a city • The bid-rent model assumes that everyone travels to the central business district (CBD) to work. • Because traveling is costly, one would prefer living at a locality that is near the CBD. That is, there is stronger demand and bidding for a locality near the CBD. This stronger demand leads to a higher rent, and thus a higher house value and price. • The bid-rent curve is also called rent gradient.

17. An example, I • Hourly wage rate is $20. • Round-trip travel to CBD is at 20 mph. • Households rent lots for motor homes. • Workers make 20 round-trips per month to CBD.

18. An example, II • What is the time cost of travel? At 20 mph, with a wage rate of $20 per hour, $1.00 per mile. • How much is saved per month by living 1 mile closer? 20 round-trips x 2 x $1 = $40. • Conclusion: workers will bid $40 per month to live 1 mile closer to CBD. • Suppose that the farthest household from CBD commutes 3 miles.

19. The bid-rent curve

20. Implications • A single-center city. • The cost of traveling is individual-specific. • Wealthy professionals have a higher cost of opportunity and thus a higher cost of traveling. The model at its simplest form predicts that they tend to live close to the CBD. • Implication: wealthy people tend to get good location, and there is an economic separation between rich households and poor households.

21. Limitation • The bid-rent model is intuitive, but not complete. The reason for this is that the model considers only one dimension of linkage, i.e., access need (the single-person commute). • The reality is that households (and businesses) have multiple needs of access: to (good) schools, to friends, to privacy, to shopping, etc. All of these linkages enter into the household’s bid for a location.

22. Location dynamics • These linkages change over time, therefore the value of a location changes over time. • Forces: (1) advances in transportation (cars and light rails), (2) technological changes (air-conditioning and electronic lighting in 1930s introduced large retailing facilities outside the CBD), and (3) social movements (the smart growth movement has made some old CBDs livable again). • Question: If MA government builds a direct high-speed light rail from Marlborough to Boston downtown, what would happen to the RE prices in Marlborough? • Implication: must take the dynamics into consideration.

23. San Diego experience • 46% premiums for condominiums and 17% for single-family housing near Coaster commuter rail stations in the north county. • 91% premiums for parcels near downtown Coaster stations and 72% premiums for parcels near trolley stations in the Mission Valley. • Source: Realtor.org

24. Multi-CBDs • It is apparent that by 1945 the form of a city departs from a single-center city. • Harris and Ullman (1945, Annals, American Academy of Political and Social Science, 242, pp. 7-17) coined the term “multinuclei city.” • The motor vehicle, combined with new technologies of production, had propelled urban activities away from the single CBD. • The failure of W.T. Grant.

25. Use-specific • RE investment is about location, location, and location. • The tricky part is that a good location for one particular type of land use (shopping mall) may be a weak location for another type of land use (industrial park). • Location (and value) is use-specific.

26. Central place location • Central place location: a location pattern where similar economic entities, e.g., regional malls, tend to disperse evenly over the market region. • These entities tend to involve in convenience activities. Example: regional malls, bakeries, supermarkets, coffee boutiques, etc. • Implication: A new suburban city with enough population may have a central locality that is ideal for a convenience good or service provider, e.g., regional shopping mall or a Barnes and Noble.

27. Maximum Market Area Central place pattern

28. Clustering location • Clustering location: this is where similar economic entities tend to cluster due to the following 2 reasons: • (1) Comparison activities: customers prefer comparison shopping and a large selection. Example: apparel stores within a shopping mall or club districts. • (2) Industry economics of scale. By clustering, firms engaged in the same kind of activity may create mutual efficiencies. Example: high-tech industrial parks.

29. Location, what location? • Suppose that you are thinking about opening a laundry store. What kind of location will be ideal?

30. Location and risk • The average change in U.S. median house prices from 2005 4Q to 2008 3Q is -12.2%. • During the same period, the price changes for the following locations are: Merced, CA (-51.0%); Fort Myers, FL (-44.0%); Riverside, CA (-37.3%); Las Vegas (-29.9%).

31. Group Assignment • Conduct a “walk-the-site” research according to Study Questions #3, p. 160 (#3, p. 177 if you use 2nd edition of Ling and Archer). • The report is due in a week.