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TECHNICAL UNIVERSITY OF KENYA

SCHOOL OF SURVEYING AND SPATIAL SCIENCE

DEPARTMENT OF GEOINFORMATION AND EARTH OBSERVATION

BACHELOR OF ENGINEERING (GEOSPATIAL ENGINEERING)

EEGQ 5174: REAL ESTATE ECONOMICS

LESSON 1 & 2
Mr. Linus K. Korir
linus.korir@tukenya.ac.ke
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INTRODUCTION TO THE CONCEPT OF PROPERTY

ECONOMICS

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Definition of Terms Relating to Real Estate Economics

• Real estate economics is the application of economic techniques to real

estate markets. It tries to describe, explain, and predict patterns of prices,
supply, and demand.
• The closely related field of housing economics is narrower in scope,
concentrating on residential real estate markets, while the research on real
estate trends focuses on the business and structural changes affecting the
industry.
• Both draw on partial equilibrium analysis (supply and demand), urban
economics, spatial economics, basic and extensive research, surveys, and
finance.

The main participants in real estate markets are:

i. Users: These people are both owners and tenants. They purchase houses or
commercial property as an investment and also to live in or utilize as a business.
Businesses may or may not require buildings to use land. The land can be used in
other ways, such as for agriculture, forestry or mining.
ii. Owners: These people are pure investors. They do not occupy the real estate that
they purchase. Typically, they rent out or lease the property to other parties.
iii.Renters: These people are pure consumers.
iv.Developers: These people are involved in developing land for buildings for sale
in the market.
v. Renovators: These people supply refurbished properties to the market.
vi.Facilitators: This group includes banks, real estate brokers, lawyers, government
regulators, and others that facilitate the purchase and sale of real estate.
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• The choices of users, owners, and renters form the demand side of the
market, while the choices of owners, developers and renovators form
the supply side.
• In order to apply simple supply and demand analysis to real estate
markets, a number of modifications need to be made to standard
microeconomic assumptions and procedures.
• In particular, the unique characteristics of the real estate market must
be accommodated.
• These characteristics include:

Durability
• Real estate is durable. A building can last for decades or even centuries, and
the land underneath it is practically indestructible. As a result, real estate
markets are modelled as a stock/flow market.
• Although the proportion is highly variable over time, the vast majority of
the building supply consists of the stock of existing buildings, while a small
proportion consists of the flow of new development.
• The stock of real estate supply in any period is determined by the existing
stock in the previous period, the rate of deterioration of the existing stock,
the rate of renovation of the existing stock, and the flow of new
development in the current period.
• The effect of real estate market adjustments tend to be mitigated by the
relatively large stock of existing buildings.
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Heterogeneity
• Every unit of real estate is unique in terms of its location, the building, and its
financing. This makes pricing difficult, increases search costs, creates information
asymmetry, and greatly restricts substitutability.
• To get around this problem, economists, beginning with Muth (1960), define
supply in terms of service units; that is, any physical unit can be deconstructed
into the services that it provides.
• Olsen (1969) describes these units of housing services as an unobservable
theoretical construct. Housing stock depreciates, making it qualitatively different
from new buildings. The market-equilibrating process operates across multiple
quality levels.
• Further, the real estate market is typically divided into residential, commercial,
and industrial segments. It can also be further divided into subcategories like
recreational, income-generating, historical or protected, and the like.

High transaction costs

• Buying and/or moving into a home costs much more than most types of
transactions. The costs include search costs, real estate fees, moving costs, legal
fees, land transfer taxes, and deed registration fees.

• Transaction costs for the seller typically range between 1.5% and 6% of the
purchase price.

• In some countries in continental Europe, transaction costs for both buyer and
seller can range between 15% and 20%.

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Long-time delays

• The market adjustment process is subject to time delays due to the length of
time it takes to finance, design, and construct new supply and also due to
the relatively slow rate of change of demand.
• Because of these lags, there is great potential for disequilibrium in the short
run.
• Adjustment mechanisms tend to be slow relative to more fluid markets.

Both an investment good and a consumption good

• Real estate can be purchased with the expectation of attaining a return (an
investment good), with the intention of using it (a consumption good), or
both.
• These functions may be separated (with market participants concentrating
on one or the other function) or combined (in the case of the person that
lives in a house that they own).
• This dual nature of the good means that it is not uncommon for people to
over-invest in real estate that is, to invest more money in an asset than it is
worth on the open market.

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Immobility
• Real estate is locationally immobile (save for mobile homes, but the land
underneath them is still immobile). Consumers come to the good rather than the
good going to the consumer.
• Because of this, there can be no physical marketplace. This spatial fixity means
that market adjustment must occur by people moving to dwelling units, rather than
the movement of the goods.
• For example, if tastes change and more people demand suburban houses, people
must find housing in the suburbs, because it is impossible to bring their existing
house and lot to the suburb (even a mobile homeowner, who could move the
house, must still find a new lot).
• Spatial fixity combined with the close proximity of housing units in urban areas
suggest the potential for externalities inherent in a given location.

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Economic Concepts of Value, Price, Cost and Investment

• Before going for difference, let us understand the meaning of price, value and cost
in simple words.
Price is what you pay.
Cost is what you expend.
Value is what you get.
• There is confusion between words price, cost and value. Many people think all the
three words are more or less same but there is some difference between them.
• Before going for differences lets try to understand the overview of these three
words.

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Price

• In commercial terms, price is the amount charged by the seller from the buyer in
exchange for any product/service. Price includes both cost and profit. When
commercial transaction is good then it is called price, when subject matter is
service, then it can be:
Supply of professional service then it is called FEES.
In case of insurance then it is called PREMIUM.
Used in case of place/machinery then it is called RENT.
In case of transportation then it is called FARE.
For work done (organization) then it is called SALARY.
• Sometimes price generates revenue and sometimes price adds to cost of
production. Price is also considered as the amount given in return of goods or
service acquired by the buyer.
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Cost
• Cost is the amount spent on inputs with the aim of producing
product/supplying services. Inputs can be land, capital, material, capital etc.
in other words or simply words, cost in the financial worth of sacrifice made
to get goods/services.
• Benefits obtained can be present or in future. Elements of costs are material,
overheads and labour.
• Costs are divided into:
i. Fixed cost − remains same irrespective of units produced (rent insurance,
deprecation etc.)
ii. Variable cost − not same or varies with units produced (labour, raw
material etc.)

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Value
• It is a benefit derived from product/service by customers. Value is decided on the
basis of benefits received in terms of features, specifications, etc. in the
marketplace. Features include functional characteristics, technical support,
customer support etc.
Characteristics:
i. Immeasurable in nature.
ii. Value Varies from time to time.
iii.Value depends on supply of product and demand.
iv. Value differs from place to place.
Differences:
• The major differences between price, value and cost are as follows:

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Price Value Cost Cost Value

Amount paid for Amount spent on Utility of a good/service.
product/service. producing/maintaining a
product.

Ascertained from the Ascertained from the Ascertained from the user's
consumer's view. producer's view. view.

Estimated through policy. Estimated through fact. Estimated through opinion.

Increase/decrease in product Rise/fall of cost depends on Value remains constant.

price depends on market market variations.
variations.

It is calculated in terms of It is calculated in monetary It is calculated in terms of

money. terms. money.
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Investment
• An investment is an asset or item acquired with the goal of generating
income or appreciation.
• Appreciation refers to an increase in the value of an asset over time.
• When an individual purchases a good as an investment, the intent is not to
consume the good but rather to use it in the future to create wealth.
• An investment always concerns the outlay of some capital today—time,
effort, money, or an asset—in hopes of a greater payoff in the future than
what was originally put in.
• For example, an investor may purchase a monetary asset now with the idea
that the asset will provide income in the future or will later be sold at a
higher price for a profit.

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How an investment works

• The act of investing has the goal of generating income and increasing value
over time. An investment can refer to any mechanism used for generating
future income.
• This includes the purchase of bonds, stocks, or real estate property, among
other examples. Additionally, purchasing a property that can be used to
produce goods can be considered an investment.
• In general, any action that is taken in the hopes of raising future revenue
can also be considered an investment.
• For example, when choosing to pursue additional education, the goal is
often to increase knowledge and improve skills (in the hopes of ultimately
producing more income).

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• Because investing is oriented toward the potential for future growth or

income, there is always a certain level of risk associated with an investment.
• An investment may not generate any income, or may actually lose value
over time.
• For example, it's also a possibility that you will invest in a company that
ends up going bankrupt or a project that fails to materialize.
• This is the primary way that saving can be differentiated from investing:
saving is accumulating money for future use and entails no risk, whereas
investment is the act of leveraging money for a potential future gain and it
entails some risk.

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Types of Investments
Economic Investments
• Within a country or a nation, economic growth is related to investments.
• When companies and other entities engage in sound business investment
practices, it typically results in economic growth.
• For example, if an entity is engaged in the production of goods, it may
manufacture or acquire a new piece of equipment that allows it to produce
more goods in a shorter period of time.
• This would raise the total output of goods for the business. Taken in
combination with the activities of many other entities, this increase in
production could cause the nation’s gross domestic product (GDP) to rise.
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Investment Vehicles
• An investment bank provides a variety of services to individuals and businesses,
including many services that are designed to assist individuals and businesses in
the process of increasing their wealth.
• Investment banking may also refer to a specific division of banking related to the
creation of capital for other companies, governments, and other entities.
• Investment banks underwrite new debt and equity securities for all types of
corporations, aid in the sale of securities, and help to facilitate mergers and
acquisitions, reorganizations, and broker trades for both institutions and private
investors.
• Investment banks may also provide guidance to companies who are considering
issuing shares publicly for the first time, such as with an initial public offering
(IPO).

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Investing vs. Speculation

• Speculation is a distinct activity from investing. Investing involves the
purchase of assets with the intent of holding them for the long term, while
speculation involves attempting to capitalize on market inefficiencies for
short-term profit.
• Ownership is generally not a goal of speculators, while investors often look
to build the number of assets in their portfolios over time.
• Although speculators are often making informed decisions, speculation
cannot usually be categorized as traditional investing.
• Speculation is generally considered a higher risk activity than traditional
investing (although this can vary depending on the type of investment
involved).
• Some experts compare speculation to gambling, but the veracity of this
analogy may be a matter of personal opinion.

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