Commercial Real Estate Analysis and Investments by David M. Geltner and David Geltner

PART I
Introduction to Real Estate Economics

In subsequent parts of this book, we are going to be navigating some pretty
narrow (and steep) paths. So let’s begin with the big picture, with an overview

of the real estate system from an economic perspective. The main
purpose of Part I is to provide this overview. But we will also present here
some of the fundamental nuts and bolts and tools useful in the economic
study of real estate. These will help to bring the big picture down to everyday
business practice, and be useful in subsequent chapters. As noted in the
preface, two major branches of economics bear on the analysis of commercial

property from an investment perspective. The first is what is usually
referred to in the United States as urban economics, and the second is
financial economics. In later parts of this book, we will explore real estate
from one or the other of these two perspectives, separately. In this first part,
by contrast, we will attempt to provide some integration and overview,
bringing both of these perspectives together. The first chapter introduces the
two major types or levels of markets relevant to commercial property
analysis. The second chapter then discusses the development industry that
links these two markets in a dynamic system and presents some tools for
understanding and analyzing this system.

Chapter Outline
1.1 Space Market
1.1.1 Segmentation of Space
Markets: The Immobility of
Real Estate
1.1.2 Supply, Demand, and Rent
in the Space Market
1.1.3 Supply Is ‘‘Kinked’’
1.1.4 Relation among Supply,
Development Cost, and
Rent
1.1.5 Forecasting the Future
Direction of Rents
1.1.6 Is the Supply Function
Rising, Level, or Falling?
1.2 Asset Market
1.2.1 Capital Markets
1.2.2 Pricing of Real Estate Assets
1.2.3 Is the Asset Market
Segmented Like the Space
Market?
1.2.4 Magnitude of Real Estate
Assets in the Overall Capital
Market
1.3 Chapter Summary

Chapter 1
Real Estate Space and Asset Markets

Learning Objectives
After reading this chapter, you should understand:
E How to apply the basic economic concepts of supply and demand to
real estate markets.
E The difference between the real estate space and asset markets.
E The concept of market segmentation within the space market.
E Why the long-run supply function in the space market is ‘‘kinked’’ and
what that means to future rents.
E The difference between, and relative magnitudes of, the public versus
private asset markets, and the difference between equity and debt
capital.
E What a cap rate is and what determines cap rate prevailing in real
estate markets.

Markets are perhaps the most basic of all economic social phenomena. In essence, a market
is a mechanism through which goods and services are voluntarily exchanged among
different owners. In this chapter, we will present a basic introduction to the two major
markets that are relevant for analyzing commercial real estate: the space market and the asset market.

I.I SPACE MARKET

The space market is the market for the usage of (or right to use) real property (land and built space).
This type of market is also often referred to as the real estate usage market or the rental market. On
the demand side of this market are individuals, households, and firms that want to use space for
either consumption or production purposes. For example, a student renting an apartment is using
space for housing consumption. A law firm renting an office is using space for production. Both
these types of users are on the demand side of the space market. On the supply side of the space
market are real estate owners who rent space to tenants.
The price of the right to use space for a specified temporary period of time is commonly called
the rent. It is usually quoted in annual terms, per square foot (SF), though other methods are also
used (such as monthly per apartment). The rental price (determined by supply and demand in the

Commercial Real Estate Analysis and Investments by David M. Geltner and David Geltner