Characteristics of Real Property PDF

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MSc Real Estate Economics lecture notes delivered by Nigel Mehdi....

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Characteristics of Real Property Property Rights - An economic system in which the dominant institutions are private property, markets and firms. - Other institutions such as governments and households are also important. Interests in Land - By land, we mean real estate and the built environment. - 2 main types of land include: a) Freehold – or fee simple absolute in possession: freehold ownership is perpetual (never expires) and is the closest that anyone (other than the monarch) can get to absolute ownership of land. This also gives you the right to create subsidiary interests – lower levels of interest below the level of freehold. E.g. leasehold b) Leasehold – a term of years absolute in possession: leasehold estates for a fixed term and are regarded as inferior to freeholds although the term of lease can be for any period of time. As the term of the lease gets longer, the property interest gets similar to freehold. - Freehold doesn’t give you complete use of the property: a) There may be other rights associated with the land such as rights of interest from neighbours, mineral rights (oil and gas are nationalised so you cannot own these on your land), also do not own the airspace. b) Freehold ownership does not mean you have free reign on development of the land either – they are both subject to development controls, planning regulations, listed building regulation, building controls (amenity space, extra developments prevented), changes of use controls. - Leaseholds contain clauses/covenants which govern what the occupier can do with the property. - Freeholders give up occupation of property to leaseholders who will take occupation at a fee and with associated clauses in place. - Capital usually comes in the form of rent to the freeholder/landlord. - Other clauses include rent revies, repair clauses, use of property clauses. Investment Interests - Where the owner receives a substantial net rental income from one or more subsidiary leaseholders: a) A freehold interest in a let property – each quarter, the tenant pays the rent to the landlord. b) A head tenants interest in a property sub-let at a substantial profit rent. Occupation Interests - These may be either: a) No value or low value leasehold interests, where the tenant is paying a rent at, or close to, the property’s rental value. b) Valuable, e.g. where the occupier is either the freeholder (owner occupier) or a leaseholder paying a rent significantly below rental value and with a substantial period of the lease still to run.

Legal interest + physical characteristics - The value, risk and potential return of a property investment is dependent upon: a) The terms of the leases to which the interest is subject. b) And the physical property over which the legal interest exists. - Every property has a specific set of physical characteristics. - This combination of legal and physical characteristics influences a property’s value. Characteristics of physical property - 5 we are going to look at here: a) Dual components – any building is made up of the land it is constructed on and the buildings itself. The building is a manufactured product which is often characterised as a capital investment. The land is a ‘free gift of nature’ (loose and mainly incorrect in the UK, would have been different in the past). They combine to create a dual component. The land is perpetual, but the building is only durable, not perpetual. A building constructed on land will depreciate because it needs to be maintained and will slowly become unfit for the purpose it was originally built for – this can be prevented or slowed by refurbishment and high maintenance. b) Durability – property is the most durable asset of all manufactured goods – they have the longest lifespan, especially after refurbishment, upgrading and maintenance through their lifetime to prevent depreciation. Properties can become obsolete where there is no longer a point making capital investments into it to keep it going. Thus, it becomes necessary to redevelop the property completely. The land stays intact, but the property does not. c) Fixed location – e.g. an increased demand for offices in Edinburgh. There may be suitable property available in Oxford, but property has fixed location and cannot move to provide for the demand elsewhere, in Edinburgh. This is different to other manufactured goods (e.g. cars) where if cars available in Oxford suddenly have demand in Edinburgh, they can be moved to satisfy that demand. d) Heterogenous – this means each item is individual and each item is different. Homogeneity means everything is identical (e.g. 1 apple share is the same as another apple share). However, if two houses are owned next to each other, they will be different no matter how similar they are. Fixed location alone makes them different. Legal interests vary, construction varies etc. Even identical properties vary because of ‘fixed location’. Other characteristics add into this  large lot size, indivisibility, high transaction costs, long period of time to complete a transaction, high management costs – all differ between different properties. e) Stock elasticity – in the short run, the supply of property in the given market cannot easily expand or change to match the conditions of demand. Stock that is being supplied (available property), the quantity available cannot easily change to satisfy demand. In the long run, the supply of property is perfectly in elastic, over a period of 25-50 years, stocks of property can adjust to meet the conditions of demand. Medium term refers to 5-15 years. This is because property takes a long time to manufacture, restrictions via planning etc.

Markets

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Product to be sold or exchanged. The needs of the buyers are satisfied through the supply of that product from the sellers.

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Property stock – represents the total quantity of all available property in a given market (sub-market) – e.g. shops in Summertown, Oxford. Property markets are segmented (no central marketplace). The property market is ubiquitous: a) The property market is a ubiquitous conglomeration of interrelated sub-markets in which prices are determined. b) The principle categorisation is into the letting, investment and development sectors, with further subdivisions according to use-type, location, quality and size etc. In our model, there is 3 different sectors: a) Letting sector b) Investment sector c) Development sector

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Yellow ring  property stock which can be bought, sold, traded etc.

Imperfect Market - The property market is very imperfect, particularly in contrast with the stock market, and values are slow to respond to changing market forces  stock prices can change in minutes, property values can take months. - The imperfection derives partly from the substantial value of most property interests, but principally from the heterogenous nature of each interest, the impact of the rent review and the lack of public information (this has been revolutionised by Co-Star, internet, Rightmove etc making property prices and transactions available to the public more easily). Types of investment property - Residential – investment grade asset class now. Government intervention in the residential property market gave security of tenure to tenants, fixed rents separately from the marketplace and caused landlords reluctance to invest in residential property in the past. There was also a negative stigma associated with investing in residential property in the past as it has been so linked to social issues and housing shortages. This has changed over the past 30 years (Housing Act 1990) meant that rents were not fixed, and tenants had less security of tenure and meant landlords could get back their property if they needed to. Buy-to-let has opened up the residential investment market to smaller landlords now. - Farmland – limited supply, no new farmland is being manufactured. We are less able to create and improve farmland through intensification. The quantity is very fixed. Improvements in agricultural productivity does mean we get a greater yield from existing farmland. - Woodlands – many tax incentives over recent years to invest in forestry, plant trees and get into that. - Commercial (retail, offices, industrial, warehouse and logistics supply) – essential for large companies’ (e.g. Amazon) supply chains to operate successfully. - Leisure (hotels, restaurants, catering, sport) – specialised property here. Hotels would maybe be measured in bedroom numbers. Restaurants by covers/seats. - Speciality (student lets, self-storage etc). -

Each of these would fit into the property market model, each of them is a type of property. They could be operating in all 3 sectors of the model (letting, investment and development)....