CHAPTER 1 MARKET ANALYSIS IN PERSPECTIVE PART A. INTRODUCTION INTRODUCTION

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1 PART A. INTRODUCTION CHAPTER 1 MARKET ANALYSIS IN PERSPECTIVE INTRODUCTION BOOK PREMISE, FOCUS AND OBJECTIVES MARKET ANALYSIS IN PERSPECTIVE DEFINITION AND CONTRIBUTION MARKET ANALYSIS COMPONENTS Metropolitan Growth Analysis Macroeconomic Analysis of Real Estate Markets Microeconomic (Site-Specific) Analysis of Development Projects MARKET STUDIES AND THEIR EMPHASIS Residential Retail Office Industrial MARKET STUDIES IN GENERAL: EVALUATION CRITERIA BOOK STRUCTURE AND CONTENT REFERENCES AND ADDITIONAL READINGS INTRODUCTION Real estate market research is a new field of study, which builds on the accumulated stock of knowledge from urban and real estate economics to address two major questions: How do the various real estate markets function at the broader macroeconomic, or metropolitan level, and at the more narrow microeconomic, or site level of analysis? How exactly should one go about analyzing meaningfully real estate markets for development and/or investment purposes?

2 These two questions highlight two major areas of knowledge in the field of real estate market research that are critically linked, as the accuracy and reliability of analytical techniques and processes is directly proportional to the degree to which they reflect the functioning of the particular market analyzed. In addressing the first question, this textbook will explore the basic economic principles guiding the operation of real estate markets, placing special emphasis on their peculiarities and idiosyncratic features. As it will become apparent later, it is the knowledge of these features that helps more accurately evaluate specific real estate development or investment opportunities. In addressing the second question this textbook will explore both state-of-the art and less sophisticated techniques that market analysts can employ to proactively design and evaluate real estate development or investment programs. The major premise underlying the structure and content of the book is that a better understanding of how markets function coupled with a working knowledge of real estate market analysis tools will help analysts and real estate professionals: become sophisticated users of market studies communicate more effectively with colleagues in the real estate development and investment community use skillfully available data to evaluate the prospects of a market and a specific project BOOK PREMISE, FOCUS AND OBJECTIVES The author rejects emphatically the Field of Dreams philosophy Build it and they will come... that seems to have dominated the real estate development industry during the 1980s. This philosophy is wrong as it basically suggests that supply generates demand, a proposition that runs against fundamental economic principles. On the contrary, the book advances the premise that solid market research, based on a good understanding of the peculiarities and idiosyncrasies of real estate markets, is a necessary and crucial component of the real estate decision-making process. The specific operational and bottom-line objective of market research is to help generate the knowledge and information that relates to space market operations and is necessary for assessing whether a project is likely to meet key development and investment objectives. For example, a typical key real estate development objective involves the maximization of residual land value (RLV) or, alternatively, profit per area of land. The two major factors involved in the calculation of RLV are property values or prices, and non-land development costs per square foot (see Figure 1.1). It is the strong link between property values and a property s income-earning capacity that underscores the importance of market analysis in real estate development and investment decision making. The strong link between property values and a property s income is embedded in the income approach to value, the most relevant property valuation technique from an investment point of view. 1 In its simplest version, the income approach postulates that property value is 1 The income approach, which focuses on the income-producing capacity of a property, is one of the three major approaches to value. The other two approaches include the sales comparison approach, which utilizes data on the most current sales prices of properties comparable to the one under consideration, and the cost approach, that focuses on the estimation of a building s replacement cost

3 a function of the property s net operating income (NOI) and the prevailing market capitalization rate. 2 Movements in a property s NOI are strongly influenced by movements in space markets. In particular, a property s NOI is a function of the rent it commands in the marketplace and its occupancy rate. Property rents and occupancies are in turn shaped by market demand and supply forces, as well as idiosyncratic structure and location characteristics. In particular, it has been widely established in the real estate literature that movements in individual-property rent and occupancy levels are primarily driven by changes in market demand and supply conditions, while differences in rent and occupancy levels across individual properties competing within the same marketplace are determined by idiosyncratic property and location characteristics. Figure 1.1 Inputs in Residual Land Value Maximization max RLV = (Price - Cost) FAR Floor Area Ratio (needs to be = [(NOI/Cap Rate) - Cost] FAR optimized) Determined in the asset market = [(f(rent, Occupancy)/Cap Rate) - Cost] FAR Determined in the user market Net Operating Income Capitalization rate: Income return required for holding an asset (driven by expected rental income growth and market strength, the opportunity cost of investment capital, risk factors, tax policy) Note : Price, NOI, Rent, and Cost are in $/sq. ft.; FAR = sq. ft. of space / sq. ft. of land Capitalization rates are not typically the focus of market studies for development projects, but they are strongly influenced by movements in local market conditions as property income does. For example, empirical analysis of movements in office capitalization rates has provided evidence of the influence of market-related variables, such as absorption 2 The more advanced version of the income approach is represented by the discounted cash-flow model in which a property s income-earning capacity is again the prominent factor driving value. In this version, instead of using a capitalization rate, which represents a required income return, a required total return (referred to as discount rate) is used within the context of a multi-year discounting formula

4 levels and changes in rents (Sivitanidou and Sivitanides, 1999). This underscores the additional importance for accurately evaluating real estate market prospects. In sum, the role of market research is to analyze the market-related determinants of project profitability at the macro and micro level, help address questions of market entry and pro-active project design, and provide the bottom-line rent and absorption figures that are necessary for the assessment of the financial feasibility of a particular development. Within this context, the focus of this book is on the forces and processes that drive broader space-market performance; the idiosyncratic project- and location-specific factors that shape deviations of individual property performance from average market performance; and the techniques that analysts can use to forecast market performance and assess the income-earning prospects of specific development projects. Hence the four major objectives of this book are: 1) to examine the major macroeconomic processes and factors that shape broader market performance of the four major property types 2) to present advanced and less sophisticated techniques for analyzing and forecasting broader market performance for the four major property types 3) to discuss project-specific and location factors that influence individual property performance, and 4) to present techniques for analyzing and forecasting individual project performance in a way that is consistent with the analysis of the prospects of the broader market MARKET ANALYSIS IN PERSPECTIVE DEFINITION AND CONTRIBUTION Generalizing along the lines discussed above, it can be argued that the major focus and contribution of market analysis for real estate is the assessment of the underlying determinants of a project s income-earning capacity at two distinct levels: the macroeconomic (non-site) level and the microeconomic or project-specific level. As indicated in Figure 1.2, a property s income-earning capacity is influenced by three major sets of factors: a) general macroeconomic and metropolitan growth forces that may affect all property types, b) macroeconomic forces that drive the demand for and supply of specific property types, and c) location- and project-specific factors that may contribute to deviations of individual property performance from market performance. We elaborate on each of these factors below. a) General Macroeconomic/Metropolitan Growth Forces These include forces that may affect the economy of a metropolitan area and all its real estate markets. Examples of such forces include increasing global competition and

5 technological advancements that may undermine an area s major industries; significant changes in exchange rates that may render foreign imports more attractive at the expense of domestic industries; the economic well-being of America s major trading partners, that can have a significant impact on export-oriented metropolitan economies; or changes in interest rates that may influence the volume of new construction, and, therefore, the supply of all property types nationally. These forces, being international, national or regional in scope, may very well impact a metropolitan area s economy and local real estate market. The effect of these forces may vary from metropolitan area to metropolitan area due to differences in industrial structure and the sectoral composition of the local economy. Figure 1.2 Influences on Project Income-Earning Capacity Project Income-Earning Capacity Influences a. General Macro/Metro c. Location and Growth Forces Property-specific Factors b. Macro Forces Driving (Amenities and Specific Space Markets constraints) (e.g., residential, office) Time-variant Fixed or time-variant Effective Competing Location Competing Space Space and Space Demand Supply Product Supply Demand Average Consumer/Tenant Project-specific Market Prices/Rents Preferences Prices/Rents Market Absorption and Project Absorption Ability to Pay Determine the average performance of a real estate market through time Determine the competitive position and performance of a project within its market at a given point in time b) Macroeconomic forces that drive the demand for and supply of specific property types. For example, as a number of empirical studies have shown (Wheaton, 1987; Rosen, 1984), the demand for office space is driven by employment in specific sectors of the

6 economy referred to as office-using. These include primarily the FIRE (Finance, Insurance and Real Estate) sector and Services, as defined in the Standard Industrial Classification (SIC) system. Thus, macroeconomic forces that affect specifically these sectors, such as the health of the nation s financial system, are bound to have an effect on an area s demand for office space. Similarly, Wheaton and Torto (1990) have shown that demand for industrial space is driven primarily by manufacturing and wholesale trade employment. Macroeconomic forces that affect an area s employment in these sectors will have an impact on the local industrial market. On the supply side, the major factors that drive new construction for a specific property type include land costs, which vary across different land uses within the same metropolitan area, as well as across metropolitan areas; labor costs that generally vary across metropolitan areas due to differences in labor market conditions; and the cost of construction materials. All these macroeconomic factors, both broader and more property-type specific, jointly shape movements in effective space demand, and competing supply and, hence, movements in absorption, vacancy rates, and average market rents/prices through time. c) Location and Project-Specific Factors These include factors that affect the demand for and the competing supply of a particular real estate product at a specific location. In particular, factors such as the quality of and amenities provided by the project and its immediate location along with consumer/tenant preferences and ability to pay play a critical role in determining location and product demand. On the supply side, factors, such as, local zoning constraints and growth controls may create supply shortages and limit competition. Furthermore, the spatial distribution of existing and new comparable properties plays a key role in determining the intensity of the competition faced by a specific property at a given location, especially in the case of retail. Overall, all these factors shape the competitive position of a project within its market area, which plays a crucial role in determining the level of rents/prices and absorption it can achieve relative to the average market rent and total market absorption, respectively. To better understand the difference between the macroeconomic and microeconomic influences on real estate markets consider Figure 1.3, portraying movements in rents for two different projects/locations with different amenity levels. Notice that, although the time path of rents is similar for both project locations, there are persistent differences in levels. Variations in performance through time are due to changes in macroeconomic forces that influence a metropolitan area s economy and affect all locations/projects similarly. Differences in performance across projects and locations at the same point in time (referred to also as cross-sectional differences) are due to differences in their amenity levels and/or constraints. Long-run shifts in cross-sectional rent differentials across projects/locations within the same market are more likely due to changes in amenity/constraint differentials, or the way these differentials are valued. For example, it is being argued that dispersion of economic activity, induced by advances in information and communication technologies, is narrowing locational differentials in rents and prices as the value of locational proximity has declined (Sivitanidou, 1997)

7 MARKET ANALYSIS COMPONENTS A comprehensive and well-integrated market study should appropriately examine all aforementioned macroeconomic and microeconomic influences. As such, it should comprise three major components: a) metropolitan growth analysis, (b) macroeconomic analysis of real estate markets, and (c) micro-marketability analysis. The basic premise underlying metropolitan growth analysis is that real estate is durable and, therefore, demand for new space is driven by growth at the margin. Can there be any demand for real estate within a metropolitan area that is not experiencing any population, employment, or income growth? The answer is yes. Two sources of such demand can be identified: 1) replacement demand, which arises because of the depreciation of the existing stock, and 2) relocation demand, arising from intra-metropolitan location adjustments, induced by advances in information and communication technologies, rent or price differentials across submarkets, or other factors influencing the location decisions of firms. It should be noted that depreciation rates are very low in the real estate sector because of its durability, and therefore, replacement demand is only a very small percentage of existing stock. By definition, these two sources of demand cannot generate an increase in aggregate real estate demand at the metropolitan level. Figure 1.3 Macroeconomic and Microeconomic Influences in Real Estate Markets Rent/Amenity Continuum Inter-temporal variations: Variations in performance through time are due to macro forces that affect similarly all projects/locations within a competitive market area Project/ Location A Cross-section differences: Differences in performance across projects/locations at the same point in time are due to differences in project/location amenities (and/or constraints) Project/ Location B Time t Time t+n Time Note: Long-run shifts in cross-section differences may occur due to changes in location amenities and/or constraints, or changes in the relative value attached to them by the users

8 The premise underlying the macro analysis component is that macro/marketwide determinants of real estate demand and supply vary through time causing fluctuations in rents and vacancy rates, thereby creating opportunities for profitable investments. Taking advantage of these opportunities requires appropriate timing of market entry in order to profit from future increases in rents and occupancy rates, and identification of niches in terms of property types and target markets that offer the best return prospects. Within this context, the purpose of macroeconomic analysis is to assess, as accurately as possible, the most likely future movements in demand, supply, rents, and occupancy rates, and provide the basis for sound and profitable investment decisions. The premise underlying the micro-marketability analysis component is that pro-active (and not re-active) product design, matching consumer preferences for location and product attributes is necessary for maximizing project value. The underlying rationale of this premise is that not only broader market prospects but also idiosyncratic project and location features are crucial in determining project-specific performance and achievable rental revenue levels. Thus, real estate developers and investors can maximize value and profits by carefully identifying the type of product that is mostly valued by consumers in the marketplace. Table 1.1 summarizes the basic characteristics of the three major components of real estate market studies. The discussion below elaborates on these components in terms of the unit of analysis, focus of analysis, bottom-line outcome, and contribution. Metropolitan Growth Analysis Unit of Analysis The unit of analysis during this stage could be the metropolitan statistical area (MSA), the primary metropolitan statistical area (PMSA), or the consolidated metropolitan statistical area (CMSA) within which the project is located. The rationale is dual. First, the metropolitan area represents an integrated economy that shapes the exogenous economic forces that drive movements in aggregate demand and supply for real estate, and, hence the time path of absorption, completions, vacancy rates, and rents. Second, the metropolitan area represents an integrated real estate market because, from a real estate demand point of view, each location is, to some extent, substitutable with any other location within the same metropolitan area, but hardly with locations in other metropolitan areas. For example, it would be inappropriate to perform an isolated macroeconomic analysis of a specific office submarket and completely ignore the demand and supply conditions and prospects within the metropolitan area the submarket is located. The reason is twofold. First, demand for a specific location and office building is shaped not only by growth in firms housed in that submarket, but also by growth in firms in other submarkets and new firms deciding to locate within the broader metropolitan area. Second, it is rather unreasonable to assume that an office building in one submarket does not compete at all with similar buildings in other submarkets within the same metropolitan area. Thus, an isolated analysis of the submarket could lead to underestimation of the competition the project may be faced when completed and an erroneous assessment of its prospects and viability. Focus of the Analysis This stage focuses on the analysis of the sources, mechanism and consequences of metropolitan growth. In terms of sources, emphasis is placed on industry

9 product demand shifts, industrial structure, amenity-induced migration and labor supply shifts. In terms of mechanism and consequences, emphasis is placed on the interaction between demand and supply forces in the product and labor markets, their effects on population, employment, and income growth, and their implications for real estate demand. Bottom-Line Outcome The bottom-line outcome of metropolitan growth analysis is the assessment of the pattern of growth the metropolitan area under consideration is experiencing and will likely experience (demand-induced, or supply-induced) in the years ahead; the direction and magnitude of physical growth (employment and capital stock) and growth in wealth associated with such a pattern; and the set of opportunities it presents for real estate development and investment. Table 1.1 Market Analysis Components a. Metropolitan b. Macro Analysis c. Micro Analysis Growth Analysis of Real Estate Markets of Development Projects Unit of The metropolitan area The project's competitive The project and its immediate analysis (economic market) market area: the geographic and neighborhood environment of the project area funneling effective demand for a project and encompassing the locations of all competing projects Focus of Analysis of the sources and Analysis of historical and Analysis of location/project analysis consequences of metropoli- current indicators of market amenities and constraints, tan growth. In terms of sources, strength: effective market consumer preferences and emphasis is placed on industry demand, competing supply, ability to pay for location demand shifts, industrial stru- prices/rents, and vacancies and project attributes, the cture and amenity-induced by product design type and project's competitive migration. In terms of conse- consumer segment, if possible position, and implications quences, emphasis is placed on regarding project absorption population, employment, and and prices income growth paths. Bottom line Type and magnitude of growth Forecasts of the time paths Location selection/evaluation outcome(s) the metropolitan area in of effective market demand/ and proactive design of a question is experiencing and net absorption, competing marketable project; forecasts will likely experience in the supply, rents, and vacancies of project-specific rent/price future; and the set of opportunities at the time of sale in the case and absorption schedules and constraints such growth of for-sale projects and during patterns present for real estate development/investment the expected holding period in the case of income-producing properties Contribution Facilitates a broad assessment Facilitates the identification of Provides inputs that are crucial of demand at the margin for product and consumer niches in evaluating the financial feasibility real estate property types and the best timing for market and viability of the project entry; provides inputs for micromarket analysis and financial feasibility analysis

10 Contribution Metropolitan growth analysis sets the stage for a broad assessment of the demand for real estate at the margin and provides some clues with respect to broader product type and consumer niches that may experience strong demand growth in the future. It should be emphasized that this stage never leads to a go or no-go decision for a specific project. Macro Analysis of Real Estate Markets Unit of Analysis This stage focuses on the project s competitive market area. This is the geographic area funneling effective demand for the project and encompassing the locations of all competing projects. With the exception of some retail property types, it is broadly accepted that any project competes with all similar projects that are located within the same metropolitan area. Thus, the most typical geographic unit of macro analysis for any property type is the metropolitan area within which the project under consideration is located. This definition serves also very well the increased data requirements for a more sophisticated analysis of an area s prospects. Focus of the Analysis The analysis focuses on historical and current indicators of market strength, such as, effective market demand, competing supply, vacancy rates, and rents/prices by product design type and consumer segment, if data availability allows it. Otherwise, the focus of the analysis will be on the broader property type that is more relevant for the project under consideration. It should be emphasized that the focus is not simply on reviewing and understanding the direction of recent trends, but also on gaining a good understanding of the factors driving the movements in critical market indicators, in a way that will allow the analyst to forecast future movements as accurately as possible. Bottom-Line Outcome The bottom-line outcome of this stage includes forecasts of effective market demand (or net absorption), completions, total inventory, vacancy rates, and prices/rents at the time of sale in the case of for sale projects, or over the expected holding period, in the case of income-producing properties. Contribution Macro analysis of real estate markets provides valuable guidance for time-ofentry decisions and can facilitate the identification of product and consumer niches. It also provides crucial inputs for micro-market analysis and financial feasibility analysis. Such inputs include forecasts of market supply and demand, as well as forecasts of the market price/rent index. Market supply and demand forecasts are necessary for calculating the project s fair market share and absorption schedule, while market rent/price forecasts can provide the basis for forecasting movements in project rents/prices and revenues. Micro (Site-Specific) Analysis of Development Projects Unit of Analysis This stage focuses on the specific site/project under consideration and its immediate environment. Major competing developments are also identified and more carefully evaluated during this stage

11 Focus of the Analysis This stage focuses on the careful evaluation of location/project amenities and constraints; evaluation of user preferences as well as ability and willingness to pay for specific location and project attributes using hedonic valuation techniques and data on most recent market transactions; assessment of the project s competitive position within the local marketplace; and development of rent/price and absorption schedules using as framework the forecasts for the broader market area developed at the macro analysis stage. 3 Bottom-Line Outcome The bottom-line outcome of this stage includes evaluation and/or selection of the site and location, pro-active design adjustments to maximize the marketability and value of the project, and forecasts of project-specific rent/price and absorption schedules. Contribution Micro analysis of real estate markets provides inputs that are necessary for assessing the financial feasibility of the project under consideration, such as the prices or rents it will command upon completion and its most likely absorption schedule. The latter cannot only help evaluate the financial feasibility of the project, but also evaluate different project phasing alternatives. In sum, market analysis provides information necessary for: Assessing metropolitan growth prospects and their likely influence on the local real estate market Assessing market strength and prospects for a particular property type (e.g. office industrial, retail or apartment) Evaluating site-specific location benefits and constraints, proactively refining product design for maximum marketability, and developing forecasts of project absorption and revenue streams It should be emphasized that market analysis differs from financial feasibility analysis since the latter utilizes price/rent and absorption schedules derived from market research in combination with other property operating data to determine whether a project meets certain financial objectives. MARKET STUDIES AND THEIR EMPHASIS There are biases in the field regarding the relative importance of each of the three market analysis components. For example, metropolitan growth analysis is incorporated in all residential and non-residential studies, but is often being done superficially. Macro analysis of specific property markets and micro analysis of specific projects within these markets differ in emphasis. 3 Schmitz and Brett (2001) argue that qualitative analytical approaches, such as surveys of consumer preferences for a certain type of product, are becoming increasingly important because of the increasing segmentation and specialization of real estate markets

12 Residential Residential macro analysis often places overwhelming emphasis on effective demand and affordability, while downplaying the role of competing supply. The argument behind such analytical approach is that residential markets are not subject to wide supply fluctuations. Although, this may be true in general, it does not necessarily apply to every market in the country. Residential micro analysis sometimes downplays location issues on the basis of the argument that within a residential market there are too many substitute locations. This may be true, but due consideration should be given to the relationship between the project and location attributes. Residential micro analysis does place strong emphasis on project design, as it should. In fact, this is extremely important. The biggest challenge for residential developers involves successful consumer targeting and identification of the most appropriate amenity packages to provide to the selected target groups. The book presents an example of how analysts can optimize amenity mix in residential product design. Retail Retail market studies are typically better than studies for other property types in terms of level of detail, sophistication, and substance. Retail macro analysis places emphasis on market Void, or Gap, which represents the unrealized retail sales potential within a project s trade area if a site is given or for a given metropolitan area if the site is not given. The market void or unrealized sales potential essentially refers to the additional sales that can be captured in a metropolitan area given its demographics and its household spending patterns. Retail micro analysis places great emphasis on (a) location with respect to consumer markets and sales potential, and (b) project design that focuses on issues of tenant mix and anchor tenants. A shopping center s retail sales are greatly dependent on consumer access. Given that retail activities are quite revenue-sensitive, the focus on consumer access is quite justifiable. The emphasis on tenant mix is also well founded given the positive effect that colocation of certain types of stores may have on sales (often referred to as shopping externalities). 4 Office Office macro analysis places emphasis on the analysis of competing supply. The emphasis of office market studies on supply is not surprising given the extreme cyclical fluctuations of office construction. The experience of the 1980s has shown that it is the lumpiness and long- 4 Such synergies may exist between stores that sell complementary products, or stores selling products that are subject to comparison shopping. Stores whose co-location facilitates comparison shopping are those selling highly heterogeneous non-standardized products

13 gestation period of office construction investments, combined with a myopic-expectations behavior on the part of investors that have largely driven such fluctuations. 5 Because of this high volatility, the most important information that the macroeconomic analysis of office markets can provide is the timing of rent and vacancy cycles. Although the focus on supply is well founded, the analysis of office-space demand prospects should not be overlooked. Given the considerable variation in office-employment growth rates through time, office-space demand prospects should be also thoroughly and carefully analyzed at the macroeconomic level. Increased focus on office demand prospects is especially warranted in the years ahead given indications that office employment will not continue to grow as fast as it did during the 1980s. Office micro analysis does not sufficiently focus on location, while project design is often perceived to be unimportant. Location is very important and should be more thoroughly evaluated because office tenants are cost sensitive and the best sites are those providing for the minimization of tenant costs. A survey conducted by the Urban Land Institute (ULI) several years ago concluded that neighborhood quality matters more than design. Nevertheless, design aspects should not be overlooked. Industrial Industrial macro analysis is not very developed and focuses mainly on industrial development potential at the metropolitan level. The macro analysis of industrial markets is more complicated because they are highly heterogeneous, comprising mainly production, warehouse/ distribution, and research/development (R&D) space. These different types of space may be driven by different macro influences, but with the exception perhaps of R&D, the degree of segmentation across product types is not very clear. 6 Industrial micro analysis typically focuses on location accessibility, as well as site and space requirements. The emphasis on location is well founded given the special access and site requirements of industrial projects, as well as problems of community acceptance. More emphasis, however, should be placed on the productive attributes of industrial sites because industrial firms are largely cost-sensitive and their location decisions are heavily influenced by the productive amenities that characterize different sites. The emphasis on site and space requirements is also well founded in light of continuous technological advances and the introduction of new manufacturing, warehouse, and distribution systems and processes. For example, latest distribution and supply chain practices emphasize flow-through, materialhandling, and vertical storage systems that require different design features for warehouse and distribution facilities. 5 In particular, empirical studies have shown that past increases in rents trigger office construction investments (Sivitanidou and Sivitanides, 2000). This suggests that investors, acting myopically, assume that if rents are rising in the present they will continue to do so in the future. 6 Production space, for example, is largely non-speculative or alternatively build-to-suit. The market for such space is driven by business investment decisions and industrial cycles parallel business cycles rather than cycles resembling those of speculative markets

14 MARKET STUDIES IN GENERAL: EVALUATION CRITERIA One of the objectives of this textbook is to help the reader become a sophisticated user of market studies. Within this context, it is important to have in mind what makes a good market study in general. Below we outline the major questions that need to be asked when evaluating a market study, as they relate to its overall appeal, objectives, methodologies, data, and conclusions. General Evaluation How persuasive are they? Objectives Are the issues addressed by the study clearly articulated and explained? Are the objectives of the study --primary and secondary-- clearly spelled out? Analysis Elements Are the peculiarities of the real estate market being studied clearly acknowledged and appropriately taken into account? Are the most important market-related determinants of project profitability both at the macro and micro level given due consideration? Methodologies, Assumptions, and Data Are the methodologies employed in the study clearly described and fully explained? Are their pros and cons discussed? Are alternative methodologies used and are their outcomes compared to assess the reasonableness of the final estimates? Are the assumptions underlying these methodologies clearly spelled out? Are future market conditions analyzed using reliable forecasting techniques, or do they merely represent simple extrapolations of most recent trends?

15 Are the data used --primary and/or secondary-- reliable? Are numerical variables assigned a range of values to account for potential forecast errors or uncertainty? Is the impact of alternative numerical assumptions on market and project performance examined through careful sensitivity analysis? Are the data sources and/or methods of data collection clearly listed and explained? Are the data incorporated in the analysis in a coherent and integral fashion or is the study full of "boilerplate" information? Conclusions Are the conclusions of the study inherently linked to its objectives and the analysis outcomes? Are they robust, that is, do they still hold for small changes in the assumed values of exogenous variables employed in the study's methodology? Are conclusions based on subjective evaluation, intuition or gut feeling distinguished from those that are derived from careful analysis? Are the results of sensitivity analysis regarding the performance of the project under alternative assumptions integrated in the recommendations of the study? BOOK STRUCTURE AND CONTENT Given the main themes of market research and the objectives of this book, the material presented is structured in six parts. The emphasis of each part is discussed below. Part A. Introduction The second chapter of the introductory part focuses on the basic economics of real estate markets. Particular topics discussed in this section include real estate demand and the relevance of absorption concepts; concepts of real estate supply, such as stock, completions, starts, and permits; and real estate cycles with emphasis on rent and vacancy adjustments. Part B. Metropolitan Growth Analysis This part places emphasis on how to meaningfully analyze and interpret metrowide economic trends and prospects, and how to make inferences regarding their effect on the demand for

16 different property types. In particular, Chapter 3 focuses on the sources, mechanisms and different types of metropolitan growth, while Chapter 4 presents the steps of a broad-brush framework for analyzing metropolitan economies using the Los Angeles metropolitan area as an example. Part C. Analyzing Residential Markets This part consists of six chapters. The first chapter, Chapter 5, focuses on the basic economics of housing markets, while the subsequent three chapters elaborate on the macroeconomic analysis of residential markets and mostly on techniques for assessing residential market strength and developing forecasts for demand, supply, vacancy rates, and rents. In particular, Chapter 6 focuses on less sophisticated or non-econometric techniques of analyzing residential real estate markets at the macro level. Chapter 7 focuses on the basics of regression analysis as a way of an introduction to Chapter 8, which elaborates on the specifics of the econometric analysis of residential real estate markets through an application to the Dallas apartment market. Chapter 9 focuses on the microeconomic analysis of residential projects, and particularly on the use of accounting and econometric techniques for the estimation of most likely project rents/prices and absorption schedule, as well as for refining project design in terms of what to build (housing type, development density, attribute mix) and for whom. Finally, Chapter 10 synthesizes macroeconomic and microeconomic analysis elements in an example of a hypothetical residential development project and provides guidelines for evaluating residential market studies. Part D. Analyzing the Market for Retail Space Part D focuses on the market for retail space and consists of three chapters. In particular, Chapter 11 focuses on the macroeconomic determinants of the demand for retail space, consumer shopping behavior, and the different retail formats that compose retail space supply. Chapter 12 elaborates on the three major phases of a retail market study. The discussion of Phase I focuses on the assessment of a market s unrealized sales potential (either at the aggregate level or by product line), and the strategic implications of such analysis. The discussion of Phases II and III focuses on the microeconomic analysis of retail development projects and, specifically, the analysis and evaluation of retail sites, and the refinement and evaluation of the final retail development concept. Specific micro issues discussed include location and site requirements for the different types of retail developments; the identification of the most profitable tenant mix; and the assessment of potential tenant sales and supportable square footage, as well as anchor and non-anchor rents. Chapter 13, the last chapter on retail markets, presents a numerical example of the analysis for a retail development project, outlines the points of emphasis of retail market studies for different retail formats, provides guidelines for evaluating retail market studies, and reviews an actual retail market study

17 Part E. Analyzing Office Markets Part E focuses on the analysis of office markets and consists of four chapters. Chapter 14 elaborates on the fundamentals of office markets, and specifically on its cyclical nature and the drivers of demand for and supply of office space. The chapter concludes with a brief overview of the office-market analysis process. Chapter 15 elaborates on the macroeconomic aspects of office market analysis and, specifically, on econometric and less sophisticated techniques for analyzing and forecasting broader office market behavior. Chapter 16 focuses on the microeconomic analysis of office projects. More specifically, this chapter elaborates on location and site attributes that are relevant in the case of office developments and discusses methodologies for estimating office project rent and absorption schedules. Finally, Chapter 17 synthesizes elements of macro and micro analysis for office projects in a simple numerical example, discusses briefly the market analysis process in the case of medical office space, and outlines broader evaluation criteria for office market studies. Part F. Analyzing Industrial Markets Part F, which consists of Chapter 18, focuses on industrial market analysis. Broader discussion topics include idiosyncrasies of the industrial market, components of industrial space demand and supply, and a brief overview of the industrial market-analysis process. Macro-analysis topics discussed include the assessment of an area s industrial development potential, and estimation of the industrial demand-supply gap through accounting techniques and econometric modeling approaches. Different versions of the latter are discussed depending on whether the emphasis is on the speculative or non-speculative segments of the industrial market. The discussion of micro issues focuses on the site-specific analysis of industrial development projects, and specifically, on the evaluation of site and location attributes for different types of industrial space (production space, warehouse/distribution and R&D), identification of most likely tenants, analysis of competing industrial projects, and the assessment of potential project/land absorption and achievable rents. The chapter concludes with a brief outline of evaluation criteria for industrial market studies. REFERENCES AND ADDITIONAL READINGS Carn, N., J. Rabianski, R. Racster, and M. Seldin Real Estate Analyses that Focus on the Market. Chap. 1 in Real Estate Market Analysis: Techniques and Applications. Englewood Cliffs, NJ: Prentice-Hall, Inc. Carn, N., J. Rabianski, R. Racster, and M. Seldin. 1988: Defining the Market and Elements of the Study. Chap. 4 in Real Estate Market Analysis: Techniques and Applications. Englewood Cliffs, NJ: Prentice-Hall, Inc. DiPasquale, D. and W. Wheaton The Property and Capital Markets. Chap. 1 in Urban Economics and Real Estate Markets. Englewood Cliffs, NJ: Prentice Hall

18 DiPasquale, D. and W. Wheaton The Operation of the Property Markets: A Macro and Micro Approach. Chap. 2 in Urban Economics and Real Estate Markets. Englewood Cliffs, NJ: Prentice Hall Rosen, K Toward a Model of the Office Building Sector. AREUEA Journal, 12:3, Schmitz, A. and D. Brett Understanding Real Estate Market Analysis. Chap. 1 in Real Estate Market Analysis: A Case Study Approach. Washington, D.C.: ULI-the Urban Land Institute. Sivitanidou, R Are Center Access Advantages Weakening? The Case of Office- Commercial Markets. Journal of Urban Economics, 42, Sivitanidou, R. and P. Sivitanides Office Capitalization Rates: Real Estate and Capital Market Influences. Journal of Real Estate Finance and Economics, 18:3, Sivitanidou, R. and P. Sivitanides Does the Theory of Irreversible Investments Help Explain Movements in Office-Commercial Construction? Real Estate Economics, 28:4, Wheaton, W The Cyclic Behavior of the National Office Market. AREUEA Journal, 15, Wheaton, W. and R. Torto An Investment Model of Demand and Supply for Industrial Real Estate. AREUEA Journal, 18,