Property Markets
At the foundation of any property career is an understanding of the markets in which you are
operating. In this part of the course we include a mix of theory and practice. Students should look to
join these together, placing the theory within the context of the property that they see around them
in the built environment, and the market practice that is available on the internet and the indicative
readings provided on Stream.
In this section we cover:
1. Land Use Economics
2. Markets and Cycles
3. The residential real estate market
4. International comparisons
Objectives: At the conclusion of your study of this topic you will be able to:
• Discuss the theoretical ideas surrounding land use theory
• Explain why location is such an important variable in determining land values
• Understand the concept of market cycles
• Understand the scale and trends within the NZ residential market, and where information can be
sourced.
• Discuss the similarities and differences between NZ and other countries
Land Use Economics
The value of property is strongly linked to it’s use (both current and potential futures uses). In order
to be a competent investor, valuer, manger or marketer of property it is critical to understand how
property is used and why. There are economic factors which drive the demand for land, as well as the
supply. These economic factors need may well be constrained by physical or legal limitations (such as
the Resource Management Act that is covered later in the course).
Land use changes over time. The house you live in may well have been farmland at one point. If you
live in a city apartment, this may well have been an office block before it was redeveloped or
converted. Going further back, the same site may have perhaps been a hotel/merchant or even horse
stable at the beginning of the last century. Land use economics helps us understand why properties
are used as they are, and importantly what is likely to happen in future.
The principle of highest & best use (covered under the valuation topic) is highly relevant here. To
value land, or to make a decision to invest, you need to know what the property is best suited to. If
it’s currently being used for that, decisions are somewhat limited. If it’s being used for a less intensive
use, there may be an opportunity to redevelop. Examples of this can be seen in many cities: an old
house on a large section surrounded by townhouses; or an ageing office building surrounded by
residential apartment conversions.
The attached readings cover land economic theory. As a guide, you should look to see how these
models reflect what you see in the city where you live, or others with which you are familiar.
Location theory is a major branch of land economics and has considerable importance in the allocation
of land resources. Location is a crucial element in the successful establishment of many types of
businesses. There is a story around that has been repeated many times but is worth repeating again.
The founder of a major international hotel chain was asked what he considered to be the three most
important aspects in the successful establishment of a hotel. He replied: “Location, location and
location”. This quote has been attributed to many property investors locally and internationally. This
is at least in part because of all the factors which you can have an impact upon as a property investor
or manager, location is not one of them, it is fixed and out of your control.
Location is a crucial element in most types of retail businesses. Occasionally you may see people
counting pedestrians at various points in central city areas. It has been shown that there is a strong
relationship between the volume of pedestrian traffic and retail turnover. Thus heavy traffic means
turnover and rents increase. Higher rents tend to lead to higher property values (all other things being
equal). Thus it is very much in the interests of people involved in real estate to understand the effect
of location on property values. An example of a pedestrian count for Wellington follows. (Source:
Property Institute of New Zealand).
Location is a big topic – it would be quite possible to devote a whole university course just to location.
There is a lot of literature around on the subject and the Journal of Land Economics has devoted many
articles to location over the years. Location is a complex topic – that goes far beyond simply a
transportation costs/site/rent concept. Thus we have only scratched the surface.
Another economic topic that is very relevant to property is that of efficient markets theory. Markets
can be described as being somewhere on a continuum of efficient through to inefficient. The share
market (and many other electronically traded commodities or financial instruments) are considered
to be highly efficient. They have low transaction costs, good pricing information and a homogenous
product. Property is quite the opposite. No two properties are the same, transactions can be
expensive and information is relatively poor (both on the properties themselves and on the
transactions). This has implications for risk and return. An efficient market has good allocation of risk
and returns. It’s difficult to ‘know better than the market what the price will bring’. With property,
returns and risks can be more difficult to quantify and with this comes opportunity for returns greater
(or less than) the market average.
Markets and Cycles
There are no text books which cover this topic in any detail. Newspapers and the internet are your
best source of information. The first important factors to consider are that property is a derived
demand product (are there indicators here that suggest a change in demand, for example vacancy
rates or population changes). The second is that supply is often slow to respond. Both the supply and
demand conditions can be predicted to a certain degree.
The Economy
New Zealand is a small country located some distance from major exporters. Whether you are
discussing manufacturing or agriculture export to other countries is a determinant of success. The
statements below refer predominantly to New Zealand’s strength in the agricultural sector. Read each
of those statements to see how the economy works. Think about how these statements impact on the
real estate market.
• One of the factors that has emerged over the years is the cyclical nature of the national economy
• The New Zealand economy seems to be particularly vulnerable to cyclical effects because of our
heavy reliance on exporting agricultural products. What would happen if we could no longer
export beef or dairy products due to disease?
• No other “developed” western country has such a large part of the gross national production
related to export activities and agriculture
• New Zealand is essentially a residual supplier on the world markets. Due to our location and size
New Zealand tends to make up the shortfall of supplies rather than being the primary supplier
• New Zealand has traditionally been a price taker on the world market. Dealing with large
institutional traders who set the price dictates that New Zealand should accept that price or lose
the trade. Because of the heavy reliance on trade our economy is closely bound up with
economies of our main trading partners. We cannot isolate our economy from the rest of the
world.
• The level of overseas product prices has tended to have a major influence on the internal
economy, particularly the money supply. High overseas product prices lead to more money in
farmers’ hands – this money is spent internally and the multiplication effect through the banking
system has led to increased demand for a variety of goods and services including real estate.
• Inflation causes people to not want to hold money (which is depreciating) but to buy goods that
will hold their real value. Real estate investments have generally been an adequate hedge against
inflation.
• Real estate transactions are mostly financed with borrowed money. When the overseas
commodity prices are high and there is an expansion of money in the internal economy –
borrowing money is relatively easy. Conversely when overseas product prices are low and the
money supply contracts the amount of money available to finance real estate transactions are
reduced.
• In the past the above trends were smoothed out somewhat by the various income equalisation
schemes for meat and wool. Nevertheless finance as the key ingredient in the facilitation of real
estate transactions is likely to continue to fluctuate in supply. This means then that the general
state of the real estate market is likely to be inextricably bound up with the state of the economy
in general. Just as we have business cycles so too are we likely to have real estate cycles.
• There is a strong relationship between expansion in the money supply and increases in property
values.
• One of the key elements in successful property management is timing. Given that the real estate
market is subject to fluctuations then the real estate manager understanding the nature of the
cycle is likely to be in a position to take advantage of the situation.
• The construction sector of the industry appears to be subject to the biggest fluctuations. Students
may have heard/read about the downturn in new housing construction in New Zealand following
the 1967 “crash” in wool prices, the 1987 share market crash and more recently the 2008 Global
Financial Crisis (‘GFC’), and we are yet to see the full impact of the Covid 19 epidemic on
commercial property as it can take some time to flow through.
• The demand for residential real estate is ultimately driven by demographics. Internal migration is
currently characterised by a drift north and east. Immigration varies over time. When net
migration is positive this will also place more pressure on the demands for real estate.
Real Estate Cycles
Real Estate, like many markets, tends to act in a cycle. If we knew how long a real estate cycle would
be we would all be wealthy. However, there are indicators which may highlight a change to the next
stage of the cycle.
The following ‘Economic Clock’ (Newland, O) provides an example of these indicators.
While keeping the “Economic Clock” in mind, a similar approach is proposed by Ratcliff (1949) wherein
he describes the real estate cycle from a post-war perspective such as building permits, vacancy rates
and volume of sales. The data that Ratcliff mentions in this six stage cycle is available on the internet
so you can compare.
Stage 1: A balance exists between the supply of and the demand for urban real estate, so that neither
real estate sales nor prices have shown any appreciable increases or decreases. Population and family
increases, higher incomes and greater employment encourage families to look for new homes. The
improved economic status permits families to “undouble” and to seek better living accommodations.
Indications of an upturn in market activity are reflected in decreasing vacancy rates and increased
building permits and deeds recorded.
Stage 2: At this point in the cycle construction of single-family homes predominates. Home building is
encouraged by the lenders, who observe the improved business conditions and provide ample
mortgage credit at reasonable rates. Higher-priced homes are built in the early part of Stage 2 because
of the higher profits and greater demand for this type of construction.
Increased subdividing, the disappearance of vacant lots in the central areas, the increasing purchase
of acreage on the periphery of the city, higher values in building permits are all indicators of this stage
of the cycle.
Stage 3: The number of deeds recorded increases sharply and the average sales prices increase as the
days from listing to sales decrease. Investors and speculators enter the market in increasing numbers,
in anticipation of increasing demand, higher prices, and larger profits. Construction of low-priced
single-family homes in large units becomes more prevalent. Expanding residential areas create the
need for a variety of commercial and business districts. Both residential and non- residential
construction increase, construction costs rise and cause increases in the prices of new homes. The
increase in price for new homes causes the prices of old homes to rise as construction fails to keep
pace with demand. Market activity reaches new heights as all kinds of persons enter the market to
speculate, to invest, to buy for use and make higher and higher profits as rising market prices absorb
all costs. An increase in both residential and non-residential building permits, rents, mortgages
recorded, and deeds recorded is typical of this stage. The totals of these items set new records each
year.
Stage 4: The peak in the cycle is reached as demand becomes saturated, and the price and quality of
new homes exceeds by too great an amount the price and quality of existing homes. At this point
builders attempt to remedy the situation by offering more amenities in the new homes. The absolute
peak will be reached when credit tightens, employment and income drop, consumers change their
attitudes toward the advisability of purchasing a home and the stock of available housing exceeds the
demand for housing. The stage is characterised by a weakening of prices for older homes, longer
periods between listing and selling, higher mortgage interest rates, larger down payments, less
subdividing and development. Rents continue with little decline although vacancy rates increase.
Stage 5: At some point in this stage a decline begins. The decline is not immediately apparent because
non-residential building, particularly the development of business and office districts, continues at
levels sufficiently high to offset declines in residential building. Builders continue to ask high prices for
new homes but accept second mortgages as part of the purchase price. Owners of rental units offer
an increasing number of services in order to attract tenants without cutting rents. The weaker
borrowers begin to show increasing signs of distress as foreclosures increase. Vacancy rates rise to
their highest levels. Both lenders and buyers become increasingly cautious as overbuilding, high
operational costs, and lower rents reduce the profits from property investments. Indications of a
declining market are found in fewer building permits recorded, lower rents, fewer deeds recorded,
increasing foreclosures, and sharp drops in building and subdividing.
Stage 6: The real estate cycle reaches its depth, which may be very shallow or very deep depending
upon income, employment, and the general level of business conditions. The absolute depth depends
upon the prices at which lenders will redeem foreclosed properties and sell them in the markets.
This must be taken within the context of the local conditions. Two leading indicators are:
(a) One component of the cycle is the volume of transactions. Sales volume typically peaks before
prices.
(b) Another important component in both the total business activity and also in the real estate industry
is the volume of building permits being taken out and work actually completed. Your territorial
authority will publish this type of information and it would be interesting to track.
Government Influences
In America the number of new housing starts is considered to be one of the leading economic
indicators. In that country the state of the housing construction industry tends to mirror the state of
the economy in general. While the number of new housing starts in New Zealand is a useful economic
indicator it must be treated with some caution as central government can reallocate resources from
other sectors to housing if this is a policy objective at the time. So while the local economy was in a
state of relative recession during most of 1974 and most of 1975 the number of houses being
constructed was not affected as much as might have been expected.
This helps to point out the social welfare aspects of housing in that housing provides people with
shelter, privacy etc. These requirements depend on population growth, the life cycle of the existing
housing stock, levels of income and are largely divorced from the state of the economy at any one
time. Since neo-liberalism (post 1984), the ups and downs of the real estate market may become
more pronounced as the Government (from both sides of the House to lesser extents) appears much
less willing to intervene in the housing market. Reductions in import protection have also resulted in
the closure of many factories, under pressure from globalisation.
Technology Influences
The rate of technological change is unprecedented. The information age is changing the way we work
the way we shop and the way we socialise. These underlying changes will inevitably change the way
we use land. Retail growth (in some sectors) is much higher online than in stores. We have seen
retailers charge clients for the face-to-face service (such as trying on clothes) in anticipation of an
online purchase. Its conceivable that retail shopfront sites may over time reduce in size these will
inevitably be replaced in part with warehouse and logistics properties that distribute good bought
online.
Perhaps one of the largest impacts will be in the commercial sector (office accommodation). Large
office buildings were constructed to facilitate the necessary clustering of people to facilitate face-to-
face meetings and the paper-based workflows. A reading in this regard is included for consideration.
Technology is also changing the way property professionals work. In the Agency sector the marketing
of properties is also becoming an online activity. Handheld devices assist property managers and
valuers to compile reports in the field, including the embedding of photographs, GPS data, and
measurements. Many property management systems are now cloud-based, enabling even small firms
access to international systems that a decade ago would only be available to institutions. The
Government is similarly investing in online services, that started with Landonline in 2002 and now
includes online lodging of residential tenancy disputes and tax returns.
Summary
Overall it can be seen that the cyclical nature of the economy in general and real estate in particular
must be appreciated. This trend appears to be likely to continue in New Zealand so long as our
economy is geared towards world trade in agricultural products. Those familiar with rural New
Zealand will probably have observed the impact of world diary prices and Fonterra payouts on local
farm profitability, land pricing and sales volumes. In addition to these cycles, there are global trends,
particularly technology, that will have impact that are unprecedented by past cycles.
The magnitude and duration of the fluctuations that occur in the real estate market are very difficult
to forecast. Many analysts have tried, few have succeeded. It is perhaps more important to
understand the general cause-effect relationships in the cycle. Economics is a social science – it deals
with people – the expectations of people are notoriously unpredictable. The long term upward trend
in real estate values has enabled many investors to ride out the periodic fluctuations in the cycle.
The NZ Residential Real Estate Market
The primary focus of this course is on the residential property market. Residential property in NZ (as
it is overseas) is comprised of a number of sub-markets and sectors. Each has its own supply and
demand conditions. There are distinct (but linked) markets for the ownership of residential
accommodation (the investment market) and the occupation of residential accommodation (the
consumption market). This principle also applies to other sectors, such as office accommodation,
retail, or industrial property.
Demand for the occupation (consumption) of will be driven by a number of factors, largely population
based. To understand the likely demand conditions, the projections of populations and household
composition is crucial. A level of granularity is also required, to understand how this demand is broken
down into the various types of property that is demanded (family homes, student apartments,
retirement units etc). This is to say that if significant population increases are projected, new builds
may be required, but studio apartments will not be demanded if this is predominantly an increase in
the number of families. Like any market, the supply and demand conditions will dictate prices over
time (as well as the fundamental purchasing power of the customers). Property supply is notoriously
slow to respond to changes in demand, due to the long lead times to developments, sometimes
leading to undersupply and then oversupply during each market cycle.
There has been quite some media attention in recent years to the supply question in our largest
growing city, Auckland. With the projected population growth, tens of thousands of additional supply
are required over the next few years. On this scale, the impact of government policy (both central
and local government) becomes important. Auckland must address the issues of extending out the
boundaries of Auckland (with corresponding pressure in infrastructure such as roads and water), and
the intensification of current land use (townhouses and apartments instead of back lawns). The issue
of government policy that affects demand has also been publically debated, especially in relation to
immigration into Auckland.
From an investment market perspective, the demand will be affected by likely returns and risk, but
also the availability of (and cost of) capital and funding. Investment capital (and debt also) is able to
be transferred between sectors, so there is an element of the relative returns being offered and the
opportunity cost of the investment. This is to say that the demand for investment property at, say 7%
return will most likely be different in the situation where returns on bank deposits are 4% or 9% per
annum.
This interrelationship between the consumption and investment markets, supply and demand, and
government policy is complex. It is only proposed here to provide an overview. The key issue for
property professionals is to understand the markets in which they operate. Valuers, investors,
property managers and real estate agents will all need to understand the local conditions in order to
adequately make decisions or advise clients.
Included in the lectures are a number of current market commentaries from the agency sector to give
a flavour of the terminology, issues, and principles being discussed by the market. Students are
encouraged to traverse the internet and seek market commentaries, information and opinion from
various research houses, commercial entities and Government.
Comparisons
Although this paper is predominantly focussed on the residential sector, we will also touch on the
other classes of property. The specifics of these sectors are covered in subsequent papers, in
particular the cashflow analysis that underpins the commercial, industrial and retail sectors. The
property and valuation facets of the rural sector are also addressed in specific papers.
It is also important to place our local conditions within the contest of our international environment,
and therefore included as readings are a number of research and opinion publications that provide an
international comparison. Students are not expected to be examinable on the content of these
papers, but the terminology and underlying concepts will be important to an understanding of the
drivers of local property markets and the academic assignments that are based on this understanding.
