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My Personal Background
My two-year, two-legged son, Beau Gordon
Personal & Professional Background
My three-year old, four-legged pup, Dolly
My wife of four years, Alexandra
After fourteen years in the industry, there is one thing that has always plagued me over the years
and this research hits it right on the head!
My Education & Professional Background
I have valued billions of commercial real estate properties across all asset types nationwide
I am a CFA Charterholder and CAIA Charterholder
I have capitalized billions of commercial real estate properties across all asset types nationwide
I am also in the final stages of completing my MAI Designation
Spent nine years in real estate investment banking in New York City
Started cutting my teeth in commercial real estate valuation during the Great Financial Crisis
while completing the Appraisal Institute curriculum
Moved to Louisville, KY, my wife’s hometown, in August 2020 as a COVID-19 refugee and began
teaching as an Adjunct Professor at the University of Louisville’s College of Business
Realized I did not want to be an appraiser, so I went back to graduate school in 2010 to pursue a
Master’s in International Real Estate Finance
Finished my undergraduate degree in Real Estate Finance in 2006.
Definition of Real Estate, Revisited
In law, land and everything more or less attached to it; ownership below to the center of earth and above to the heaven.
– Dictionary of Real Estate Terms
Things that are not movable such as land and improvements permanently attached to the land
– Brueggeman & Fisher
A New Definition for Real Estate
Real estate is the physical land and appurtenances affixed to the land – e.g. structures; real estate is immobile and tangible
– The Appraisal of Real Estate
Real Estate is a Depreciable Asset
The physical improvements are effectively a depreciable asset comprised of brick-and-mortar that has a finite life.
However, real estate is an investment with an income stream that is capitalized into perpetuity.
Two concepts: one appreciates and the other depreciates
Definition of Real Estate, Redefined
Real Estate is a Space-Time Product:
- It is characterized by its spatial and temporal dimensions.
- It is the physical space used over time to house economic activities or satisfy human needs.
Viewing real estate in this manner invalidates the common perception that value is inherent in physical objects.
A New Definition for Real Estate
Real Estate is the environment that has been derivatized into tangible form, where the economic activity of space users
- Owners, tenants and customers
- Is used to house economic activity or satisfy human needs.
Transaction Market vs. Fundamental Market
01
By visualizing real estate as a space-time product that houses economic activities, we must further categorize this asset class into two groupings: “Asset Investment Market” and the “Space User Market”.
Transaction Market vs. Fundamental Market
02
The Asset Investment Market is the transaction market where buyers and sellers trade real estate assets and is part of the larger capital investment market.
03
The Space User Market is the fundamental market of the users of the real estate’s physical space.
04
“Market Analysis for Real Estate – Concepts and Applications in Valuation and Highest & Best Use” by Stephen F. Fanning, MAI examines each category exquisitely.
Asset Market vs. Space User Market
The asset investment market in real estate must be viewed as part of the larger capital market, the market for capital assets of all types.
Real estate assets compete with other alternatives for the pool of money looking for investments.
The financial return in the capital market is often driven by short-term resale expectations rather
than the sustainable, long-term income potential of the property.
Asset Market vs. Space User Market Continued
The space user market, on the contrary, is the market for the right to use real property over time.
This market involves the interaction of property owners, tenants, and customers who need space
to house economic activities, to supply services, and to provide amenities that meet human needs.
Asset Market vs. Space User Market Continued
The idea of fundamental value, or intrinsic value, is based on the economics of space users, i.e.,
what they can afford to pay for the real estate for use of the property to sustain their enterprise or
amenity needs.
This concept contrasts with the idea of the price a buyer might pay in the transaction for that asset
at any point in time.
Asset Market vs. Space User Market Continued
This variance in value in the asset investment market and space user market happens most often in inflated (“bubble”) or depressed markets but can also be found in more stable markets, as real estate markets are cyclical and highly inefficient.
However, the asset investment market and fundamental space user market are intrinsically tied together.
Prices in the asset investment market, whether high or low in the cycle, have historically returned to the price indicated by the fundamentals of the space user market, a reversion to the mean.
Asset Market vs. Space User Market Findings
Real estate is a space-time product that houses economic activities and its fundamental value is
measured in the space market.
This finding will be alien to most real estate professionals and arbitrary to the current tools that practitioners use to measure value, such as price indices
Commercial Real Estate Price Indices and the Asset Investment Market
Most measures of value take place in the asset investment market, typically in stale fashion andare further diluted with backward-looking appraisals.
Types of Existing Commercial Real Estate Price Indices:
- Repeat-Sales Indices (or “RSM”)
- Transaction-Based Indices (Hedonic Pricing Model, or “HPM”)
- Appraisal-Based Indices
Inefficiencies of a Repeat-Sales Index
The main disadvantage of the RSM is that the sample of properties from which the price changes and the resulting index are calculated typically represents a small portion of all the properties that are transacted during a given period of time.
Existing Commercial Real Estate Price Indices
It also assumes the property does not experience changes, such as depreciation and aging.
Creates backward adjustments in the historical series of returns, and thus previously estimated
returns for certain years in the past may change.
Only measures value movements in the Asset Investment Market
Inefficiencies of a Hedonic-Pricing Model
HPM requires a large amount of data on several hedonic variables.
As in the case of the repeat-sales model, HPM may also suffer from sample selection bias.
The HPM is also exposed to specification error. That is, not all attributes of properties may be included.
Only measures value movements in the Asset Investment Market
Inefficiencies of Appraisal-Based Indices
Appraisals are inherently subjective and backward-looking and create a “stale-pricing” effect.
These indices are smoothed compared to actual changes in real estate market values.
Appraisal methods tend to rely on data from comparable properties. Therefore, the quality of the appraisal will depend critically on the quality of available data.
Only measures value movements in the Asset Investment Market
A New Commercial Real Estate Price Index is Required
Commercial real estate practitioners require a new methodology for translating real property
performance into a live pricing index that captures true intrinsic value.
A new index that measures the residual demand of space users can provide a leading indicator to track the natural reversion to the mean of the Asset Investment Market.
By employing certain steps of real estate market analysis, the industry can measure the economic activity of a market to determine its equilibrium need and then translate this demand into a square footage or unit count to evaluate if a market is under or over-supplied.
Measuring Residual Demand Using Market Analysis Techniques
Six Steps of Market Analysis
Forecast Subject Capture
Supply Analysis (Survey and Forecast Competition)
Market Condition Analysis (Estimate Residual Demand)
Delineate the Market
Demand Analysis (Forecast Demand)
Property Productivity Analysis
For this research, we focus primarily on c-e.
Example of Real Estate Market Analysis – Office
Demand Analysis – Forecast Demand
Generally, the demand forecast for an office market considers changes in total employment segmented to office-based employment and then tangibilizes this economic data it into average square foot per employee.
Real Estate Market Analysis
- Derive demand by using an inferred (historical) analysis
- Derive demand by fundamental analysis using a segmentation method.
- Forecast the workforce
- Estimate the % occupying office space.
- Estimate the size of the workforce occupying space by class of office building and multiply c. by the specific percentage for that class of building.
- Estimate the requisite space per office worker.
- Calculate the demand for the specific class of office space by multiplying the number derived in e. by the figure derived in f.
- Adjust for frictional vacancy
- Derive demand by fundamental analysis using the ratio method.
- Reconcile the results of each method and forecast fundamental demand.
Example of Real Estate Market Analysis – Office Continued
Survey and Forecast Competition
- Inventory current and proposed supply
- Demolitions, renovations, and adaption of space should also be considered.
Example of Real Estate Market Analysis – Office Continued
Market Conditions Analysis
- Lastly, we analyze the interaction of supply and demand to determine residual demand
Is the market oversupplied or is there unmet demand?
This data-point will be continually calibrated in the index, as it constitutes the equilibrium need for the market, or the fundamental mean value to which the Asset Market will revert.
Where Do We Source the Data for Market Analysis?
Population and Demographic:
- Source: US Census of Population and Housing
- Frequency: Every ten years.
Where Do We Source the Data for Market Analysis? Continued
Buying Power and Consumer Spending
- Source: Bureau of Labor Statistics – Consumer Expenditure Survey
- Frequency: Biennially
Where Do We Source the Data for Market Analysis? Continued
Employment
- Source: State Agencies – Employment and Wages by Industry and County
- Frequency: Quarterly, semiannually (varies from State to State)
3rd
Party Data Providers
STBD (Site To Do Business) provides comprehensive US Census demographics with current and five-year forecasts of population, household and income data; Consumer spending estimates by
category; Lists of business establishments in the area; Et cetera
Woods & Poole Economics (www.woodsandpoole.com) provides data at the county level
McKinsey Article: “How Big Data is Transforming Real Estate”
“How Big Data is Transforming Real Estate”
- “Many real estate firms have long made decisions based on a combination of intuition and traditional, retrospective data. Today, a host of new variables make it possible to paint a more vivid picture of a location’s future risks and opportunities.”
- “Resident surveys, mobile phone signal patterns, and Yelp reviews of local restaurants can help identify hyperlocal patterns – granular trends at the city block level rather than at the city level.”
- “Thousands of non-traditional variables can be linked to diverging, location-specific outcomes.
These variables include:
o Change in number of coffee shops within a one-mile radius;
o Building energy consumption relative to other structures in the same zip code;
o In-office mobility, based on frequency of elevator movement;
o Tone of Yelp reviews for nearby businesses;”
- “When it comes to these classic real estate conundrums, advanced analytics can rapidly yield powerful input that informs new hypotheses, challenges conventional intuition, and sifts through the noise to identify what matters most.”
McKinsey Article: “How Big Data is Transforming Real Estate”
Existing Data Sources are Too Slow!
We Need a Revolutionary New Index
- This new commercial real estate price index will require “live” economic data, so we need to amplify the data collection processes significantly.
- Develop machine-learning algorithms to source and filter economic data, such as population, employment and income trends, as well as media headlines like, “Austin-based Oracle considering $1.2 billion expansion in Nashville.”
- Extracting relevant data from these headlines, “The proposed campus could eventually employ 8,500 people and would be among the largest economic development deals and job infusions in Nashville’s history”
- This economic data will then be tangibilized through the residual demand calculator, or Steps 3-5 of Real Estate Market Analysis.
- The new residual demand output will feed into the pricing index
- This procedure repeats continually…
Existing Data Sources are Too Slow!
We Have a Formula, But We Need Proof of Concept
We now have a formula to tangibilize economic data into real estate form in order to provide the fundamental value of a commercial real estate market, to provide a value indication that is quicker than the Asset Investment Market.
But we need Proof of Concept for this thesis
And we need to answer the following questions:
- How long does this price lag occur? Or, said another way, how much does residual demand in the space user market lead pricing in the asset investment market?
- What is the correlation between price in the asset investment market and residual demand in the space user market?
This Research Will Provide Various New Tools for the Industry
- It will allow us to scale across markets, asset types and property classes
- Serve the public sector: zoning officials can magnify the economic footprint of their city to maximize the highest and best use as well as hedge any attempt by the private sector to overbuild within their jurisdiction.
- Serve the private sector: private sector investors can use this methodology to “heat-map” major markets and provide measurements of residual demand to accurately time the point of entry for a new investment.
- Establish a foundation so that a derivatives marketplace can be constructed to allow investors to purchase long positions in markets before the economic activity becomes tangible or to short markets that have been overbuilt.
Operationalize “CRE Index Utilizing the Residual Demand of Space Users”
Operationalizing
the Thesis
“A commercial real estate index based on the residual demand of real property space users will provide a leading indicator of future price changes in commercial real estate markets.”