Which side of the tallahassee principal meridian is range 1e

Eleventh EDITION

REAL ESTATE PRINCIPLES

CHARLES F. FLOYD and MARCUS T. ALLEN

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This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

President: Dr. Andrew Temte Chief Learning Officer: Dr. Tim Smaby Executive Director, Real Estate Education: Melissa Kleeman-Moy Development Editor: Julia Marti

REAL ESTATE PRINCIPLES ELEVENTH EDITION ©2014 Kaplan, Inc. Published by DF Institute, Inc., d/b/a Dearborn Real Estate Education 332 Front St. S., Suite 501 La Crosse, WI 54601

All rights reserved. The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher.

Printed in the United States of America ISBN: 978-1-4754-2173-6 / 1-4754-2173-7 PPN: 1515-0111

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DEDICATION

This book is dedicated to R. W. Barber

a man of the land and

C. O. Floyd a man of business. —Charles F. Floyd

This book is dedicated to Rhonda, Melanie, and Issabella.

—Marcus T. Allen

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v

c o n t e n t s

p r e fa c e xi i i r e a l e s tat e t o d ay f e at u r e s xvi i

c h a p t e r 1

Why Study Real Estate? xx Chapter Preview 1

The Role of Real Estate Studies in Business Education 2

Personal and Business-Related Real Estate Decisions 2

Organization of This Book 3

Special Characteristics of Real Estate 4

The Economic Importance of Real Estate 9

The Real Estate Industry: Career Opportunities 10

Chapter Review 13

Key Terms 14

p a r t o n e

Real Estate Legal Analysis 15

c h a p t e r 2

Property Rights and Legal Descriptions 16 Chapter Preview 17

Real versus Personal Property 18

Fixtures 18

Mineral and Air Rights 20

Water Rights 20

Estates in Land 23

Concurrent Estates 29

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vi Contents

Condominium Ownership 31

Cooperative Ownership 32

Time-Shares 32

Legal Descriptions 32

Chapter Review 43

Key Terms 45

Study Exercises 46

Further Reading 47

c h a p t e r 3

Private Restrictions on Ownership 48 Chapter Preview 49

Covenants, Conditions, and Restrictions 50

Liens 54

Easements 58

A Relatively New Type of Easement 64

Profit a Prendre 64

Encroachments 64

Adverse Possession 66

Chapter Review 67

Key Terms 68

Study Exercises 68

c h a p t e r 4

Public Restrictions on Ownership 70 Chapter Preview 71

The Property Tax 72

Power of Eminent Domain 74

Police Power 75

The Comprehensive General Plan 76

Zoning 76

Chapter Review 94

Key Terms 96

Study Exercises 96

Further Reading 97

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Contents vii

c h a p t e r 5

Deeds and Title Examination 98 Chapter Preview 99

Deeds 100

Title Examination 107

Chapter Review 114

Key Terms 115

Study Exercises 115

Further Reading 115

c h a p t e r 6

Contracts and Title Closings 116 Chapter Preview 117

Necessary Elements of a Contract 118

Breach of Contract 120

Contract Contingencies 121

Real Estate Sales Contracts 122

Option-to-Buy Contracts 128

Contract for Deed 129

Some Basic Negotiation Strategies 129

Title Closings 130

Chapter Review 137

Key Terms 138

Study Exercises 139

Further Reading 140

c h a p t e r 7

Real Estate Leases 142 Chapter Preview 143

Leases 144

The Landlord-Tenant Relationship 146

Chapter Review 155

Key Terms 157

Study Exercises 157

Further Reading 158

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viii Contents

p a r t t w o

Real Estate Service Industries 159

c h a p t e r 8

Real Estate Brokerage 160 Chapter Preview 161

The Real Estate Sales Process 162

Real Estate Brokers and Sales Associates 163

Licensing of Sales Associates and Brokers 163

Real Estate Brokerage Regulation 164

Legal Aspects of the Broker-Client Relationship 164

The Role of Real Estate Brokers 165

The Creation of Agency Relationships 166

Duties and Rights Under Agency Relationships 168

Termination of Agency Relationships 171

Types of Brokerage Firms 174

Broker and Sales Associate Compensation 175

Chapter Review 176

Key Terms 177

Study Exercises 178

c h a p t e r 9

Real Estate Appraisal 180 Chapter Preview 181

Appraisal Regulatory Environment 182

What Is Value? 184

Some Key Appraisal Principles 186

The Appraisal Process 187

The Sales Comparison Approach 192

The Cost Approach 196

The Income Approach 199

Chapter Review 201

Key Terms 203

Study Exercises 203

Further Reading 205

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Contents ix

c h a p t e r 10

Property and Asset Management 206 Chapter Preview 207

The Role of the Property Manager 208

The Management Agreement 208

Functions of a Property Manager 209

The Role and Function of Asset Managers 215

Chapter Review 216

Key Terms 217

Study Exercises 217

Further Reading 217

p a r t t h r e e

Real Estate Market Analysis 219

c h a p t e r 11

Residential Land Uses 220 Chapter Preview 221

Types of Residential Development 222

Market and Feasibility Analysis 229

Financial Feasibility Analysis 237

The Importance of Market Analysis 237

Chapter Review 237

Key Terms 238

Study Exercises 239

Further Reading 239

c h a p t e r 12

Commercial and Industrial Land Uses 240 Chapter Preview 241

Shopping Center Development 242

Evolution of the Shopping Center 244

The Shopping Center Development Process 246

Office Buildings 249

Industrial Parks and Distribution Facilities 252

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x Contents

Analysis of Industrial Sites 254

Hotel, Motel, and Resort Developments 254

Chapter Review 256

Key Terms 257

Study Exercises 258

Further Reading 258

c h a p t e r 13

Understanding Real Estate Market Dynamics 260 Chapter Preview 261

Owner-Occupied Residential Real Estate Markets 262

Example: Fort Lauderdale, Florida 265

Commercial Real Estate Markets 267

Real Estate Asset Markets 270

Tying Together the Space and Asset Markets 272

Preparing a Commercial Real Estate Market Analysis 272

Chapter Review 275

Key Terms 276

Study Exercises 276

Further Reading 277

c h a p t e r 14

Urban and Regional Economics 278 Chapter Preview 279

Economic Factors Influencing the Growth and Decline of Cities 280

The Location of People 283

Analyzing Local Real Estate Demand 284

The Bid-Rent Curve and the Concept of Highest and Best Use 286

Models of Urban Growth Patterns 287

The Importance of Public Facilities in the Growth Process 291

The Dynamics of Neighborhood Change 293

Urban Form: A Synthesis 297

Chapter Review 298

Key Terms 299

Study Exercises 299

Further Reading 300

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Contents xi

c h a p t e r 15

Home Purchase Decisions 302 Chapter Preview 303

The Rent-or-Buy Decision 304

How Much Can You Afford? 310

Choosing a Property 312

Making and Closing the Deal 316

Selling the Home 318

Chapter Review 319

Study Exercises 320

p a r t f o u r

Real Estate Finance and Investment Analysis 321

c h a p t e r 16

Residential and Commercial Property Financing 322 Chapter Preview 323

Understanding the Mortgage Concept 324

U.S. Mortgage Practice 325

Typical Provisions of a Promissory Note 325

Understanding the Foreclosure Process 327

Structure of the U.S. Housing Finance System 330

Mortgage Market Participants 336

Federal Legislation Affecting Mortgage Lending 338

Mortgage Underwriting 340

Sources of Capital in Commercial Property Markets 344

Commercial Financing Underwriting Criteria 349

Chapter Review 349

Key Terms 351

Study Exercises 351

Further Reading 353

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xii Contents

c h a p t e r 17

Risk, Return, and the Time Value of Money 354 Chapter Preview 355

The Relationship Between Risk and Return 356

Time Value of Money Formulas 358

Financial Decision Rules: NPV and IRR 368

Chapter Review 370

Key Terms 370

Study Exercises 370

c h a p t e r 18

Mortgage Mechanics 372 Chapter Preview 373

Mortgage Mechanics 374

Understanding the Fixed-Rate Mortgage: Prepayment 378

Understanding the Fixed-Rate Mortgage: Refinancing 382

Understanding the Fixed-Rate Mortgage: Discount Points and Effective Interest Rates 383

Alternatives to the Fixed-Rate Mortgage 386

Chapter Review 390

Key Terms 390

Study Exercises 391

Further Reading 393

c h a p t e r 19

Analyzing Income-Producing Properties 394 Chapter Preview 395

Advantages of Real Estate Investment 396

Financial Decision Making 398

The Discounted Cash Flow Model 401

Chapter Review 410

Key Terms 411

Study Exercises 411

Further Reading 412

g l o s s a ry 413 a p p e n d i x 431

i n d e x 437 c r e d i t s a n d a c k n o w l e d g m e n t s 447

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xiii

p r e f a c e

Welcome to the eleventh edition of Real Estate Principles! As one of the most popular and well-respected texts in college-level real estate education, this book has served as the framework for a practical and rigorous learning experience for intro- ductory real estate students at schools across the nation since its first edition was published in 1981. This edition continues that tradition by incorporating the latest industry advances and education technologies into a comprehensive, student-friendly presentation of the real estate “body of knowledge.” We are absolutely convinced that students who master the material presented in this text will become better-informed real estate market participants whether their primary real estate interests lie in con- sumption, investment, brokerage, appraisal, law, property and asset management, or any combination of these aspects of real estate.

| pedagogical devices ______________________________________

For students, the book contains the following pedagogical devices designed to enhance their learning experience:

■■ Each chapter begins with a Chapter Preview that clearly sets forth the learning objectives.

■■ The Key Terms discussed in each chapter appear in boldface for emphasis. These terms are succinctly defined in the end-of-book Glossary.

■■ Many tables, figures, and photographs are provided throughout the text to help readers visualize the topics and incorporate them in their knowledge base.

■■ Each chapter ends with a Chapter Review that concisely summarizes the key concepts.

■■ Thought-provoking review exercises are provided at the end of each chapter.

■■ Suggested reading lists for each chapter are included to direct students who wish to learn more about specific concepts to additional sources of information, including books, academic journals, practitioner journals, newspapers, magazines, and internet sites.

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xiv Preface

| instructor support _____________________________________

For instructors, we have developed an extensive collection of support materials that can be easily downloaded (with the proper password) from the publisher’s web- site at www.dearborn.com. The materials include

■■ detailed lecture notes in Microsoft PowerPoint and Microsoft Word format for each chapter (for use with a computer display projector or as transparency slides);

■■ assignment exercises for each chapter (with answers); and

■■ multiple-choice, true-false, and short-answer questions by chapter.

Readers familiar with previous editions of this text will be pleased to find that this edition continues to incorporate many of the special features from previous edi- tions that enhance the students’ learning experiences. Close-Ups, Legal Highlights, People Profiles, and Case Studies are liberally sprinkled throughout the book to dem- onstrate how real estate principles can be observed and applied in the “real world.”

| flexible pathways through the text ______________________

Because real estate is such a dynamic and diverse discipline, we have purpose- fully designed Real Estate Principles in such a way that instructors who wish to approach the material from their own preferred direction can do so with relative ease. Each chapter can be treated as a stand-alone learning module within the real estate body of knowledge. While we recommend presenting the material in the chapter order provided for general business students, an instructor who wishes to focus on finance and investment analysis issues can easily shift Chapters 16 through 20 to the beginning of the semester (after Chapter 1) to allow adequate time for in-depth cov- erage. Or an instructor who wishes to focus on real estate economics might consider following the first chapter with Chapters 11 through 15. We would be pleased to get feedback from instructors describing how they choose to sequence the chapters in their courses.

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Preface xv

| acknowledgments _______________________________________

No project of the magnitude of this book can be accomplished without a spirit of teamwork and mutual respect between all the parties involved. We wish to sincerely thank all of the people who provided comments, suggestions, and other invaluable forms of support in the research, writing, and production process, especially Jeffrey J. Rymaszewski, senior lecturer, University of Wisconsin at Milwaukee, Frank T. Cook, and Ron Williams.

In addition, special thanks are due to the students in our classrooms who served as guinea pigs for the new material.

Finally, we hope that everyone who reads this book will be able to use the lessons contained herein to improve their real estate decision-making skills and, ultimately, to enrich their lives with respect to real estate resources.

Charles F. Floyd, PhD University of Georgia

Marcus T. Allen, PhD Florida Gulf Coast University

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xvii

c h a p t e r 1

Case Study: The Importance of Location Case Study: The Gestation of Park Springs

c h a p t e r 2

Close-Up: Water Wars Legal Highlight: Who Can Use the Shore?

Close-Up: The Empire State Building Legal Highlight: How Did an Acre Get to Be an Acre?

c h a p t e r 3

Close-Up: Meadow Brook Ranch Use Covenants Legal Highlight: Validity of Restrictive Covenants

Legal Highlight: Restrictive Covenant Disputes Legal Highlight: A Cautionary Tale on Mechanics’ Liens

Legal Highlight: Prescriptive Easement Legal Highlight: The Case of the Landlocked Parcel

Close-Up: Use of Conservation Easements Legal Highlight: Adverse Possession

c h a p t e r 4

Legal Highlight: What Constitutes “Public Use”? Legal Highlight: Inverse Condemnation

Close-Up: The Smart Growth Controversy Legal Highlight: The Strange Case of the Incredible Shrinking Building

Legal Highlight: The Case of the Costly Permit Legal Highlight: The Takings Issue

c h a p t e r 5

Close-Up: Sleuthing for Transaction Price Legal Highlight: Title Examination through the Grantor and Grantee Indexes

r e a l e s t a t e t o d a y f e a t u r e s

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xviii Real Estate Today Features

c h a p t e r 6

Legal Highlight: Validity of an Oral Contract Legal Highlight: Necessity to Meet “Concurrent Conditions” by Date of Closing

c h a p t e r 7

Legal Highlight: Landlord’s Liability for Failure to Provide Adequate Maintenance Legal Highlight: Liability of Landlords for Injuries to Guests of Tenants

c h a p t e r 8

Legal Highlight: The Seller’s Agent’s Obligations to the Buyer Legal Highlight: Fair Housing

c h a p t e r 10

Close-Up: Green Acres Shopping Center—A Property Management Success Story

c h a p t e r 11

Close-Up: Civita: An Urban Green Village Close-Up: If You Build It Green, Will They Come? Yes!

Close-Up: Five Historic New Towns: Savannah, Riverside, Radburn, Levittown, and Reston Close-Up: Highlands Falls Country Club

Case Study: Milford Hills Saga

c h a p t e r 12

Close-Up: Atlantic Station: A Successful Brownfields Redevelopment Project Close-Up: The First Suburban Shopping Center: Country Club Plaza

Case Study: Birkdale Village Case Study: The Trump Building: 40 Wall Street Case Study: The Interstate North Industrial Park

Case Study: The Boiler Room Office Building: A Unique Adaptive Use

c h a p t e r 14

Close-Up: The Rise of the “Location-Neutral” Urban Migrant Case Study: A Tale of Two Cities: Flint and West Point

Case Study: Neighborhood Revitalization

c h a p t e r 15

Close-Up: Prequalified vs. Preapproved Case Study: The House That Came Off the Mountain

c h a p t e r 16

Close-Up: What Is Credit Scoring?

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Why Study Real Estate?

1c h a p t e r

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1

case study The Importance

of Location

case study The Gestation of Park Springs

r e a l e s t a t e t o d a y

c h a p t e r p r e v i e w

Why study real estate? Why is it important? What are the characteristics that make real estate different from other types of assets? Fundamentally, people must have places to live and businesses must have locations for their activities. As a result, real estate is a vital resource that touches the economic lives of all people. A thorough understanding of the complexities of real estate resources and the markets in which they are traded enables us to make informed choices regarding real estate for either personal or business use. The objective of this book is to present the general principles necessary for effective real estate deci- sion making. The text also serves as a starting point for more advanced study of the concepts and issues facing real estate market participants.

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2 R E A L E STAT E P R I N C I P L E S

| the role of real estate studies in business education _____

When you first learned that your college or university offers a real estate prin- ciples course as part of its business school curriculum, you may have thought that the focus of the course would be to prepare for a career as a real estate broker. While real estate brokerage is an excellent career choice for many people, this book does not assume that a career in brokerage is your motivation for studying real estate issues. Instead, we present the principles of real estate from the perspective of the user of real estate resources. These principles provide a foundation for effective real estate decision making, whether you intend to make a career in the real estate industry or simply to become more knowledgeable about your personal real estate transactions.

In most universities and colleges, real estate is regarded as a specialty area under the general umbrella of business studies. As such, a real estate principles course cov- ers issues and topics unique to the real estate discipline that are much too specific for adequate coverage in other areas of academic study. Because of the special- ized knowledge required for effective real estate decision making, real estate issues deserve independent attention in a business school curriculum. The intricacies of real estate resources and markets can baffle the ill-prepared decision maker, but a solid foundation in real estate principles will help you make effective personal and business real estate decisions throughout your life and career. In addition, the topics covered in this text will serve as a springboard for those students who wish to pursue a more detailed study of real estate in subsequent courses.

| personal and business-related real estate decisions ______

A thorough understanding of real estate principles is extremely important for real estate decision making in both personal and business-related venues. As indi- viduals, all of us will probably face the following questions several times over the years:

■■ Should I buy a house or a condo or should I lease an apartment for my personal residence?

■■ In what neighborhood do I want to live?

■■ What type of financing should I use, and how do I arrange it?

■■ Should I use a broker to sell my property or try to sell it myself?

■■ How should I structure the sales contract to get the best deal?

■■ How do I decide which property I should invest in?

The same issues that face us as individuals also apply in the business environ- ment. Consider a company that requires additional office space to expand its opera- tions and compete effectively in its product market. Such a company faces many questions that can be addressed only with the knowledge of real estate principles. The following are examples:

■■ Should the company buy or lease additional space? If the company leases space, how should it structure the details of the lease agreement to best serve its objectives?

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C H A P T E R 1 Why Study Real Estate? 3

■■ If the company decides to buy more real estate, should it build a new property or purchase an existing one?

■■ How should the company finance the purchase or development?

■■ Should the company acquire a larger building than it currently requires and lease the additional spaced to tenants until the company needs it?

■■ Should the company consider relocating the corporate headquarters to a different location, either in its current city or in another city altogether?

Appropriate answers to these and other important questions require familiarity with the overall operation of real estate markets, as well as specific knowledge of legal issues, transaction details, and the financial framework of real estate resources. For this reason, real estate principles are a fundamental component of undergraduate business education, regardless of your chosen field of study.

| organization of this book ________________________________

Our goal is to present some of the basic principles of real estate in such a manner that you will be well prepared to anticipate and evaluate changing market conditions and make real estate decisions that best serve your personal and business objectives. We have divided the topics considered in the text into four categories:

1. Part One, Real Estate Legal Analysis (Chapters 2–7) consid- ers issues related to the legal concept of real estate ownership. We define various ownership interests one can obtain in real estate, deed and legal description methods, and private and public limitations on ownership.

2. Part Two, Real Estate Service Industries (Chapters 8–10) discusses the real estate services industry, including brokerage, property man- agement, and appraisal.

3. Part Three, Real Estate Market Analysis (Chapters 11–15) consid- ers the dynamics of real estate markets as a result of national, regional, and local influences on property values and uses. In addition, we review the classic models of urban growth and discuss various aspects of the land development process. We also examine the residential, commercial, and industrial development process.

4. Part Four, Real Estate Finance and Investment Analysis (Chapters 16–19) examines the financing of real estate investment and owner- ship, and real estate investment analysis.

The remainder of this introductory chapter sets the stage for the topics to be addressed throughout this text by describing the special economic characteristics of real estate, the economic importance of real estate, and various career opportunities in the real estate industry.

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4 R E A L E STAT E P R I N C I P L E S

| special characteristics of real estate ___________________

What is real estate? Simply defined, real estate is land and things attached to it such as buildings and other improvements to the land. Real property consists of the legal interests associated with ownership of the physical real estate. In practice, how- ever, the two terms are often used synonymously. All other movable property such as automobiles, furniture, boats, and clothing is known as personal property. As an economic resource, real estate has some distinct characteristics that distinguish it from other types of resources. These characteristics are

■■ fixed location;

■■ uniqueness;

■■ interdependence of land uses;

■■ long life;

■■ long-term commitments;

■■ large transactions; and

■■ long gestation period.

Fixed Location

The characteristic of real estate that distinguishes it from all other types of eco- nomic resources is its fixed location. If there is an oversupply of wheat in Kansas, or of automobiles in Michigan, they can be moved to areas of relative scarcity. This is not true of real estate resources. If there is an oversupply of condominiums in Miami, office space in Manhattan, or shopping centers in Minneapolis, they cannot be trans- ported to other communities where the demand is stronger. A tract of land, of course, cannot be moved a few feet up the street to help meet demand for space at that site. Thus, the success of real estate acquisition, development, and investment decisions is directly affected by the forces of supply and demand in a local area.

Uniqueness

Because real estate is fixed in location, every parcel is unique or, to use a fancy term, heterogeneous. Even subdivision lots located side by side are not perfect sub- stitutes for each other because of differences in such factors as topography, tree cover, and view. These factors often create large differences in property values. For example, lots fronting on a lake will probably sell for much more than lots just across the street; lots with a spectacular mountain view may sell for many times more than nearby ones without the view.

Interdependence of Land Uses

Real estate’s fixed location leads to another economic characteristic: interde- pendence of land uses. The use of real property depends greatly on the provision of

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C H A P T E R 1 Why Study Real Estate? 5

public services, the uses made of nearby land, and the general economic vitality of the neighborhood and community.

It is extremely difficult to use land to its full economic potential, particularly in an urban setting, unless adequate public services are provided and neighboring land is used in complementary ways. Even agricultural lands need to be served by roads, and such basic utilities as electricity and telephone service are necessary for prac- tical homestead use. As we move to denser residential development, public water and sewerage systems are essential as are such governmental services as education, police and fire protection, and various social services. Land must be converted to public use for parks, schools, and other governmental services, particularly trans- portation facilities. If adequate governmental services and public land uses are not available, it will be difficult or even impossible to develop land for residential, com- mercial, or industrial use.

The use of land is also affected greatly by nearby land use. If a large tract of vacant land is located near areas of expanding residential and commercial develop- ment, this location should increase both the land’s potential use and its value in the marketplace. Conversely, the value of land may be affected adversely by its proxim- ity to “undesirable” uses. It would probably be difficult, for example, to develop a single-family housing development next to a chemical plant or slaughterhouse. Such uses, however, particularly if served by transportation facilities and other public ser- vices, may make nearby land valuable for industrial purposes.

The economic vitality of a neighborhood, community, or region greatly affects the demand for real property and its value. If the economy of the area is expanding,

r e a l e s t a t e t o d a y

c a s e s t u d y

The Importance of Location

How important is location to the value of real estate? Very important in the case of a 77-square-foot “studio apart- ment” in the exclusive Knights-

bridge neighborhood of London. The former storage closet, originally conceived as a maid’s room, is only slightly larger than a prison cell, but is priced at $335,000, or about $4,500 per square foot. Moreover, the room has no electricity or heat, which would cost an additional $59,000 to make it habitable. Rather pricey, but the tiny apartment is

located in one of the wealthiest neighborhoods in the world and is within walking distance to exclu- sive stores such as Harrod’s and the city’s iconic Hyde Park.

Almost unbelievably, other ultra high-end Lon- don properties have been selling for even higher prices, sometimes as much as $6,000 per square foot. By comparison, the closet-sized apartment is a bargain. The old real estate axiom that the three most important factors in real estate are location, location, and location certainly applies in this case.

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6 R E A L E STAT E P R I N C I P L E S

the population also will increase, bringing about a corresponding increase in the demand for residential, commercial, and industrial land. Conversely, if the economy of the area is in temporary or long-term decline, the demand for real estate and real estate value also will tend to decline.

It is the interdependence of land uses that leads to the existence of both private and public land-use controls, topics we will study in Chapters 3 and 4. The use of land affects the owners of other land more than the use of almost any other type of private property and may create costs to the public at large. For example, the fill- ing of floodplain lands (the low-lying land near streams) to make them suitable for high-density residential use may cause other owners of land on the floodplain to be affected adversely in periods of heavy rainfall. If other landowners also fill in their portion of the floodplain, a flood hazard may be created that will require large public expenditures to alleviate.

Long Life

Although its ability to generate income may change over time, land is virtu- ally indestructible. Additionally, real estate improvements—that is, buildings on the land—generally have very long lives. For example, a family would expect a new home to last as long as they wanted to live there and beyond, and many houses last for a century or more when maintained properly. Apartment houses, shopping cen- ters, and other types of income-producing property also have very long lives.

Long-Term Commitments

The long lives of real estate improvements mean that investment decisions are, by their very nature, long-term commitments. Although the immediate prospects for the production of income are very important in real estate investment analysis, the factors that influence income generation over the long term are equally critical. For example, the proximity of a hotel to a heavily traveled highway is a predominant fac- tor in the financial success of the hotel. If the hotel is built in a location that soon will be bypassed by a new freeway, it probably will not be a successful investment during much of its life. Conversely, shopping centers are often built somewhat ahead of the market to gain advantageous location in advance of expected population growth.

The characteristics of long life and long-term commitments force the real estate investor and developer to establish realistic, long-term outlooks if they want to make successful investment decisions. The real estate investor who merely assumes that favorable economic trends will continue will probably be unsuccessful. For exam- ple, most of the problems that arose during the recent decline in real estate prices occurred because investors and financial institutions regarded the future with unbri- dled optimism. Investors should analyze carefully the factors that have caused eco- nomic trends to be favorable in the past and try to ascertain what will happen to these factors for some years into the future.