the economics of development: integrating land economics and portfolio analytics european real...

The Economics of Development: Integrating Land Economics and Portfolio Analytics

European Real Estate SocietyStockholm, Sweden

June 2009Terry V. Grissom Ph.D.*

James N. Berry Professor.*Jasmine L.C. Lim Ph.D.*

*School of the Built Environment University of Ulster, Jordanstown

The Economics of Development

• Development decisions/strategies are highly associated if not dependent on development valuation analysis

• This valuation approach is directly linked to the constructs of distributive theory requiring a consideration of value differences and potential profits that arise from differing land uses associated with alternative project proposals

• Distributive theory requires an analysis of the return or compensation for each of the factors of production that define economic production, growth and development

• This requires that consideration of the differences in returns to the varying levels of distributive factors of labour, capital, land and entrepreneurship and their associated risk exposures that may arise under proposed alternative developments possible on any given site.

• This approach combines the options approach to development with the traditional production/manufacturing process


• This integrated approach to development: option and production fits one scenario of capital theory defining capital as:– The “product of production” and as investment (economic measures of

time) See Ahmed (1990)

• This allows labour and capital (real and financial) as development inputs and allows the distributive measures of land and profit (residuals) as the dependent (determined) measures along with the total returns measure of performance as defined by risk and uncertainty variables in the context of the Fama-French Three factor model (1992).

Applicability of the Three Factor Model to Property Development

• Variables – Leverage– Capital cost as spread between construction loan cost less LIBOR

– Capital size variable where size is the log of the equity cost of development

– Proxy for development performance which the ratio of equity cost of development is divided by the gross development value which is equivalent to the Fama French book equity to market equity ratio#

EMRY FML /)(

)ln( ESUi C

)/ln( EE CDV

# This is a proxy which could include entrepreneurial effort, enterprise, innovation, coordination and strategic management

iUEEESUiFMLFMmpMmFiU CDVCEMRYRRURRE )/ln()ln(/)()(|)(

3 Factor Fama-French Model for Single Use Development

3 Factor Fama-French Model for Mixed Use Development

iUjEjC

EjDV

j

EiC

EiDV

iEC

SUiEM

FR

MY

LFR

MupiR

MuiU

)/ln(

)/ln()ln(/)()(|)F

RiU

E(R


iUjkEkC

EkDV

kEjC

EjV

j

EiC

EiDV

iEC

SUiEM

FR

MY

LFR

MupiR

MuiU

)/ln()/ln(

)/ln()ln(/)()(|)F

RiU

E(R

3 Factor Fama-French Model extended to multiple

Mixed Use Development


• Equating development especially mixed use development to a portfolio of uses subject to risk associated with alternative combination of use strategies is an extension of the option approach adopted by real estate, financial and urban economists. See Grenadier (1995,1996), Williams (1991, 1993), Capozza and Henley (1989) and Geltner and Miller (2001).

• This focus on development as a strategic choice of alternatives also allows the use of data development from the development valuation reports employed by practitioners, lenders and others considering proposed development. This data in turn is a function of the random market and project specific data available in any given market.

• Use of the development valuation reports for given sites and proposed projects offers an empirical approach that is similar to the simulation derived from developing an array of alternative portfolios based on different weightings of securities and general economic data.

• See data extraction form

Information Single Use Mixed Use Single Ranges

Mixed Ranges *

Return Measures: Rates/Yields

Rents Values Costs Profit

Finance Information: Options or Choices of financing considered

Loan-to-value ratio Interest rate Loan term

Payment frequency Property Use

Prior Use Single Use (HBU?)

Mix Uses: Primary

Secondary Others

-1 .05 0 .05 1 Rank Range: Quality of Associations:

Primary to Area Primary-secondary

Primary-others

-1 -0.5 0 0.5 +1

Physical Size Mix Use Break Down: % of each use to total:

Physical Size: Value: Cost:

Neighbourhood Land Uses in Area (#)

Quality

Return and Risk Factors and Data Development Matrix


A sample application of the model considering project yields, land value residuals, and profit as a percentage of proposed project development valuation are depicted in the tables that follow:

Base/HBU Use

Additional Use

R2 α β Coeff t- Stat

Leverage β Coeff t- Stat

Log Size (cost)β Coeff t-Stat

Log BEMEβ Coeff t-Stat

Office OfficeRetailResidentialHotel

56.638.556.697.8

-0.7900 -1.288 0.0912 1.520-0.7907 -1.288-0.1697 -6.505

-0.1133 -0.4033-0.1331 -0.8260-0.1133 -0.4033 0.0146 0.0650

0.0078 2.1040-0.0015 0.4432 0.0078 2.1041 0.0132 -7.6961

-0.0165 -1.9920-0.0006 -0.0941-0.0165 -1.9922 0.0081 1.3507

Resi-dential

OfficeRetailResidentialHotel

21.747.816.737.3

-0.1614 -0.26080.0341 1.12900.0220 0.26390.0845 0.5520

0.1903 0.5560-0.1075 -0.8583 0.1020 2.9980 0.9945 0.9070

0.0038 1.1732 0.0018 1.0168 0.0017 0.3547-0.0037 - 0.3598

-0.0014 0.7726 0.0013 0.2489-0.0064 -0.4164-0.0376 -0.6902

OfficeResident

MixOffice/Retail

14.948.0

0.0542 0.49900.0327 0.8884

0.0647 0.1975-0.1009 - 0.6503

-0.00016 - 0.2737 0.0018 0.8082

-0.0105 -0.7982Off:-0.000094 -0.1142Ret: 0.00145 -0.2259

Statistics and Variable Coefficients Yield (Total Return) per Project for Proposed Use Mix

Base/HBU Use

Additional Use

R2 α β Coeff t-Stat

Leverage β Coeff t-Stat

Log Size (cost)β Coefft t-Stat


Office

OfficeRetailResidentHotel

84.794.984.799.7

-4.28E+09 -1.760-1.04E+10 -3.520-4.28E+09 -1.760 6.77E+08 1.240

-1.98E+10 -1.7870-1.93E+09 -2.4124-1.98E+10 -1.7870 1.32E+10 2.8378

2.67E+09 1.8183 6.05E+08 3.6112 2.67E+09 1.8183-1.23E+09 - 2.5430

-1.51E+09 -4.7210 -2.10E+09 -6.3740 -1.51E+09 -4.7210 -3.07E+09 -24.470

Resi-dent

OfficeRetailResidentialHotel

81.989.488.399.3

-8.37E+09 -4.212-5.78E+09 -2.394-5.43E+09 -2.601-1.69E+09 -1.589

-1.51E+09 -0.1371-5.43E+09 -0.5430-4.51E+09 -0.5291 5.04E+09 0.6980

5.04E+08 4.7680 3.50E+08 2.4566 3.23E+09 2.6390 6709807 0.9681

-28084931 -0.4790-5.67E+08 -1.2790 -6.91E+08 -1.9026 -2.56E+09 -7.1356

Statistics and Variable Coefficients for Residual Land Value Difference by Project Proposed Use Mix

Base/HBU Use

Additional Use





Mixed OfficeRetailResidentialHotel

95.587.888.199.8

-1.65E+10 -9.847-7.00E+09 -2.412-6.98E+09 -2.567-3.72E+10 -3.186

-2.41E+09 -0.4490-1.13E+08 -1.0920-1.03E+10 -1.2520 -3.72E+10 -2.5078

9.05E+09 10.4809 3.96E+08 2.1827 3.91E+08 2.5920 1.21E+09 3.0840

-1.83E+09 -5.2260 -7.91E+08 -1.9027 - 8.39E+08 -2.5530 -7.11E+08 -0.6619

Statistics and Variable Coefficients for Residual Land Value Difference by Mixed Project and Additional Land Uses

Base/HBU Use

Additional Use





Office


51.038.351.071.7

-0.2557 -1.2890-0.3307 -0.7663-0.2557 -1.2891-0.5251 -0.1724

-0.4851 -0.5375-0.4305 -0.3689-0.4851 -0.5375 2.9422 1.1306

0.0269 2.2480 0.0382 1.2630 0.0269 2.2480 0.0093 0.4632

-0.0134 -0.5037 -0.0219 -0.4574 -0.0134 -0.5037 -0.0855 -1.2175

Resi-dent


09.431.321.476.1

-0.4010 -0.1997-0.9320 -0.3730-0.1110 -0.45510.3365 1.0390

0.6069 0.5470 0.2174 0.2100 0.5890 0.5912 4.0980 1.8670

0.0076 0.7128 0.0180 1.2250 0.1761 1.2370-0.0165 - 0.7857

-0.0022 -0.3732 0.0589 1.2857 0.0447 1.0408 -0.1812 -1.6617

MIX Mix 48.1 0.0670 1.6049 0.7082 0.9038 1.38E-10 2.3366 0.11438 1.6560

Statistics and Variable Coefficients Profit (Residual as Percentage of Value) per Project for Proposed Use Mix

Conclusions• Yield analysis from the proposed model is consistent

with the findings of systematic investment portfolios using the Fama-French model (See Bond, Karoyli, Sanders 2004)

• This research is broader as applied to development in three perspectives:– in allowing the consideration of mixed uses not just the

difference in alternative development scenarios as offered by option models

– in allowing for the consideration of combination of uses (a mixed portfolio) as the use mix impact land values measures and profit as a residual calculation

– in allowing for the incorporation of risk and uncertainty into traditional valuation and land economic measures of performance

Conclusions• The performance of office and retail synergies within a

mixed use development increases all measures (yield, profit and residual land value) compared to the dominance of a single use.

• Residential within a mixed use development increases the complexity of a risk and market model as a consequence of mixed tenure housing/affordability housing provision

• The inclusion of hotels in a mixed use development contribute to a residual land value enhancement over a single use development

Conclusions

• Mixed use development increases land residual value relative to risk levels and may offer strategy to hedge recessionary impact.

• The findings of the model emphasises the benefits of entrepreneurial developer’s effort of innovation and strategic management in value creation.

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