Market Area Dynamics: Boundaries and Influences

Chapter: Market Area Dynamics: Boundaries and Influences

Introduction

Market area analysis is a crucial component of real estate valuation and decision-making. It provides a framework for understanding the forces that shape property values within a specific geographic region. This chapter delves into the dynamics of market areas, focusing on their boundaries and the influences that impact them. We will explore the social, economic, governmental, and environmental factors that interact to create unique market conditions.

1. Defining Market Areas and Boundaries

A market area is a geographically defined region where similar properties compete with each other for buyers or tenants. Determining the boundaries of a market area is critical for accurate analysis. Unlike political boundaries, market area boundaries are often fluid and based on factors influencing property values.

1. Traditional vs. Modern Approaches: Traditionally, “neighborhood analysis” was used, but modern real estate uses “market area analysis” which is a broader term. Market analysis focuses on supply and demand for the subject property.

2. Methods for Identifying Boundaries:

   a. Examination of the Subject Property: Analysis begins with the subject property, considering its location, type, and characteristics.

   b. Physical Characteristics: A visual inspection of the area identifies changes in land use, structure types, architectural styles, and maintenance levels. Physical barriers like major streets, hills, rivers, and railroad tracks can delineate boundaries.
   i. Example: A transition from single-family homes to high-rise apartments along a lakeshore could signify a distinct market area boundary.
   ii. Experiment: Conduct a “windshield survey” driving through the area, documenting changes in property characteristics at specific GPS coordinates. Overlay this data on a map to identify potential boundaries.

   c. Mapping and Geospatial Analysis: Using Geographic Information Systems (GIS), data points representing changes in physical characteristics are connected to form preliminary boundaries on a map.

   d. Demographic Data Analysis: Preliminary boundaries are overlaid on demographic maps (zip codes, census tracts, block groups). Data segmentation refines boundaries based on pertinent submarkets. Data is obtained from census data, chambers of commerce, universities, and research organizations. Survey residents, interview business people, brokers, and community representatives.

3. Mathematical Representation of Market Area:

   • Let M represent the market area.
   • M = f(P, D, S, G, E)
     • Where:
       • P = Physical characteristics
       • D = Demographic characteristics
       • S = Social influences
       • G = Governmental influences
       • E = Economic influences
   • This formula indicates that the market area is a function of multiple variables which interact.

4. Defining Districts: Variations in property characteristics within a market area create districts, which require even more limited boundaries.
   a. Example: In an urban area with high-rise apartment buildings along a natural lakeshore, there may be variations in apartment prices, sizes, views, parking availability, proximity to public transportation, and building ages.

5. Secondary Data and Primary Research: Because legal, political, and economic organizations collect data for statistically defined areas, appraisers should verify and supplement data with primary research.

2. Forces Influencing Market Area Dynamics

The four forces (social, economic, governmental, and environmental) create combinations of factors in the marketplace.

1. Social Influences:

   a. Demographic Characteristics: Age, income, education, household size, and lifestyle influence property values. Comparing price levels across areas indicates desirability.

   b. Social Preferences: Buying public views social characteristics. Ethics Rule of the Uniform Standards of Professional Appraisal Practice prevents appraiser’s bias.

   c. Measuring Social Influence:
   i. Social influence is difficult to quantify, but demographic trends can be analyzed using statistical methods.

   d. Example: An influx of young professionals seeking urban living spaces can drive up prices in previously declining neighborhoods, illustrating the impact of demographic shifts.

2. Economic Influences:

   a. Financial Capacity: Occupants’ ability to rent, own, maintain, and renovate properties is influenced by income levels.

   b. Economic Characteristics:
   * Mean and median household income levels
   * Per capita income
   * Income distribution for households
   * Consumer activity
   * Extent of owner occupancy
   * Property rent levels and trends
   * Property value levels and trends
   * Vacancy rates for various types of property
   * Amount of development and construction

   c. Vacancy and Construction Trends: Vacant lots may signify future development, while current construction trends affect values of existing properties.

   d. Economic Base: Economic changes may depend on the rate of population growth or decline.

   e. Mathematical Representation of Economic Influence:
   * Price Elasticity of Demand (Ed) = (% Change in Quantity Demanded) / (% Change in Price)
   * Ed > 1: Elastic demand (sensitive to price changes)
   * Ed < 1: Inelastic demand (insensitive to price changes)
   * Example: Analyze vacancy rates in office buildings after a major employer relocates. High vacancy rates and falling rents show a negative economic influence.

   f. Multiyear Analysis: An appraiser expands analysis to include economic trends over a multiyear period.

   g. Comparison: Appraiser must compare the economic characteristics of competing market areas.

3. Governmental Influences:

   a. National Level: Significant legislative actions influence economic climate for real estate.
   i. Example: Dodd-Frank Wall Street Reform and Consumer Protection Act

   b. Local Level: Property taxes, regulations, zoning, and building codes affect properties.

   c. Governmental Characteristics:
   * Property tax burden (including special assessments) relative to services provided, compared with other areas in the community
   * Policies regarding developmental growth
   * Local government development levies (impact fees)
   * Zoning, building, and housing codes
   * Quality of public services, such as fire and police protection, schools, and other governmental services
   * Environmental regulations

   d. Zoning and Land Use Plans: Zoning regulates land use and development density. Communities use zoning to halt or slow growth, and encourage new development.

   e. Local Tax Rates: Tax rates may favor or penalize certain property types.

   f. Mathematical Representation of Governmental Influence:
   * Effective Tax Rate = (Total Property Taxes Paid) / (Market Value of Property)
   * Compare effective tax rates across different market areas to understand the impact of property taxes on value.

   g. Impact Fees and Development Regulations: Impact fees and environmental regulations can increase development costs, affecting property values.

   h. Transportation and Services: The creation or modification of the transportation system and the provision of services are government actions. An improvement in the transportation system can affect a site’s accessibility and, thus, its value.

4. Environmental Influences:

   a. Natural and Man-Made Features: Topography, waterways, open spaces, nuisances, hazards, public utilities, traffic, and access to amenities.

   b. Environmental Characteristics:
   * Topographical features (terrain and vegetation)
   * Environmental features important to wildlife habitat
   * Navigable waterways
   * Open space
   * Nuisances and hazards emanating from nearby facilities such as shopping centers, factories, and schools—e.g., odors, noises, litter, vibrations, fog, smoke, and smog
   * The adequacy of public utilities such as streetlights, water, sewers, and electricity
   * General maintenance
   * Effective ages of properties
   * Changes in property use and land use patterns
   * Traffic flow and traffic patterns
   * Environmental liabilities—e.g., threat of landslides or flooding
   * Access to public transportation (and type of system, e.g., bus, rail), schools (and quality of schools), stores and service establishments, parks and recreational facilities, houses of worship, and workplaces

   c. Environmental Liabilities: Landslides, flooding, and contamination decrease property values.

   d. Environmental Characteristics Cannot Be Judged on an Absolute Scale: Instead, they must be compared with the characteristics of competing areas.

   e. Utilities: A deficiency in utilities tends to decrease property values in a market area.

   f. Mathematical Representation of Environmental Influence:
   * Hedonic Pricing Model: Property Value = β0 + β1(SQFT) + β2(LOTSIZE) + β3(AIRQUALITY) + …
   * This model quantifies the impact of various environmental factors (like air quality) on property values.

   g. Example: The presence of a park can increase property values. The presence of spotted owls in forested areas in the Northwest has led to bans on logging and development.

3. Market Cycles and Transition

Real estate markets operate in cycles, undergoing periods of expansion, decline, recession, and recovery. Transition occurs when a market shifts from one land use to another.

1. Real Estate Market Cycle:
   a. Expansion: Sustained growth in demand, increasing construction.
   b. Decline: Positive but falling demand, increasing vacancy.
   c. Recession: Falling demand, increasing vacancy.
   d. Recovery: Increasing demand, decreasing vacancy.

2. Market Cycle Interruption:
   a. A major change can interrupt the order of the stages. Example: A strong negative influence such as a major employer suddenly pulling out of a community or the closing of a military base can cause a real estate market that is growing to decline rather than stabilize.

3. Revitalization:
   a. After a period of decline, a real estate market may undergo a transition to other land uses, or its life cycle may begin again due to revitalization. Revitalization often results from organized rebuilding or restoration undertaken to preserve the architecture of significant structures. It may also be caused by a natural resurgence of demand. Example: The rebirth of an older, inner-city neighborhood, may simply be due to changing preferences and lifestyles.

4. Transition:
   a. Transition is the Result of Change:
   i. Example: The arrival of a major new employer in a market may cause a change in demand for residential property, and that change in market conditions may then lead to the transition of formerly undeveloped land within the market to a more intensive use as the site of new homes or apartments.

   b. Indications of Transition: Variations within the neighborhood.
   i. Example: New uses may indicate potential increases or decreases in property values. A residential neighborhood in which some homes are well maintained and others are not well maintained may be undergoing either decline or revitalization. The introduction of different uses, such as residential apartments or offices, into a single-unit residential neighborhood may also indicate potential transition to a more intensive use.

   c. Changes in One Market Area are Influenced by Other Competing Areas: Growth of one market area may lead to the downfall of a competing market area.

   d. Market Evidence of Changing Markets:
   i. Signs of a bubble market include prices increasing more quickly than rents, shorter marketing times, and an increase in the number of properties remaining vacant after purchase. Evidence of a bust market includes an increase in the rate of foreclosures and a tightening of credit markets.

Conclusion

Market area analysis is a dynamic process requiring a thorough understanding of boundaries and the forces that shape them. Social, economic, governmental, and environmental factors interact to influence property values, creating unique market conditions. By using a combination of physical observation, data analysis, and mathematical tools, appraisers can effectively analyze market area dynamics and make informed valuation decisions. Understanding the market cycle and the potential for transition is equally important for anticipating future trends and assessing long-term investment opportunities.