Market Area Analysis

Chapter 11: Market Area analysis❓

Introduction

Market area analysis is a critical component of the real estate valuation process. It involves the identification and examination of the geographic region that influences a property’s value. This chapter will delve into the scientific principles underlying market area analysis, providing a comprehensive understanding of its application in real estate valuation.

1. Understanding the Market Area

• Definition: A market area is a geographic region where properties compete with one another for buyers and tenants. It is characterized by a set of economic, social, and political factors that influence real estate values.

• Delineation: Defining the market area is not always straightforward. It depends on the property type, location, and market conditions. Consider factors like:

  • Proximity: How far are potential substitutes?
  • Accessibility: How easily can people reach the property?
  • Homogeneity: Are properties within the area similar?
  • Competition: Which properties actively compete?
  • Levels of Market Analysis: Market analysis can occur on various levels, starting from the macro-economic view and going to a specific property. They can be categorized as follows:
  • National Analysis: includes national economic trends, demographic shifts, interest rates and inflation.
  • Regional Analysis: includes the economic, demographic and geographic characteristic.
  • Metropolitan Analysis: Includes employment trends, income level, housing affordability.
  • Neighborhood Analysis: includes the neighborhood’s amenities, accessibility, zoning and property values.
  • Property-Specific Analysis: Includes the competitive position, unique features and potential for improvement.
  • Market Segmentation: Recognize that real estate markets are often segmented. Market segmentation is the process of dividing a broad consumer or industrial market into sub-groups of consumers based on shared characteristics. Different segments may have different market areas.

2. Scientific Principles and Theories

• Location Theory:
  • Core Principle: Location is a key determinant of value. Access to amenities, transportation, and other desirable locations drives up property values.
  • Von Thünen Model: This model, developed by Johann Heinrich von Thünen, explains land use patterns based on Transportation costs❓❓. In its simplest form, it suggests that the most profitable land use will be located closest to the market center, with less intensive uses further away.
    • Equation: R = Y(p - c) - Ytf
      • Where:
        • R = Land Rent
        • Y = Yield per unit of land
        • p = Market price per unit of commodity
        • c = Production costs per unit of commodity
        • t = Transportation costs per unit of distance
        • f = Distance from market
  • Central Place Theory (Walter Christaller): Explains the spatial distribution of urban areas, with larger cities offering a wider range of goods and services and smaller towns providing basic necessities.
• Supply and Demand:
  • Basic Economic Principle: Market values are determined by the interaction of supply (the availability of properties) and demand (the willingness and ability of buyers/tenants to purchase/rent).
  • Market Equilibrium: The point where supply and demand are balanced, resulting in a stable market price.
  • Elasticity: The responsiveness of supply or demand to changes in price or other factors. For example, if a large increase in the number of apartments available has a relatively small effect on rental rates, the demand is considered inelastic.
    • Equation: Price Elasticity of Demand = (% Change in Quantity Demanded) / (% Change in Price)
• Spatial Economics: This field applies economic principles to the analysis of spatial phenomena, including real estate markets.
  • Spatial Autocorrelation: The tendency for properties close to each other to have similar values. This is because they share similar locational advantages and are subject to the same market forces.
  • Hedonic Pricing: A statistical technique used to estimate the value of individual property characteristics. It analyzes the relationship between a property’s price and its attributes (e.g., size, location, amenities).
    • Equation: P = β0 + β1X1 + β2X2 + … + βnXn + ε
      • Where:
        • P = Property Price
        • β0 = Intercept (base price)
        • βi = Coefficient for attribute i (marginal value of attribute i)
        • Xi = Quantity of attribute i
        • ε = Error term

3. Data Collection and Analysis

• Data Sources:
  • Public Records: County assessor’s offices, land registries, zoning departments.
  • Market Data Providers: Real estate listing services (MLS), commercial data providers (CoStar, RCA).
  • Economic Data: Government agencies (Bureau of Labor Statistics, Census Bureau), economic forecasting firms.
  • Surveys and Interviews: Gathering information directly from market participants (buyers, sellers, developers, brokers).
• Key Market Indicators:
  • Vacancy Rates: The percentage of unoccupied properties.
    • Equation: Vacancy Rate = (Number of Vacant Units / Total Number of Units) * 100
  • Absorption Rates: The rate at which properties are being leased or sold.
  • Rental Rates/Sale Prices: The prevailing prices for comparable properties.
  • Construction Activity: The amount of new construction underway.
  • Demographic Trends: Population growth, household income, age distribution.
  • Employment Trends: Job growth, industry mix, unemployment rates.
• Analytical Techniques:
  • Geographic Information Systems (GIS): Mapping software used to visualize and analyze spatial data.
  • Regression Analysis: Statistical technique used to identify the factors that influence property values.
  • Comparative Analysis: Comparing the subject property to similar properties in the market area.
  • SWOT Analysis: Identifying the Strengths, Weaknesses, Opportunities, and Threats related to the market area.

4. Practical Applications

• Identifying Comparable Sales: Market area analysis helps in identifying properties that are truly comparable to the subject property, ensuring that the sales comparison approach is accurate.
• Forecasting Future Demand: Understanding market trends allows appraisers to project future demand for a property type in the area.
• Assessing Risk: Market area analysis can reveal potential risks, such as oversupply, economic downturns, or changing demographics.
• Highest and Best Use Analysis: Market area analysis is an integral part of determining the most profitable and legally permissible use for a property.
• Investment Decisions: Helps investors determine if a property is a good investment based on market area conditions.

5. Experiments and Case Studies

• Experiment: Impact of School District on Housing Values:
  • Objective: To determine the impact of school district quality on residential property values.
  • Method: Collect data on house prices and school district rankings in different neighborhoods. Use regression analysis to control for other factors (e.g., house size, age) and isolate the effect of school district quality.
  • Expected Result: Houses located in highly-ranked school districts will have significantly higher values, ceteris paribus.
• Case Study: Analyzing a Retail Market:
  • Objective: To evaluate the market potential for a new retail development in a specific area.
  • Method: Collect data on demographics, income levels, consumer spending patterns, existing retail competition, and traffic counts. Analyze this data to determine the demand for retail goods and services in the area.
  • Expected Result: The analysis will reveal whether there is sufficient demand to support a new retail development and what types of stores are most likely to succeed.

6. Common Pitfalls and Considerations

• Defining Too Broad or Too Narrow a Market Area: An overly broad market area may include irrelevant data, while an overly narrow market area may exclude important competition.
• Over-Reliance on Historical Data: Market conditions can change rapidly, so it’s important to consider current trends and future expectations.
• Ignoring Qualitative Factors: While quantitative data is important, qualitative factors such as neighborhood character, aesthetics, and community perception can also influence property values.
• Bias: Ensure objectivity in data collection and analysis to avoid skewing the results.

Conclusion

Market area analysis is a multifaceted process that requires a strong understanding of economic principles, data analysis techniques, and real estate market dynamics. By carefully analyzing the factors that influence property values within a specific geographic region, appraisers can develop credible and well-supported value opinions. It is an essential tool for informed decision-making in the real estate industry.