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Real Estate Market Analysis
Methods and Case Studies
By Deborah L. Brett, Adrienne Schmitz
Urban Land InstituteCopyright © 2009 Urban Land Institute
All rights reserved.
Understanding Real Estate Market Analysis
Real estate market analysis provides guidance for the many decision makers — in both the private and the public sectors — involved in real estate development. It is an ongoing process that provides vital information during predevelopment, acquisition, development, marketing, and disposition of a property. The goal of market analysis is to minimize the risks to, and maximize the opportunities for developers, investors, lenders, and public sector participants. Good market analysis combines timely and accurate information and nuanced interpretation of the data based on real-world experience. Although market studies are filled with data, interpreting the data takes experience, and drawing conclusions from the data is more of an art than a science.
The word market can be used in a variety of ways. Businesspeople usually use the word to mean the various ways of grouping customers, including geographic location (the Pacific Northwest, the Midwest), demographic profiles (young urban professionals, empty nesters), and product types (family restaurants, high-fashion apparel). Economists refer to both buyers and sellers when describing markets in terms of supply and demand, while marketing professionals consider sellers as the client and buyers as the market.
In real estate, product refers to property type — apartment buildings, offices, warehouses, for example — which is further distinguished by locational attributes, size or layout, quality, interior design features, project amenities, services (those included in the cost and those that are optional), and prices or rents. Hotels are subdivided into luxury resort properties, downtown conference hotels, limited-service establishments and so on. Retail projects include regional malls, neighborhood strip centers, "power" or "lifestyle" centers, outlet malls, and urban street retail. The housing sector can be segmented by physical characteristics, into single-family detached or attached models or low-rise, mid-rise, and high-rise apartments, and by tenure: for sale or rental. Industrial properties include 36-foot-high warehouses, research laboratories, and modest "flex" space used for offices, light assembly, and storage. Narrowly defining the market segment helps fine-tune the analysis.
A project's architecture, construction materials, layout, and finishes all influence perceived quality. However, most types of real estate can be customized to some extent to meet the perceived needs and wants of the buyer or tenant. For-sale housing offers options, including upgraded appliance packages, a choice of facades, and bump-outs for additional space. Hotels offer rooms with different bed configurations. Office buildings typically offer a tenant improvement allowance to a company that is leasing new space; tenants may opt to spend more.
Most rental property types offer standard tenant services (building management, maintenance of common areas, security, janitorial). In today's market, where technological features are important amenities, builders will incorporate Internet and cable television connections and sophisticated video security systems in their plans. Enclosed shopping malls and town centers typically provide joint marketing and promotional services for all the tenants, with the cost passed through on a pro rata basis. Office buildings, apartment complexes, and hotels offer an array of concierge services, exercise facilities, meeting space, and social activities. Housing for seniors may offer optional meals or maid service, along with a variety of group activities. Business hotels often include shops, restaurants, and bars; at a minimum, they will have a breakfast buffet area. Many of these services provide additional income to management. All of these "extras" need to be considered when evaluating the strengths of competitive properties.
Market analysis forms the basis for decisions regarding location and site, project size, design and quality, features and amenities, target audience, pricing, and phasing. Although market analysis examines demographic trends and projects sales, rents, vacancies, and absorption, qualitative insights are increasingly important. Characteristics such as how certain market segments perceive a themed retail center or what design features appeal to homebuyers in certain communities are being examined through surveys, psychographic research, focus groups, and cluster analysis.
A strong overall market does not necessarily equate to a good opportunity for development. Neither does a weak market mean that a good idea cannot be implemented. In other words, a good market from the perspective of demand may be oversupplied; at the same time, a good concept may overcome the challenges of a low-growth market. Moreover, not all demand is driven by growth; there are many opportunities to replace obsolete properties — buildings that have deteriorated, are poorly located, or no longer meet the needs of consumers. In-depth market analysis can reveal opportunities that may not be readily apparent. Poor implementation can undermine the most promising opportunities in any market, while even flawless implementation cannot redeem a bad idea. Understanding the market is a prerequisite to generating good development ideas.
What Is Real Estate Market Analysis?
Real estate market analysis is the identification and study of demand and supply. On the demand side are the end users — the buyers or renters of real estate (homebuyers, apartment tenants, retail stores, businesses seeking office or warehouse space, visitors needing hotel accommodations). On the supply side are competitors — both existing properties and those at various stages in the development pipeline.
Market analysis identifies prospective users of real estate, both buyers and renters, and their characteristics. Some product types appeal to a relatively narrow market niche — for example, a for-sale residential development that is targeted to active seniors who like to play golf. Others reach broad segments of the potential market — for example, a supermarket-anchored retail center that will be patronized by a large percentage of residents in adjacent neighborhoods. Location influences the target market. A neighborhood with a very desirable school district will draw families with young children. For childless households and empty nesters, the quality of schools will have little influence on the decision to rent or buy a home.
Analyzing competition helps a developer determine how to set prices or rents. Homebuyers will pay more for a home if it offers more desirable or up-to-date features or styling than another home. Tenants will be willing to pay the higher rents typical of a new building only if it has features, amenities, and locational attributes that are at least equivalent to those of established properties. Supply conditions also affect rents. If existing properties are experiencing high vacancy rates, prospective tenants may see opportunities to negotiate lower rents in older properties, thereby limiting the occupancy and income potential of a new building.
A market study can cover a single land use or multiple property types. With the growing popularity of mixed-use development, a single report can cover more than one use, each with a distinct geographic area from which prospective buyers or tenants will be drawn. A good example is a downtown high-rise apartment building with retail space on the ground floor. The target market for the apartments could include young adults from throughout the county or metropolitan area. However, the main source of patronage for the retail space would be nearby workers, with residents of the building providing secondary market support.
Depending on the type of project proposed, the geographic scope of a market study can be national or regional, but more often it covers a relatively small geographic area. The market area (or trade area for retail properties) is the geographic region from which the majority of demand comes and where the majority of competitors are located. Market reports that cover an entire metropolitan area or report on countywide conditions help set the context for project-level decision making.
A market study of a product type that is narrowly focused will yield the most useful results. For example, a study of all hotels in a region is a good starting point for providing background information. But more useful data come from homing in on directly competitive properties in the same price and amenity categories.
Most real estate market analyses examine both the market potential and the marketability, or competitiveness, of the proposed project. The market potential analysis examines aggregate data on demand and supply. Demand is, by far, the more difficult half of the equation. Projecting the strength of demand requires a mix of research, experience, and intuition.
Why Do a Market Analysis?
Just as there are many types of market studies, there are many reasons for doing them, from researching the potential of a site to refocusing a marketing effort.
Provide input for preliminary project planning. Developers will often commission a market overview when deciding whether to exercise an option on a parcel or to proceed with land planning for a project. This type of market study is often a brief memo or report with supporting data. It analyzes the location's advantages and drawbacks, suggests the types of uses that would be appropriate, and provides general guidelines on the range of rents or prices that could be achieved given current market conditions. The developer can then decide whether it makes sense to hire a land planner to further examine how many units or buildings the site could accommodate, what traffic issues must be considered, and whether detailed environmental studies will be needed.
Generate inputs for financial feasibility analysis. The results of the market analysis lead to the core assumptions that developers use in analyzing the financial feasibility of a project. The market study's conclusions regarding achievable rents and prices, the potential for additional income from project amenities or upgrades, and absorption and vacancy rate forecasts are important in determining projected cash flows and returns on investment. Developers can also predict what the impact on the bottom line will be if market conditions change.
Demonstrate the potential for a new product or an unproven location. As the demographics of an area change, existing real estate products may not meet current demands. For example, an upscale retail center may be appropriate for an evolving neighborhood, even though high end retail is untested in that area. Sometimes a developer can create a market for a new product type. A new style of rental apartment community can quickly render existing apartments obsolete in the minds of renters, thus creating an instant market for new, more stylish units. Today, "green" features enhance marketability; 20 years ago, environmentally sensitive construction techniques and materials might have been viewed as unnecessary or too costly. The notion of what constitutes the most desirable office space, shopping center, or housing can change overnight, forcing owners and managers to upgrade older buildings or lower their price points.
Locations once considered remote, unsafe, or inaccessible can become desirable. Expanding transit service, creating usable open space, providing a new highway interchange or improving the perceived quality of public schools can change the attractiveness of available parcels, offering opportunities to savvy, pioneering developers.
Attract equity investors, debt financing, or government funds. Partners, lenders, and other parties that are providing capital for a project need evidence that the developer's expectations are well founded, and that the proposed project can generate an attractive return, carry its debt load, and justify participation by government agencies. Investors and lenders will often commission their own market studies (separate from those submitted by the developer) as part of their due diligence requirements. These market studies may be conducted by staff members or by consultants.
Create a better, more marketable product. Market studies can help fine-tune the product by revealing the characteristics and demands of the market. For large projects, the market analyst should be an active member of the developer's preconstruction team, which will also include land planners, civil engineers, architects, traffic consultants, financial analysts, public relations specialists, and attorneys. Give-and-take among these development professionals is likely to result in a more successful project.
Build community support for private development. Few projects are able to proceed without some type of approval or assistance from a government agency, be it a variance in site planning standards, a change in permitted uses, or help in assembling land for a redevelopment project. When evaluating development proposals, local staff, elected officials, and consultants usually focus on issues of density, design, and traffic. However, developers who are requesting public subsidy for a project may be required to submit a market study and financial projections that demonstrate the need for government funding and conclude that the development has the potential to succeed.
Produce input for public sector housing or economic development planning. Government agencies also monitor real estate markets. At a minimum, local governments have a vested interest in keeping abreast of trends that affect property tax collections. And they may aggressively seek to attract development, hoping to diversify their tax base, revitalize a sagging business district, or provide needed workforce housing. State housing finance and economic development agencies often require that market studies be done before they will issue revenue bonds or allocate tax credits.
How Does Market Analysis Fit Into the Development Process?
Market studies are important at many stages of development. At the earliest point, an analyst might be asked to look at one or several metropolitan areas for development potential (sometimes called market screening). The analyst will then focus on a submarket and finally seek out a site that is most appropriate for the proposed development concept. But given the limited availability of developable land today, it is more common for a developer to have an eye on a specific site and ask that the site be studied.
If the site proves viable, the market analyst might provide a basis for determining its value so that a purchase price can be negotiated. Or this valuation might be performed by an appraiser. Either the market analyst or the land planner will investigate the development climate of the jurisdiction, looking for answers to the following questions:
Will the proposed project likely meet with public acceptance?
Will it gain the necessary approvals in a timely manner?
Are utilities readily available?
Are there difficulties that might slow or hinder the development process?
Recognizing that entitlement authorities represent customers to be sold on a project, experienced developers have learned that it is useful to address local authorities' concerns from the onset. A series of negotiations often transpires as developers seek to tailor their projects to regulators' expectations. It is far better to identify and address community concerns early in the project approval process than to face an anxious audience in a public hearing. Elected officials are much more comfortable issuing approvals when the electorate is at ease with a project.
Although market analysis is a crucial part of the initial feasibility study for a real estate project, market conditions come into play throughout the project design, approval, construction, sales or leasing, and management stages. Once the project is developed, a market analyst might be asked to evaluate the project's performance and compare it with earlier forecasts. It is very common for market analysts to be consulted for repositioning strategies after a project is up and running and the developer realizes that absorption is not meeting projections. Property managers continually monitor their competitors, checking to see how occupancy has changed, whether rents have moved up or down, and using new information to reposition the project as change occurs.
Who Uses Market Analysis?
Developers cannot rely solely on instinct or even past experience to decide what to build or to assure prospective lenders that a project will be successful. A rigorous market study early in the process stimulates development ideas, improves initial concepts, and serves as a device to control risk. However, developers are not the only players who benefit from market analysis. Research may be undertaken for the benefit of the investor, the lender, and the community whose well-being will be affected by the proposed project.
Real estate developers are probably the most frequent users of market studies, especially if they continue to own or manage their buildings. Market analysis is used during the predevelopment process; reports are often updated when applying for construction financing and again when sales or leasing efforts are underway. A good market study helps a developer
determine whether a location is suitable for development or choose among alternative locations;
identify a product or mix of products that best meets the demands of the market;
Excerpted from Real Estate Market Analysis by Deborah L. Brett, Adrienne Schmitz. Copyright © 2009 Urban Land Institute. Excerpted by permission of Urban Land Institute.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents
ContentsChapter 1 Understanding Real Estate Market Analysis,
Chapter 2 Basic Approach to Real Estate Market Studies,
Chapter 3 Analyzing Demand and Supply,
Chapter 4 Residential,
Chapter 5 Retail,
Chapter 6 Office and Industrial,
Chapter 7 Hotels and Resorts,
Chapter 8 Mixed Use,
Appendix A: Webliography,
Appendix B: Glossary,