Market determinants of value

Chapter 5
Learning objectives

• Explain the role of transportation modes and natural

resources in the location and evolution of cities.
• Define economic base activities and location quotient.
• Discuss concentric zone model and the bid rent theory.
• Explain importance of urban analysis in real estate decisions.
What does investors need to know about urban markets?

• First, it is important to recognize the fundamental forces that

create these markets, which are the forces that create and
shape cities.
• In addition, it is important to understand what brings change
to the shape of cities.
• Finally, it is important to understand how land use types
differ in their locational needs, something we refer them as
linkages.
The creation, growth, and decline of cities
• The most compelling locations for cities were the intersections of
different modes of transportation.
• Still other cities were born of mining and resource extraction.
• A number of American cities, for example, were propelled by coal
and iron ore extraction, and then became efficient centers for
heavy manufacturing. Other cities were propelled by the
extraction of oil and gas.
• Many of the great modern cities result from the good fortune of
being in a location that became important for a chain of functions,
or core activities, through time.
Economic base of a city
• The economic base is that set of economic activities that a city
provides for the world beyond its boundaries (thus, often called its
export base). The economic base of a city determines its growth or
decline.
• For example, many cities heavily oriented toward defense production
faced a time of stagnation/boom.
• Cities centered on supporting agriculture have faced decline for many
decades as farms and farm populations have diminished in number.
• Similarly, many university cities have experienced strong growth due
to the expansion of university age population and the growing
importance in modern economies of higher education.
• Growth and decline depends on the economic base of a city. Consider
the cases of Detroit, Tokyo, and Abu Dhabi.
Indicators of the economic base
• To quickly examine a local economic base, a growing number of
information sources is available.
• Always important are data from a local chamber of commerce or
government agency concerning the major employers, what they
produce, and how many persons they employ locally.
• One quick indicator of a community’s economic base is called a
location quotient.
• The underlying idea is that a community has some normal
pattern of employment distribution, and excessive
concentrations of employment in a particular industry indicate
that the industry is producing surpluses for export.
Location quotient
• Compute the percentage of total employment in a given
industry—for example, education—for the local community.
Suppose this is 20 percent.
• Compute the percentage in education employment for a
reference (national) population. Suppose this is 9 percent.
• Compute the location quotient, the ratio of the local to
reference percentage (20 ÷ 9 = 2.22)
Location quotient
• In this case the 2.2 indicates that the concentration of
education employment in the local community is 2.2
times than the national level, suggesting that education
must be an export industry.
• By calculating location quotients for all industries, one
can gain quick clues about the economic base of a
local community.
 The Shape of a City: Concentric Zone Model
Also called the Burgess model
◦ Developed in 1925 by E.W. Burgess
◦ 1st model to explain and predict urban growth
 All other urban models are built on this model

Based on urban growth in Chicago

Model suggests that a city’s land use can be viewed from above as a
series of concentric rings
◦ As the city grows and expands, new rings are added and older rings change
their function
◦ Size and shape of rings vary per city
Concentric Zone Model
Concentric Zone Model
Zone I (Central Business District)
◦ Definition:
 CBD- original core of a city’s economy, like a nucleus of a cell
CBD is compact, less than 1% of urban land area
◦ But contains a large % of shops, offices, and public institutions
◦ Consumer services and business services are attracted to the CBD
because of its accessibility
 Center is easiest part of city to reach from the rest of the region
◦ Focal point of region’s transportation network
Characteristics of a CBD
◦ High land costs
 Discourages Industry in the CBD
◦ Intensive land use
 Skyscrapers
Concentric Zone Model
• Zone II (Transition Zone) –
• The mixed residential and commercial use characterizes this zone.
This is located adjacent and around the CBD and is continuously
changing, i.e. transition takes place.
• Another feature is the range of activities taking place like mixed land
use, car parking, cafe, old buildings.
• This zone is considered to “decay”  because of a large number of old
structures as the buildings in transition zone were earlier used for
factories and multi occupancy building. This zone has a high
population density when industrial activities are at their peak.
• Those residing in this zone were of the poorest segment and had the
lowest housing condition.
Concentric Zone Model
• Zone III (Inner City/ Working Class zone) –
• This area is occupied for residential purpose and also known as
“inner city” or “inner suburbs.”
• It consisted of houses built to accommodate factory workers but
has better condition than the transition zone.
• This area has a mix of new and old development and generally
requires orderly redevelopment.
• People living in this zone are second generation immigrants as
many moves out of the transition zone to this zone whenever
affordable.
• This zone is nearest to the working area with modest living
conditions, and this resulted in reduced commuting cost.
Concentric Zone Model

• Zone IV (Outer Suburbs/ White Collar Homes)  –

• This zone had bigger houses and new development occupied by
the middle class.
• Many of the homes are detached, and unlike single occupants of
inner suburbs, families resided in these homes.
• Better facilities are available to the residents like parks, open
spaces, shops, large gardens but this comes at an increased
commuting cost.
Concentric Zone Model
• Zone V (Commuter Zone)  –
• This is the peripheral area and farthest from the CBD, this resulted in
highest commuting cost when compared with other zones.
• Significant commuting cost gave the name “commuter zone” to this
part.
• People living in this part were high-income groups which could afford
large houses, could pay commuting charges, had access to different
transportation mode, enjoy modern facilities like shopping malls.
• Low rise development, large gardens, less population density are
some of the characteristics of this zone.
 The rationale behind Concentric zone theory

• Burgess model takes into account the positive correlation between economic
status and distance from downtown. This considers, better the economic
status more the distance from the central area.
• The central area has high density, and the availability of land is scarce.
Because of this more affluent segment of the society reside away from the
city center where they can build large houses.
• Burgess described the changing spatial patterns of residential areas as a
process of “invasion” and “succession”.
• As the city grew and developed over time, the CBD would exert pressure on
the surrounding zone (the zone of transition). Outward expansion of the CBD
would invade nearby residential neighborhoods causing them to expand
outward. The process continues with each successive neighborhood moving
further from the CBD.
Bid rent theory
Burgess work included the study of bid rent curves according to
which the land with the highest rent was occupied with economic
activities of highest returns.
Bid-Rent curve predicts the land prices and population density
decline as distance from the CBD increases.
Bid-rent curves show the variations in rent different users pay for
land at different distances from some peak point of accessibility and
visibility in the market usually the CBD.
Transportation costs increase as you move away from the market
◦ Rents usually decrease as distance increases from the market.
 Bid rent
theory
Different types of land use
generate different bid-rent
curve
◦ Ex: commercial retail,
industrial, agriculture,
housing
Bid rent curves explain the
series of concentric rings of
land use found in the
concentric zone model
Bid rent theory
• It can be seen that commerce (in particular large department
stores/chain stores) is willing to pay the greatest rent to be
located in the CBD.
• The CBD is very valuable for them because it is traditionally the
most accessible location for a large population.
• This large population is essential for department stores, which
require a considerable turnover. As a result, they are willing and
able to pay a very high land rent value.
• They maximise the potential of their site by building many
stories.
Bid rent theory
• Industry is, however, willing to pay to be on the outskirts of the CBD.
• There is more land available for their factories, but they still have
many of the benefits of the CBD, such as a market place and good
communications.
• As you move further out, so the land is less attractive to industry and
the householder is able to purchase land.
• The further you go from the CBD, the cheaper the land. This is why
inner city areas are very densely populated (flats and high rises),
whilst the suburbs and rural areas are sparsely populated (semi and
detached houses with gardens).
• The pattern is never as simple in reality. Today, out-of-town shopping
centres and industrial sites have influenced the pattern.
The Role of Urban Analysis in Real Estate Decisions
• It is reasonable to ask how the broad ideas about urban land use we
have presented in this chapter really help with particular real estate
decisions.
• First, the location of a parcel is about its linkages or access to various
nodes within the urban matrix.
• Second, the nature of this location depends on the type of land use
being considered.
• For example, a weak location for a central place may be a strong
location for a shopping activity.
• Similarly, a weak location for offices may be a strong location for
warehouses.
The Role of Urban Analysis in Real Estate Decisions

• In short, the location quality of a particular site cannot be evaluated except

as part of the larger urban matrix.
• The growth potential for a site, and the appreciation potential of a site,
depends on where it is with respect to growing and declining within the city.
• In real estate analysis one must look not only to the current urban matrix
but also to changes in technology, transportation systems, and the economic
base in the future.
• The good location of one decade can become the declining location of the
next.
• It is imperative for persons considering real estate investments or real estate
careers to be aware of the economic base of cities they are contemplating.