Real Estate and the Urban Economy

Abstract

How does consideration of an asset market for realty help us better understand the operation of the urban economy? On the one hand, the asset market for realty bridges the gap between the short run (current demand) and the longer run (the economic life of a building). We distinguish here between realty as an asset (over that longer run) and the role of realty in the provision by landlords of a service (e.g., accommodation) to users in the short run. In this chapter, I present and interpret a four-quadrant model of the realty market that originates with DiPasquale and Wheaton (1996). In that model, a sufficiently high asset price (for floor space) gradually attracts investment which builds up stock (net of depreciation) and thus reduces market rent and asset price until finally there is no further incentive to add to the stock. To make that model easier to understand, I first begin with a two-quadrant version. Here, new stock is added instantly in the amount needed to bring market rent and hence asset price down to where the latter is just equal to the cost of construction. The two-quadrant model is in market equilibrium . However, the four-quadrant model is only a slow approximation to capital market equilibrium. To me, the slow approximation reflects the risks of investment. Spanning from the two-quadrant model to the four-quadrant model forces us to think about risk and its incorporation into the functioning of the urban economy . That sets up the following chapter.