Urban Real Estate

Economics
Professor Susan Wachter
REAL 215/724
Class 2 January 21, 2015
Why Cities

Outline
1. Administration and Introduction
2. What is a City?
3. Why Cities Develop
4. Systems of Cities and Future of Cities
5. Next Class: Readings and Topic

Administration and Introduction

Administrative information
Professor: Dr. Susan Wachter
Albert Sussman Professor of Real Estate, Professor of Finance
http://www.wharton.upenn.edu/faculty/wachter.cfm
http://www.upenn.edu/penniur/

Telephone: 215-898-6355
Office:
RM 430 Vance Hall
E-mail:
wachter@wharton.upenn.edu
Office Hours:
Tuesday 6:00-7:00pm

TA:
Matthew DeGagne
E-mail:
degagnem@wharton.upenn.edu
Office:
Vance Hall, Room 432
Office Hours:
Tuesday 10:00 am 12:00 pm

How to Access Readings/Course

Material
Most readings are available on Study Net as a
course packet.
Log on to www.study.net (you have been registered if
you are enrolled in this course and you should have
already received instructions via e-mail). Your
password should be your last name, which you can
change upon logging in.

Additional readings as noted on the syllabus are

available on canvas. You should be automatically
added to the canvas site.
For assistance, email your name and the name of
the course to courseware@wharton.upenn.edu
5

Readings
Today

Mills and Hamilton, (pp.7-20; rest optional)(BP#3) KEY READING

OSullivan, Ch. 2 & 3, (pp. 17-24) (BP#4) (pp. 45-52, 57-63) (BP#5)
Moretti The New Geography of Jobs (pp. 121 144)(BP#1) (optional)
Lin, Geography, History, Economies of Density, and the Location of
Cities (canvas)(optional)
Duranton, Urban Evolutions: The Fast, the Slow, and the Still (canvas)
(optional)
Glaeser, Why Growth (canvas)(optional required for Class 21)

Next Class
DiPasquale and Wheaton, The Property and Capital Markets,
Chapter 1 (BP#6)
Wachter and Kroll, Simple Analytics of Equilibrium and Disequilibrium,
(pp. 1-17) (BP#7)
6

Course Objective: Pricing Real Estate over

space and time
Value over space: nation, metro, local (city
and neighborhood)
Value over time:(next class) How capital
markets determine prices given rents through
cap rates.
Markets do price real estate but importantly
real estate is different : fixed supply, role of
government and lack of short selling.
Market analysis- methods and data (later)
since cannot rely on efficiency of markets for
build, buy, sell decision
7

How markets price real estate:

Cap Rates and Rents
Property price is the net present value of
expected cash flows rents which vary over
space. Rents reflect the value of location: what
firms and households are willing to pay.
Cap rates vary by metro, reflecting different
expectations on market rent growth rates.
When you buy real estate in a metro you are
buying into market wide expectations of rent
growth which depends on the growth or decline
of the metro economy (jobs). Buying at the going8

Commercial and Residential Real

Estate Bubbles

Ren
t

Today
Focus today: Region wide demand for real estate as
determined by urban marketmetro economic activity.
National economy and macro cycle matter.
Regional markets driven by demand for regional (metro)output.

GNP= GMP which determines demand for real estate.

Jobs and industries are not uniformly distributed. GMP growth
depends on growth of underlying regional industry cluster.
Cities are made up of specific job and industry clusters. Why?
In the age of the internet, why does location matter?
10

Next Class: Rent and Price

Linkages-in National and Metro
Real Estate Markets
Equilibrium
rents and
prices are
determined
for national
and metro
markets
based on
fundamental
s.

Note 2:
Construc
tion is a
flow =
depreciati
on rate =
percentag
e of
Stock
that keeps
Stock
constant

Note 1: Prices, rents, construction (starts), and stock are constant in

equilibrium given underlying demand curve, supply curve, depreciation
rate and interest (cap) rate

11

In metros with higher GMP, prices and

rents are higher due to higher land costs.

With higher GMP ,

demand for real
estate is higher.
Higher rent,
price, (due to
higher land
costs),
construction
starts, and stock
result.
DiPasquale/Whea
ton long run
equilibrium 4
quadrant model
for 2 metros with
different
quantities (stock)
of real estate.
12

What is a City?

13

Cities are Clusters of Population and

Jobs Boston to DC

Boston

NYC
PHILA
DC

NJ Pine
Barren
s

Pine Barrens
are 2,000 sq.
miles;
density of 10
people/sq.
mile
NYC (all 5
boroughs)
300 sq. miles
and 9 million
people
30,000
people/sq.
mile

http://www.census.gov/geo/reference/gtc/gtc_cbsa.html
14

Cities=Where Densities, Rents, and

Prices Peak
Density=ratio of population to land area
Per square mile, hectare or acre.
Square mile=259 hectares. Hectare=about 2
acres

Population densities vary from 10 people per

square mile (rural) to, eg, about 30,000
people in NYC, to 100,000 psm in Manhattan.
Tot pop of 20 million in NYC metro.
Per hectare: from 40 in NY metro to 115 in NYC to
300 in Manhattan.

Land values vary, eg in NYC, can vary from

$10,000 at edge to $1 billion per acre or more
at center.
15

Within Metro Density

16

Density Across Metro Areas

17

Metro Areas are the Economic

City
Defined as the market area where real estate
prices rise and fall together
Metro areas economies are driven by different
job/industty clusters, different economic engines
Firms choose metros and provide jobs.
Within metros, HHs keep prices in line by location
decisions =>metros are defined as commuting sheds.
Metros include urban core =central city (and center
business districts) and surrounding suburban counties
with significant commuting to the core.
Metros can and often do cross municipal and state
borders.
18

MSAs (381) = 85% of US Pop

19

US Metro Areas
Metropolitan Statistical Area (MSA):
Core city of more than 50k plus surrounding counties from
which there is substantial commuting
3,144 counties, boundaries more or less constant over time

Micropolitan Statistical Area:

Urban core (10-50k) + surrounding counties with substantial
commuting (541 in the US)

Core-based Statistical Area (CBSA):

Refers to both Metro and Micro Statistical Areas economically
tied to urban center

Combined Statistical Area (CSA):

2+ adjacent CBSAs with substantial employment
interchange

https://www.census.gov/popest/about/geo/terms.html
20

Philadelphia: Metropolitan Statistical Area

(MSA) & Combined Statistical Area (CSA)
Philadelphia-Reading-Camden CSA

Metropolitan Statistical Area:

1. Is a geographical region with
a relatively high population
density at its core and close
economic ties throughout
the area
2. Center city of 50,000 or
more and its surrounding
commuter shed
Combined Statistical Area:
. Grouping of adjacent MSAs
Green on map represents
national parks and forests

21

County-level cities in China

600+ countylevel cities in
China and
growing
Over 500
million people
move out of
poverty into
cities over past
35 years

Cities Around the World

Metros generally recognized economic entities
Paris is a municipality within the Ile de France,
metropolitan region. Also in France, metro
regions include Lyon, Marseilles, and Lille.
Greater London (extends to the green belt
around London), also Manchester, Birmingham,
Leeds, Liverpool, 46 in total
China has X cities which include
Within cities, high demand for real estate,
given locational advantage of clusters..
http://en.wikipedia.org/wiki/Greater_London_Built-up_Area
23

Why Cities Develop

24

Historical Perspective
Urban settlements extend back to
beginning of recorded history=> fortress,
mining, port (trading) cities
Industrial revolution=> manufacturing cities
Globalization=> knowledge based
command and control cities

25

Why do cities form?

Cities form where there is market demand due
to production and consumption efficiencies
Clustered production and clustered consumption
are efficient and result in lower cost output and
services
Cities produce goods that they exchange for raw
materials from the surrounding rural area
The traded good (or service) is the base good
(export good) of the urban economy
Growth of export/base goods predicts growth of
employment in city and overall pop growth of
city
26

Another Word for Cluster:

Agglomeration
Paul Krugman 2008 Nobel Prize for the New Urban
Geography, and New Trade Theory. Concentration of
specialized industries in particular localities
Nobody really thinks that Silicon Valley owes its
existence to exogenously given factors of production
advantage. (God made the Santa Clara valley for
apricots, not semiconductors.)
How are global cities/clusters linked?
The Increasing Returns Revolution in Trade and
Geography Prize Lecture 12/8/2008
http://www.nobelprize.org/nobel_prizes/economics/laureates/2008/ krugman_lecture.pdf (canvas)

27

Global Urbanization
New trade theory motivated by similar-similar trade
occurring among advanced economies due to
specialization
A global shift by 2000s, the United States did more
trade in manufactured goods with developing countries
than with other advanced nations - Krugman
Rapidly rising trade between high and low wage
economies occurring through rise in trade between
cities of the industrialized world and emerging
economies
Rise of cities in China.

28

Without clusters, no cities

World with no cities
Uniform distribution of population
Uniform density with no density peaks (e.g. 9
acres per person in the U.S.)

Assumptions for a world without cities

1. Uniform physical plane (no comparative
advantage of the place)
2. No economies of scale in production or
consumption
29

If no advantages to spatial
clusters
No production or consumption
organized in density or scale
All goods would be made at home
No trade

30

Trading cities
Comparative spatial advantages
Differences in resources (e.g. proximity to
resource extraction)
Natural trading points (e.g. trading cities
along a river or seaport)

Trading cities develop as a result

Uniform physical plane, then why cities?
Why industrial cities which supplanted
trading cities.
31

Why did industrial cities

develop?
Assume away comparative spatial
advantages, assume a uniform plane
Why are there cities?
Assume one firm with economies of scale
Customers of that firm and suppliers to that
firm, all else equal will want to locate near.
Other firms with economies of scale will
want to locate near to access market.

32

Why Industrial Cities Develop:

Agglomeration Economies
AE=advantages of spatial concentration resulting
from firm scale economies with transportation costs
Industries with economies of scale attracted to an
urban customer base, labor base and/or supplier base
Will bid up land prices and rents near market, with
bigger markets commanding higher rents and prices
Economies of scale vary by industry, gives rise to cities
of all sizes
If transportation costs are zero, no need to cluster near
market, near other firms for this reason, so will cities
exist in a virtual economy?

33

Sources of Urban Agglomeration

Kinds of AE urban and local Duranton (1999)

Distance, Land, and Proximity: Economic Analysis

and the Evolution of Cities.
http://www.envplan.com/epa/fulltext/a31/a312169. pdf (canvas)

Advantages of spatial concentration that result

from the scale of an entire urban area or industry
size
Urbanization economies: across industries, large
market sizes create large pools of supplier/consumer and
allow specialization.
Localization economies: within an industry, arise from
many firms in the same industry locating close to each
other.
34

Urbanization Economies
Specialized service firms need large cities to
find a sufficient market.
Firms from many different industries need
suppliers, such as banks, insurance, printing,
office technology, etc.
Input sharing- scale economies in input use and
production-result in efficiencies in shared input
use e.g. airport, university
The larger the city, the more specialized needs
can be supported

35

Localization Economies
Production costs of a firm fall if the total
output of the local industry increases
Labor Market Pooling
Lowers search and moving costs for workers and
firms

Input Sharing
Scale economies in input use and productionresult in efficiencies in shared input use e.g.
airport, university

Knowledge spillovers
Industry cluster facilitates rapid exchange of
information and diffusion of technologylike
Silicon Valley

36

Examples
Localization agglomeration economies
gained from specialization:
Finance: London, NY
Media, entertainment: Los Angeles and
Mumbai Bollywood
Geneva and watches
Milan, NY, Paris and fashion
Eds and meds: NY, Boston, Philadelphia
Aerospace, Seattle
IT, Silicon Valley, Bangalore
37

Urban Bright Lights and

Consumption Agglomerations
AE hold for consumption as well:
Restaurants, music, arts
Large groupings of heterogeneous people
increase the likelihood that there will be
sufficient demand for idiosyncratic products.
Carlino and Saiz (2008) Beautiful Cities:
Leisure Amenities and Urban Growth
http://ssrn.com/abstract=1280157
Paris!
38

Systems of Cities

39

How are cities constructed

in space?
How will cities be arranged in space
Two key concepts of central place theory
Threshold: the minimum market size for a firm to
exist due to costs and economies of scale
Range: the average maximum distance people
will travel to purchase goods and services

Gives rise to the rank size rule and map

40

Central Place Hierarchy: 2

pictures

41

Rank Size Rule: Zipfs Law

The largest city with the highest economies of
scale firms has the largest population & jobs
Firms with second highest economies of scale
will locate in the two second largest cities each
with half the population (and jobs) of the first
tier city
Rank size rule

Definition: The product of an urban areas rank and

population is a constant equal to the population of the
largest urban area

The rank size rule implies that the second

largest urban area is half the size of the largest,
etc.
With a given market size, one city will serve all
market with highest level scale economies, the
second two cities will each serve half42that
market

Rank Size Rule

25000
20000
15000
10000
5000
0
1

7
43

City Size Distribution

Conforms broadly to rule
City size range reflects economies of scale
Cities compete for industries and
agglomerations with highest scale econ
i.e. Mercedes Benz in Atlanta and Tuscaloosa,
Alabama
Branson, Mocountry music competing with
Nashville

44

US Size Distribution of Urbanized

Areas

>12.8 million
1
6.4-12.8 million
2
3.2-6.4 million
4
1.6 to 3.2 million
14
800,000 to 1.6 million
19
400,000 to 800,000
33
200,000 to 400,000
52
100,000 to 200,000
99
50,000 to 100,000
172
45

47

Future of Cities

48

Cities and Knowledge

Creation
Information flows intensify the need for face
to face interaction
Cities are the best provider of the social
connectivity
Cities foster central functions and
specialization within global trading networks
The internet and in person exchange are
complements.
49

Moretti, The New Geography of

Jobs
Why do innovative firms cluster near each
other in expensive locations when they could
be elsewhere?
No obvious natural advantage
Place matters! But why?
Productivity and creativity
Dynamic and net work advantages
1. Thick labor markets skilled workers, become
more skilled
2. Knowledge spillovers: social diffusion of ideas
50

Glaeser, Revitalizing American Cities

Inequalities in skills
have been growing
over time
Places that started
more skilled have
become more skilled
51

Dynamic Advantages
Global Superstar Cities and Knowledge Economies
Global super star cities: Innovation speeds up
because smart people are connected to each
other, and because they are gateways to
finance, that spurs economic growth
Paradox of modern metropolis urban proximity
has become ever more valuable even as the cost
of connecting across long distances has fallen
High population densities give residents greater
opportunities for face-to-face interactions.
Result: Nonlinearity in wealth and productivity
increases by city size =>global super star cities
52

2014 NYC Adds a San Franciscos

Worth of Skyscrapers to
Development
Pipeline
Applications for 51 towers of 300+ ft. submitted to
the DOB
17 of these towers at 500+ ft.

San Francisco only has 18 structures total of such

500+ ft. height

53

Cities with Population >20 Million by 2025

Tokyo, Japan
Delhi, India
Shanghai, China
Mumbai, India
Mexico City,
Mexico
New YorkNewark, USA
Sao Paulo, Brazil
Dhaka,
Bangladesh
Beijing, China
Karachi, Pakistan

Population
1970
1990
23.3
32.5
3.5
9.7
6
7.8
5.8
12.4

(millions)
2011
2025
37.2
38.7
22.7
32.9
20.2
28.4
19.7
26.6

8.8

15.3

20.4

24.6

16.2
7.6

16.3
14.8

20.4
19.9

23.6
23.2

1.4
4.4
3.1

6.6
6.8
7.1

15.4
15.6
13.9

22.9
22.6
20.2

In 1970, 2
cities > 10
Million
In 2011, more
than 20 cities
> 10 Million
By 2025, more
than 10 cities
> 20 Million

54
UN World Urbanization Prospects: http://esa.un.org/unup/pdf/WUP2011_Highlights.pdf

How Cities Respond to

Markets
If there is a market demand for
development of cities:
Cities have incentives to spur local
development, to sell themselves to
industry and employers and to build
infrastructure
Land sales in China motivated by desire
to grow cities by local officials (similar to
US)

55

Do markets or governments
dictate?
But infrastructure and government
regulations determine where cities will exist
as well
Roads: national system links local areas to
markets and local roads follow development if
financing and incentives to provide local
infrastructure
Do cities have ability to self-finance
infrastructure?

56

Indias Golden Quadrilateral

57

The Century of the City

First time in world history that the majority of the
globes population lives in cities
Today 7 billion people worldwide; by 2050, about
9-11 billion people
Global urban population will grow by 2-3 billion by
2050; of which, 2.5 billion will be in developing
countries
In 2025 there will be more than thirty mega cities of
more than 10 million people. Before 1950 there were
only 2: New York City and London
More than 50 million move into cities each year
A city about the size of Philadelphia per week
58

World Population Continues to

Grow
1950 1.5 billion. Today
7 billion people
worldwide; 3 billion
more by 2050; of
which, 2.5 billion will be
in developing countries
15 years for next 1
billion
Build out of earth by
2050?

Source: http://www.economist.com/node/21533364

59

Future Population Growth is in Cities

ource: World Urban Prospects: UN

60

Next Class: Readings and Topic

61

Next Class: Readings and

Topic
DiPasquale and Wheaton, The
Property and Capital Markets,
Chapter 1 (BP#6)
Wachter and Kroll, Simple Analytics
of Equilibrium and Disequilibrium,
(pp. 1-17) (BP#7)

62

Zell/Lurie Real Estate

Career Fair
Friday, January 23, 2015
Houston Hall, 11 a.m. to 1:30 p.m.
Open to ALL students interested in real estate.
Meet more than 100 professionals in all areas of the
industry: development, finance, management, and more.
The
The Zell/Lurie
Zell/Lurie Real
Real Estate
Estate Center
Center gratefully
gratefully acknowledges
acknowledges the
the Jeff
Jeff T.
T. Blau
Blau Endowment
Endowment for
for Student
Student
Placement,
Placement,
which
which has
has helped
helped make
make this
this event
event possible.
possible.