Chapter 1 - The Real Estate Business
At the completion of this chapter, students will be able to do the following:
1) List at least three professionals associated with the real estate industry.
2) List at least three types of property.
1.1 Kinds of Professional Activity
You’ve seen them in front of homes, commercial buildings, and on empty lots. Showing up in all shapes and sizes, from stout wooden posts to slim metal stakes, real estate for-sale signs seem to be everywhere. The buying and selling of real estate is a booming business.
The demand for land has been going on for a while. The Homestead Act of 1862 allowed people to acquire up to 160 acres of free land if they worked it for five years. Eager settlers jumped at the chance and 1.6 million claims for land were approved. Private property ownership provided new opportunities, and it still does today.
When people relocate for new jobs, grow their families, downsize, or decide to invest in real property, they turn to the services of real estate brokers and agents.
The real estate industry includes residential, commercial and industrial property. It also includes land, and the rights above and below the land. The professions that build, buy and sell real estate are all part of the greater real estate industry. A primary industry professional is the real estate salesperson.
Real estate brokers and agents are required to be licensed by the state in which they work, and most states require completion of approved real estate courses and passing an exam in order to become licensed.
Anyone who receives the appropriate license can call themselves a real estate broker or real estate agent, but only those who belong to the National Association of REALTORS® (NAR) can use the title of REALTOR®. Residential and commercial real estate brokers and agents can become REALTORS® by joining the NAR, a trade organization. REALTORS® are pledged to Standards of Practice and a Code of Ethics and receive continuing education and professional development.
So, what is a real estate broker?
A real estate broker is a person or organization acting as an agent for others in negotiating the purchase and sale of real property for a fee, called a commission.
A real estate broker can do everything a real estate agent does, but they can also establish their own business and manage a team of real estate agents. However, they can also work independently, for franchises or for other brokers as associate brokers.
If the broker has agents working for them they are responsible for the agents and their actions. To become a real estate broker requires experience as an agent, a broker’s license, and additional education, depending on the state’s requirements.
Now, what is a real estate salesperson?
A real estate salesperson is a licensed agent that negotiates and arranges real estate sales. Agents must work under a real estate broker and the commission earned from sales is split between the broker and agent. The split can vary depending on the arrangement. Most agents specialize in working with residential buyers or sellers, land, businesses or commercial or industrial clients.
Buyer’s agents find properties, show them, negotiate prices and terms, and guide buyers through the purchasing process. Seller’s agents work with sellers to list and market their property, negotiate prices and terms, and guide sellers through the selling process.
Residential and commercial real estate agents can become REALTORS® by joining the National Association of REALTORS®.
In addition to real estate brokers and agents, there are other professionals involved in the real estate industry as well:
- Appraisers assess and report their opinion on the value of a property. The types of property can include residential, commercial, or agricultural real property, business valuation, or personal property.
- A property manager takes care of rental property for the owner, screens prospective renters, coordinates repairs, handles maintenance and tenant concerns, and even evicts when necessary. Most states require a property manager to have a broker’s license or work as a licensed agent under a broker. This can vary by state.
- Home inspectors come in when a property has been sold and before the transaction is completed to examine it for the buyer. According to the National Association of Home Inspectors, there are 1,600 items their members are trained to check. These include the physical exterior and interior, and the surrounding area. When presented with the final report, buyers can negotiate repairs or adjustments, depending on the terms of the contract. If the parties can’t agree, the contract might be canceled.
- Mortgage brokers and bankers provide financing for real estate transactions. While all-cash deals happen, most of the time some type of loan is involved. The difference between a mortgage broker and banker is that the mortgage banker is a direct lender, working for one institution, where a mortgage broker can work with several different lending companies. If someone has credit issues, they might find more options with a mortgage broker.
- Architects design and plan buildings and work with contractors to construct them. Most states have educational requirements, such as a professional degree, experience requirements, and an examination, such as the Architectural Registration Examination (ARE), to be licensed.
- Contractors build the buildings. Usually, a general contractor coordinates all aspects of construction, using their industry knowledge to bring together the many different aspects so the process goes well. They hire and schedule subcontractors, such as plumbers, electricians, roofers, framers, and others. The contractor oversees the job and is a constant single presence with whom the property owner works. A professional contractor has knowledge of architecture, building codes, restrictions, and limitations, knows which subcontractors are most qualified, has the ability to schedule for best outcomes, and implement the plans.
Now, let’s discuss how it all comes together when buying a house
Let’s say the Smith family has decided to buy a house. One of the first things they might do is to look online to see what’s available in the area they like. Studies show nearly 50% of buyers begin their search online. Then they will find a real estate agent to work with, as the majority (88%) of buyers buy their home through an agent or broker.
Next, they might go to a mortgage broker or banker to see what they qualify for, and to get pre-approved in preparation for buying.
When they find the right house, they’ll sit down with their agent and write a purchasing contract. The knowledge of the broker or salesperson results in a solid offer that protects the buyers while still being attractive to the seller. There might be negotiations as to price, terms, or other details that the agent will coordinate.
When the seller accepts the offer, a home inspection will be ordered, along with an appraisal.
The real estate salesperson oversees the aspects of the sales process, keeps the buyers informed along the way, and makes sure the progress is smooth.
Once each step of the sale is complete, the closing takes place and the property is officially transferred to the Smiths.
Let’s now discuss how it all comes together when selling a house
When the Smith family decides to move, there’s a good chance they will contact the agent they had worked with when they purchased, as 88% of buyers would use their agent again. Their agent or broker will research similar homes to give the sellers a good idea of an appropriate listing price.
Once the property is listed, it will appear on the Multiple Listing Service (MLS), which includes 92% of all listed homes on the market.
The agent or broker will promote and advertise the property, arrange for it to be seen, and market it to find a buyer.
Agents for the buyers will present offers and the selling agent will help the owners evaluate and negotiate the best offer for them. When agreement is reached, the property will undergo inspection and appraisal, with the possibility of contractors or even architects becoming involved if serious construction issues arise.
When all details are resolved to everyone’s satisfaction, the property will close and ownership transfers.
This is a general overview of the real estate industry. You can use this overview as a starting point to see how the various real estate professionals contribute to the industry at large.
Real Estate Broker
A person or an organization acting as the agent for others in negotiating the purchase and sale of real property for a fee.
Real Estate Salesperson
An individual who is licensed to negotiate and arrange real estate sales; works for a real estate broker.
1.1a Real Estate Professionals Infographic
1.2 Kinds of Property
Property types are generally categorized by the zoning law that applies to that property. Zoning laws determine how the property can be used in order to create more appealing and useful development.
The three most common zoning designations are: residential, commercial, and industrial. Most property falls into one of these three categories. However, zoning definitions can be different in different communities, counties, or states.
Residential properties include single family homes and multi-family buildings. Single family homes are private freestanding residential houses, while a multi-family building has more than one housing unit. Examples would be an apartment building, duplex, fourplex, condo, or townhome.
Single-family homes and single-family lots are always residential property, but there can be cross-over in other areas. For example, a multi-family apartment building is residential but could also be considered commercial. When obtaining a loan on a multi-family property, banks consider any property with 5 or more apartments as commercial.
The majority of real estate agents work with residential properties, as the homeownership rate is around 63%. Within the category of residential, agents can choose to concentrate their efforts in a certain area, depending on their skills and interests. Some agents prefer to work with buyers, while others want to work with sellers. Some agents might become experts with first-time buyers or decide they want to focus solely on luxury homes. Specializing has advantages because the agent can become an expert in a particular niche and build a reputation from that knowledge.
Commercial property is property used for profit-driven business purposes, such as retail stores, restaurants or offices. Shopping centers, hotels, nursing homes, and mobile home parks are also commercial property.
Agents who specialize in commercial property sales need to have a good understanding of the business side of ownership. Commercial property, since it’s used for business, could involve leases, rentals, tenants, maintenance, expenses, parking lots, and other elements not present in residential properties.
If for example you are interested in restaurants then you will have to know quite a lot about the restaurant business. You will need to know what the foot traffic to a given location is, if a given space has an entrance for customers and a separate entrance used for food delivery, in order for the restaurant to be compliant with the stringent safety regulations. Also you will have to know how competing restaurants in the region are doing as well as how long will take a restaurant on average to break even after moving in a new location. These are all factors that will affect a restaurant owner’s decision when making the decision to purchase or lease a space.
Mixed Use Properties
Mixed-use is a combination of commercial and residential real estate. An example of mixed-use would be an area where there are storefronts on the ground floor and residential spaces above. Another possibility would be an apartment building with retail or business space included.
Typically, the residential portion is greater than the commercial portion of the whole building.
One of the driving forces behind the popularity of mixed-use is the desire of residents to have retail shops and restaurants within walking distance. For example, people can live in apartments above stores, restaurants, and coffee shops with easy foot access to their apartments. Businesses also like the ability to build loyalty by having customers nearby.
Getting a mortgage for residential property is a different process from getting financing for commercial real estate. The income-generating potential will be a consideration, and other factors could come into play that will require additional information about the property and the buyer.
Industrial properties can include factories or warehouses and can range from small to enormous. They can cover a wide variety of applications. In addition to assembly and production, there can be distribution, warehousing, and research and development.
Agents who work with industrial property should know the business aspects of commercial property, but should also have an understanding of what the different needs are based on use. Manufacturers might want proximity to transportation for delivering their products. Tech companies might be looking for access to an educated labor force.
A company like Amazon who is shipping a lot of goods needs a lot of warehouses space is various locations throughout the country, in order to be closer to consumers, and ensure a fast delivery. This is very different than a company like Tesla who is producing electric cars and batteries and has just a few really large facilities in the United States.
Agricultural property can be farms or ranches. These properties are generally intended to be income-producing but can be for personal use as well. They can vary greatly in size, from family farms and ranches to large commercial projects. Agricultural property is usually used to grow and harvest crops, or raise, breed, and care for livestock such as cows, horses, pigs, sheep or goats.
The zoning of agricultural property helps protect it from having residential activity interfere with the operations of the ranch or farm, and distances residential areas from the sounds and smells of a farming operation.
Special purpose, or special use, real estate includes schools or churches. Special purpose means the property is characterized by the specific reason it was constructed. These are properties that are not easily converted to another application. For example, a school could not be turned into an apartment building, or a church could not become a grocery store without difficulty.
This is an area where the zoning doesn’t necessarily define the category. When Congress passed the Religious Land Use and Institutionalized Persons Act of 2000 (RLUIPA), it was designed to protect religious institutions from zoning discrimination. That means that while a house of worship might be most often found in a commercial area, it could also be in a residential area with the appropriate permit.
Special purpose properties can present a challenge when determining value, since the property is unusual enough that comparables are not common.
Vacant land is land that has no improvements added to it. Sometimes called raw land, this property is usually purchased with future use in mind, therefore zoning is an important consideration. Land can be found in the city or in a rural area, and can be residential, commercial, or industrial. It can be purchased to develop a sub-division, to build a single building, for an industrial complex or offices.
If purchased with the intent to develop, the availability of water, gas, electricity, and septic should be investigated. Cell phone service could be a factor, depending on what the purchaser wants to do with the land. Easements for utilities and the previous use of the property can affect the value or attractiveness of the land. If rural, the ability to access the property in all kinds of weather might be an issue.
In order to understand the characteristics of the property types in your area, it helps to know the zoning classifications. If you decide to specialize, familiarizing yourself with the features of the category you choose will help you become the expert your buyers and sellers will appreciate.
1.2a Types of Property Infographic
1.3 Factors Affecting Real Estate Markets
There are several factors that affect the real estate market, but they are all related in some way to supply and demand. Demographics, interest rates, costs, pricing, and the economy each affect the market by changing the balance.
What is Supply and Demand?
Supply is the quantity of goods or services available, whether in abundance or scarcity. Demand is the supply of willing and able consumers, which can be few or numerous.
In real estate, supply would be the number of properties available and demand would be the number of potential buyers.
Imagine it this way. When you were young, you might have played on a teeter-totter, or seesaw, where one side was up while the other down depending on the weight distributions. In this case, the weight is determined by the supply and demand. When the supply is plentiful and the demand is low, the pricing drops, increasing demand. When the supply is limited and demand is high, the price escalates, eliminating some possible buyers and reducing demand. Just like the teeter-totter, finding a balance between supply and demand can be challenging.
In practice, when there is a high demand for property in a certain location, developers and builders target the area for new homes. If the homes are built quickly, the balance can tip because now there are many homes available, the demand is satisfied and drops, and the price goes down in the hopes of creating another wave of buyers. However, like most things, it’s not that simple. There are other factors that weigh in on supply and demand and affect how the seesaw swings.
Factors that Affect Supply
There’s an old piece of advice, credited to Mark Twain, that says “buy land, they’re not making it anymore.” The wisdom in this saying is the fact that there is a fixed supply of land, which naturally creates a demand due to scarcity.
Even just the idea of a shortage can bolster demand to crazy extremes. For example, in 1973, talk show host Johnny Carson commented on an article he’d read in the newspaper about an impending toilet paper shortage. Because he had a large audience and credibility, people started panicking and buying toilet paper in huge quantities. Whether there had been any truth in the rumor, the reaction of people hoarding toilet paper caused a real shortage, increasing the hysteria and demand. People were afraid of missing out and being caught with no toilet paper.
How does this work in real estate?
Fear of Missing Out (FoMO), can create demand. Any perceived shortage, whether real or illusionary, drives a desire to acquire.
You’ve probably heard the old chestnut: “location, location, location.” That means that where a property is located directly affects how desirable it is. Since we know the available land is limited, and you add the fact that the most sought-after land is in specific areas, you’ve got a finite selection of property in high demand.
Consider ocean-front property or homes in ski resort areas. The prices are astronomical, which eliminates many potential buyers, but the property is so highly prized and so scarce that it sells briskly.
Location also plays a less obvious role. No two properties are identical, which makes each piece of real estate unique. In a subdivision where homes might appear similar, there are differences in their specific location, such as a corner lot, or proximity to a school or shopping center. That means two very similar homes might exist, one in a prime location and the other in a place less sought-after, and the location will affect the demand and the price.
With each property being different, people often prefer one above the others, creating a demand for that home. In these situations, a bidding war can develop, to the delight of the seller.
Construction costs can influence supply. There are hard and soft costs that can push the price up. Hard costs are the actual physical construction costs, such as excavating the land, grading the property, the cost of materials, utilities, paving, and landscaping. Soft costs include engineering, architectural design, project management, permits, insurance, and taxes. These costs can limit the number of homes built or increase the price since the contractors pass them on to the end buyer.
Local and state governments can also affect the cost of real estate. In places where there are zoning issues, building codes, land-use controls, there may be associated costs that increase the final price. For example, if property in a certain zoning area is restricted, the demand goes up, and the price increases. If the building codes put limitations on a popular development, this creates scarcity, and the price escalates. On the other hand, tax credits and subsidies can encourage buying and increase demand. For example, in 2009, when the government introduced a first-time homebuyers tax credit it motivated people to buy.
Factors that Affect Demand
Since we know people tend to gravitate to certain locations, the resulting large population needs homes in which to live. The more people who are around, the more buyers there are competing for a fixed number of properties. This can drive prices up.
The demographics in an area come into play. Demographics study of the statistical characteristics of human populations such as age or income, which is used to identify markets. This data about population and the people influence real estate because it has a direct influence on demand. For example, in an area where there is an uptick in families and children, the demand for bigger homes, larger backyards, or nearness to schools could increase.
The Baby Boomers are a demographic that currently is affecting demand. As this group enters retirement, many are downsizing, creating a market for smaller homes, condos or townhomes. In locations known as good retirement areas, the demand will be for different types of housing than in those with a large population of young families.
The economy of an area plays a part. Areas with an abundance of good jobs and wages draw people and increase home sales. People want to set down roots. The opposite is also true. Areas where jobs are hard to find and the income level is low, homes don’t move as quickly. The population can be transient as they travel from place-to-place seeking employment. If people can’t find jobs, if they can’t earn a decent amount of money, they can’t buy homes.
Sometimes housing might thrive because of a successful industry offering good jobs and pay. If the industry shuts down, or fails, the properties in the area can go from high demand to no demand suddenly. Boom! The seesaw lands with a jolt.
Interest rates impact the number of buyers who can qualify. We see the seesaw effect again. When interest rates rise, prices fall to increase demand. As demand increases, supply dwindles. When supply is low, demand increases, and prices do, too. When interest rates are low contractors can get more financing, so they build more homes, the supply increases, but demand continues because people can qualify for bigger mortgages, until the seesaw eventually levels out again.
Super high interest rates can stop this progress in its tracks. For example, in the early 1980’s the prime rate went to 21% and borrowers who qualified on Monday couldn’t close on their loan on Friday. Sales plummeted. Few people could pay the high rates, while inflation and unemployment added to the woes. Builders couldn’t get financing and the market stalled.
Understanding the cycles and impact of supply and demand will help you, as a real estate agent, be more confident as you guide your buyers and sellers and help them have a positive experience.
The supply of willing and able buyers in the marketplace or lack thereof.
A lack of supply.
The amount of a certain good or service that is available in the market.
1.3a Supply and Demand Infographic
1.4 Industry Trends
One of the responsibilities of being a good agent is understanding the trends of the real estate market.
No one can accurately predict the future. There are too many factors involved, and there are too many variables. However, since we know that the market generally follows a pattern that repeats itself, we can make some educated guesses about the direction based on what’s happened in the past.
There are four phases in the real estate cycle: Recovery, Expansion, Hyper Supply, and Recession. Each of the four phases has specific attributes.
The Recovery phase is when there is low demand, which is indicated by declining vacancies in properties, and no new construction is happening. It’s a lull where the demand is balanced with the available supply.
The Expansion phase is when activity resumes. While the vacancies are still down, implying a market for property, new construction is going on to meet the anticipated need.
The Hyper Supply phase is when there is new construction but vacancies are increasing, indicating there might be an oversupply developing.
The Recession phase is when supply has reached a point where it tips the seesaw, with an excess of units available, more than the demand requires. This results in increasing inventory.
Let’s look at how that might work in a typical residential neighborhood.
In the Recovery phase, activity is relatively quiet. The existing homes are nearly all occupied with homeowners or renters not looking to move, new homes aren’t being built and there are few real estate signs in yards.
As it moves into the Expansion phase, you might notice some of the remaining empty lots have sold, and the contractors are showing up to grade the land, and start framing. The skeletons of new housing appear and the sounds of hammering, drilling, and loud music fill the air. Let the party begin.
It’s all going along well. Homes are selling and people are busy. Then you notice a shift. In the Hyper Supply phase, sales slow as the previous demand is satisfied. However, houses are still being built. Since it takes about two years to complete new construction there can be a lag from the time the buyers have reached the saturation point to when the construction can wrap up and recognize that things have transitioned into the next phase.
The next phase is the Recession phase. Due to enthusiastic construction during Expansion, continuing through to Hyper Supply, you now see a lot of real estate signs in the neighborhood and not a lot of property changing hands.
To further complicate things, the term “real estate market” does not mean the same to everyone. It can mean the local market, which could be a state, county, city, or even a neighborhood. The factors that influence the phases are unique to that particular area. You could have one neighborhood in Hyper Supply, while across town another area could be in Expansion phase.
It’s not just location. It could be the type of real estate we’re talking about. There could be a glut of homes with low demand, while office buildings could be scarce and contractors can’t build them fast enough.
And what about perception? In the above example, a homebuyer might think the market is great since there are so many available homes, while the sellers think it’s terrible.
Real estate is local, perception is important, and the market is cyclical. This knowledge helps you be a better agent and serve your clients well.
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