Location Analysis and Location Selection in Property Investing
by Petros S. Sivitanides, Ph.D.
Location analysis and selection is one of the most important components of a real estate investment strategy and can make the difference between small profits (or no profits) and big profits. Understanding at which locations new demand for housing and commercial real estate will be distributed within a metropolitan area will give valuable clues in identifying neighborhoods and areas that will allow for higher profits in property investments.
Theories of urban growth can help investors understand and anticipate the path of urban growth and the spatial distribution of new demand in the longer-term. Such theories, however, are inadequate in answering the question of how strong increases in market demand due to economic growth will be distributed to existing structures at different locations within the urban area at a given point in time. An analytical framework that may help identify which locations may benefit the most from strong economic growth within an urban area is based on the notion of the hierarchical structure of the market, introduced by Sweeny (1974)1. Although Sweeny’s model refers to the housing market, it is applicable to other real estate markets as well.
For the purpose of a meaningful dynamic analysis, an area’s real estate market should be perceived as consisting of a bi-hierarchical structure. This bi-hierarchical structure consists of a quality hierarchy within each use and a spatial hierarchy for each quality. Within this framework, the residential real estate market of a city consists of submarkets of different qualities, such as the submarket for high-income houses, the submarket for middle-income houses, and the submarket for low-income houses. Furthermore, we can describe the spatial structure of each submarket as consisting of different neighborhoods/communities that can be ranked in terms of their locational strength and attractiveness to best location, second best, etc. In classifying locations, one needs to take into account another important dichotomy of locational preferences-the dichotomy of suburban versus downtown, or central city. Thus, it may be more helpful to classify the locations of different clusters as downtown and suburban first, and then rank them by strength and attractiveness. The ranking of the different clusters, neighborhoods, or communities should be based on an evaluation of how well they satisfy the different locational requirements for the specific use considered. The dual strategy I have been suggesting so far is to select first metropolitan markets with the strongest employment, income, and/or population growth prospects, and within these markets, select the locations best positioned to attract the new demand from firms and households. Sweeny’s framework can help identify the locations where new demand for commercial and residential real estate will be distributed within a metropolitan market. It is logical to assume that the locations that best satisfy the quality and locational requirements of the types of households and firms that will be the source of new demand will be the ones to reap the greatest benefits from metrowide economic growth. For example, if there is an increase in demand for class A suburban office space, it is very likely that that the strongest and most advantageous suburban clusters with class A office space will be the ones to benefit the most from such a surge in demand. In using Sweeny’s framework to identify destinations of displaced uses, the basic hypothesis is that demand displaced from best location will be distributed to the second best, displacing the tenants at that location to the third best location, and so on. This hypothesis is based on the rationale that displaced users will seek locations of similar quality and characteristics with the location they are displaced from. If this hypothesis is true, the displaced uses will turn to locations that rank closest to the location they are displaced from, as long as the residence-work commuting time remains within acceptable bounds. When classifying locations in terms of quality and strength, it is not necessary that every location be better than one location and worse than another. The classification should reflect reality. If two locations have similar locational strength and quality, they should be classified in the same category. If the superiority or inferiority of one location is not clear, one can include it in the closest category and try to keep in mind how it differs from superior or inferior classes. Not all locational differences can be translated into a plus or minus. Some locational attributes are multi-dimensional, and their contribution to the strength of a location is conditional on the nature of locational requirements of the groups that may demand that location.
1 Sweeny, J. 1974. “A Commodity Hierarchy Model of the Rental Housing Market.” Journal of Urban Economics, Vol. 1, No. 3, pp: 288-323.2This is an excerpt from the book Profitable Real Estate Investing: A Value Growth Approach by Petros S. Sivitanides, Ph.D.
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Anticipating the Path of Urban Growth
Anticipating the Path of Suburban Growth
Return from Location Analysis Page to the Real Estate Articles Page
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