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The Real Estate System

Blog by Andrew Reid | February 4th, 2021

The Real Estate System is a tool that creates a general framework in which to understand the connections between the space market, the asset market and the development industry and how these connections affect the demand for commercial real estate. The space market is the driving force in forming the asset market and development industry since it is from the space market that the cash flow to support property valuation and the financing of future projects is derived (Geltner, et al., p. 21). The income from the space market, coupled with the cap rate requirement in the asset market, determines the market value, which acts as a signal to the development industry to build when asset values are higher than development costs (Geltner, et al., p. 27).  Two key components of the real estate system are the negative and positive feedback loops. The negative feedback loop is a self-regulating mechanism that brings the market back into equilibrium if supply and demand in the space market are out of balance. The positive feedback loop is a self-reinforcing market dynamic that is generally associated with irrational exuberance and asset bubbles, but can also accelerate market corrections and push assets below their intrinsic value (Geltner, et al., p. 28, 29). An understanding of the positive and negative feedback loops in the real estate system is crucial in order for investors to gauge where they are in the real estate cycle and how they should deploy their capital.