Overview
This lecture explains the Four Quadrant Model, which illustrates the interactions between real estate space and asset markets, focusing on how rent, supply, demand, and pricing dynamics connect.
The Four Quadrant Model Structure
- The model links the space market (rent and quantity) with the asset market (price and rent).
- The demand curve in the space market slopes downward: higher rents reduce demand.
- The asset market quadrant shows the relationship between rent level and asset price, connected by the price-to-rent ratio (inverse of cap rate).
- The supply side is depicted as a kinked supply curve: fixed in the short run, more elastic above cost-feasible prices.
- The kink in the supply curve represents the cost-feasible value, above which new construction is viable.
Market Interactions and Changes
- An increase in demand (e.g., due to population or job growth) shifts the demand curve, increasing quantity demanded at each rent level.
- This demand shift raises rents and the asset price, which can trigger new supply if prices exceed construction costs.
- The market tends toward equilibrium where all quadrants align, although overshooting and cycles can occur.
- Normal vacancy rates exist even in equilibrium.
Asset Market Influence on Supply
- Lower required yields (cap rates) in the asset market increase property values, inducing new supply—even without changes in rent or vacancy.
- Higher required yields decrease prices below construction viability, stopping new supply.
- Asset market valuations influence supply independently from space market vacancy and demand.
Key Terms & Definitions
- Four Quadrant Model — A framework connecting space (rent, quantity) and asset (price) markets in real estate.
- Cap Rate — Current yield, calculated as net operating income divided by price.
- Cost-Feasible Value — The price point above which new construction becomes profitable.
- Kinked Supply Curve — A curve showing fixed supply in the short run and elastic supply above construction cost.
Action Items / Next Steps
- Review Chapter 2 of the referenced textbook for more details on the Four Quadrant Model.