hi my name is Norm Miller and I'm going to talk about the four quadrant model I'm from the University of San Diego berore Center and this discussion is meant to support lectures on this particular topic that are derived from a book by David geltner and myself along with Jim Clayton and Pete I Colts it's the third edition chapter 2 that I'm referring to but previous editions also cover the four quadrant model this model is important because it connects the space and the asset models it connects the markets for Real Estate assets that is what we're going to pay for Real Estate independent of the market uh for the space itself so let me go ahead and explain a little bit about how this works so let's start with the upper quadrant what you have in the upper quadrant on the right side here is quantity and rent now you could typically see an economic graph of supply and demand with price and stock here we have just the demand portion and we're going to put the supply portion down down here I'll come back to that in a minute so this demand curve slopes down because the um the higher the rent would be or Price the less would be demanded so you see that it's slopes such that the higher the rent the less demand it let's look at the next quadrant here we have the rent level and here we have the price that somebody will pay in the market the typical investor for that given rent level so the slope of this line here is the ratio between what the market will pay in price for a given level of rent you can think of that as a price to rent ratio but it is in fact the inverse of a cap rate um of course it's a cap rate on the total rent in this case but you can think of it as reflecting cap rates and yields in the market a cap rate in the market Market of course is a current yield calculation defined as the net operating income divided by price but this slope right here is pretty important because it reflects how much a property is worth per dollar of rent now if this slope would flatten out that would mean that people are willing to pay a higher price for given level of rent and accept lower yields and that would raise the price in the market for an asset even at the same rent level if on the other hand the yields would get steeper or higher and the slope would be more like this what that would do would be pay less for a given level of rent and that would lower the price or value of those assets in the market so here we have the space Market on the demand side here we have the asset market and then let's go down to the lower quadrant on the left this is a Kink supply curve right here it's fixed in the short run and then it's fairly elastic that is at a given price you will see um more construction so long as the price of that particular type of property exceeds construction cost so this point where the Kink is is the cost feasible value of the property above o which you'll see new construction below which you'll see none and here we have a uh adjustment to the stock as we add more Supply um in terms of uh adding Supply and quantity and technically we should have an adjustment there for units lost as well but you can think of this line as being a net adjustment all right let's go ahead and say what happens if if something changes in the market what if the demand would increase then at the same rent level we would see more quantity demanded let's go ahead and do that so demand increases because maybe population increased or jobs increased increasing the population but for whatever driver at that same rent level you see that the quantity to demand it is right here a much higher Q or quantity level than we have before again at this rent level it hits the demand curve here it hits the supply curve here or the quantity line here and so there's a much higher quantity demand it at that rent level than before let's go ahead and see what happens as we extend this at the current level of quantity Supply right there where you see the dot Red Line go up the rents are going to increase aren't they and they're going to increase all the way up to that R1 now note that before the price that that was supported was at this rent level and this price now it's much higher let's continue to take it down that P1 level is way above the Kink way above cost feasible construction of course this is an exaggerated curve but you see that it hits the construction rate way out there everybody's going to try to add Supply as quick as they can and try to add net new Supply and you can see that this doesn't really look like an equilibrium because it doesn't really match up as a square where all the markets are connected it is possible of course for the market to overshoot and go through cycles and we see that all the time but let's go ahead and assume that um that the market doesn't overshoot then it anticipates uh who's going to add Supply and and doesn't not overshoot what would equilibrium look like something a little bit more like this demand increases forcing rents up at first uh reducing vacancy down to zero perhaps and the value of the properties initially go up to this higher level R1 the prices are up at that level but as we add new Supply and the market sees it coming it reduces the value of the properties a little bit and we end up getting this rectangle or square that connects all the markets in equilibrium and the point is this the Market's always working towards and trying to move towards equilibrium even though sometimes it may undershoot or overshoot also keep in mind there's a normal level of vacancy in the Market at all the time and that should be expected what happens if we change the slope in the asset Market that is what somebody's willing to pay for a dollar of rent so here we change the yield from 11% I know that's high by today's standards but the grph still works to something lower 8% the slope moves down the value of the property which would have been right here now moves all the way out to here the price of the properties now much higher you can see that new Supply will be induced from this level to this level and we're going to see quantity move from here all the way out to there so here's the point even if rents don't change vacancy doesn't change if the yields required in the market are reduced you're going to induce new Supply I hope that makes sense let me reverse it if if the yields required went the other way and were higher the prices would go down below cost feasible construction and you would get no new Supply so this can work in both directions that is we may be at Cost feasible prices right now but if yields would go down it would increase the value of the assets and you could get new Supply and if yields required would go up it would shut off new Supply so there's an asset Market connection to the amount of Supply that's independent of the vacancy rate and the particular demand and Supply that we see in the space Market that is the space Market could have a given vacancy even 15% but if the yields are going down enough you might even see new construction in a market that that may have what might seem to be abnormally High vacancy but because yields go down enough you could still see new Supply and used again the point is that the asset Market valuation is related to but somewhat independent of the space Market it's related to it in terms of risk but in terms of yield that's really dependent on the other Alternatives in the capital market and the appetite uh for real estate and I'd like to thank you for your time I hope that makes sense and I hope this uh helps for those of you that need review