System Dynamics as a complementary

method for Real Estate

June 27th, 2009

Martijn Eskinasi

What is system dynamics?

• An explanatory and simulation methodology

• Used for both quantitative and qualitative modeling

• Used in expert approach and interactive learning processes

• Its claim to fame:

– “Find robust policy measures for highly complex dynamic problems”

Basic ideas & concepts

• Structure of a system drives its dynamic behaviour in time

• Structure is based on causal loop, stocks and flows

• Policy measures are very tenacious• Because people cannot mentally simulate highly

complex dynamic systems

• Murphy's law in practice??

Causal loops and feedback

• Axioma of circular causalities and feedback• Reality consists of intertwined causal loops

– “Laundry list thinking” is not realistic, • at least does not lead to dynamic behaviour

• Identify causal relations– Positive and negative polarities

• Identify the causal loops!– Balancing and reinforcing

Some simple examples

Rent Demand

Structure Behaviour

O

B

W 0 1 W 0 2 W 0 3 W 0 4

4 0

6 0

8 0

Var

YieldCompression

Investorfrenzy

R

W 0 1 W 0 2 W 0 3 W 0 4

3 0

6 0

9 0

Rein

forc

ing

Some small examples

• Flows are change rates over time• Stocks integrate and accumulate

Stock

DemolitionConstruction

But modeling can get complex rapidly

Ge dra gsmo de l w o o nco nsume nte n (Ra s, 2006 )

De mo gra fie & e co no mie

W he a to n & d iP a squa le -mo de l ko o pse cto r

W he a to n & d iP a squa le -mo de l huu rse cto r

Arb itra ge

Fisca le e ffe cte n be le idsma a tre ge le n

W K

W H

W KinB

W HinB

LK

LH

ROK

ROH

BK

BH

o p lK

o p lH

S lK

S lH

tB

tlvdK

tlvdH

GK

GH

P K

P H

RK

HRA

ARB

minP K

minBK e BK

minP H

minBH

e BHRH

e VK

e VH

fe BK

fe VK

fe VH

fe BH

W Kre f

W Hre f

HRE G

pro b itK

re lG

HH

dHH

I NKdyn

P K

W OZH

GH

GK

W OZHK

W OZHK

P H

ln functie

TC K

dTC KMUT

W Hre f

W Kre f

W H

W K

te ko rtH

te ko rtK

subsKW K

P K

RK

HRA

xtrinkH

GH

W H

P H W OZH

ARB

GHre f

VTAX

HH

VALGAP

HHo n tw

I NK

d I NKI NKo n tw

I NK

Re xo

Re xo

Re xo

te ko rtH

te ko rtK

tP

Track record of SD in Real Estate

• J.W. Forrester (1969), Urban Dynamics• Bakken & Sterman (1993) Commercial RE flight

simulator• Barlas et al (2007) RE Price oscillations in Istanbul• Cheng (2005) Modeling Shanghai RE Markets• Klammt (2000) Modeling in CREM• Kummerow (1999) Cyclical Office Oversupply• Price & Kelly (2005) Boston Housing Dynamics• And much more

Evaluation of usefulness for RE research

Assets• Strong basic paradigm• Stock / flow concept• SD Society• Expert and interactive• Software

Drawbacks• No spatial dimension• Risk of complexity

www.systemdynamics.org

Putting SD to the test

Rent

Stock

Construction

Price

Demand curve

Interest

Stock adjustmentConstruction curve

Stock adjustment

Rent

Price

StockConstruction

O

Demand

Interest

O

Delay

Interest

B

Testing a simple simulation model

Wheaton & DiPasquale• Test for demand shift

– At t =10: 600k + 10%

• Test for interest change– At t =60: 5% → 6%

Run

Sto ckW inP

Op l De mo lit io nCo nstructio n

Co nstructio n t ime Life spa n

Re nt

P rice

I n te re st

Ba se De ma nd

E la sticy o f De ma nd

Ba se Co st

E la sticity o fCo nstructio n

0 2 0 4 0 6 0 8 0 1 0 0

2 .9 0 0 .0 0 0

3 .0 0 0 .0 0 0

3 .1 0 0 .0 0 0

3 .2 0 0 .0 0 0

3 .3 0 0 .0 0 0

wo n

Sto

ck

0 2 0 4 0 6 0 8 0 1 0 00

1 0 .0 0 0

2 0 .0 0 0

3 0 .0 0 0

wo n / jr

Constr

uction

0 2 0 4 0 6 0 8 0 1 0 0

1 1 .5 0 0

1 2 .0 0 0

1 2 .5 0 0

1 3 .0 0 0

1 3 .5 0 0EU R p wo n jr

Rent

0 2 0 4 0 6 0 8 0 1 0 0

1 9 0 .0 0 0

2 0 0 .0 0 0

2 1 0 .0 0 0

2 2 0 .0 0 0

2 3 0 .0 0 0

EU R p wo n

Price

Conclusion and discussion

• System Dynamics is a useful method for RE Research– Complex systems and dynamic behaviour

– Stock and flows as building blocks

– Scientific community, track record, software

• A simple WdP model provides plausible results– Responds to market stimuli as expected

• We will see an upswing in SD RE Research– But that's ultimately up to you....