Time-Series Characteristics and Long-Run Equilibrium for Major Australian Office Markets

While much attention has focused on the modeling of office property markets, little emphasis has been put on distinguishing between permanent and temporary effects. This article attempts to address this issue in the context of the rental adjustment mechanism and the demand–employment relationship for major Australian central business district office markets. It is shown that, by allowing the natural vacancy rate and the work–space ratio to be endogenously determined, it offers richer model specifications that permit a partitioning between long-run and short-run influences. This is achieved by employing econometric techniques that examine the stochastic behavior of time series data. It is found that, while equilibrium relationships exist (between the vacancy rate and rent, and demand and employment), other macroeconomic variables are found to be relevant cyclical determinants.     

Adjustment in Property Space Markets: Taking Long-Term Leases and Transaction Costs Seriously

Markets for property space adjust only gradually because tenants and landlords are constrained by long-term leases and transaction and information costs. Not only do rents adjust slowly, but space occupancy, which depends on historical rents, often differs from demand at current rent. This creates "hidden vacancies," vacancies that will develop in the future if market rent and the space demand driver are unchanged. That is, if current rent is greater/lesser than average rent, then hidden vacancies are positive/negative. Moreover, because of hidden vacancies, open vacancies and rent are not mirror images of each other. Thus it is necessary to estimate both rental and vacancy rate adjustment processes. We do this using annual data for Stockholm offices during the 1977–2002 period and simulate the response of rent and vacancies (open and hidden) to an employment shock.     

Profitability of Office Rental Market in Seoul: An Application of Simultaneous Structural Equations

This article is concerned with the estimation of excess rates of return on the office rental market in Seoul using a simultaneous structural equation model. The office rental market in Seoul is spatially divided into CBD and non-CBD, and the model has three behavior equations of Chonsei price, monthly rent and key deposit, with two identity equations of conversion rate and excess rate of return. This article reveals that it would be rational for the owners to ask tenants for a higher deposit with a lower monthly rent under increasing interest rates because the interest rate has a positive effect on the Chonsei deposit and the key deposit, but a negative effect on the monthly rent. Although high nominal interest rate and low economic growth reduce the excess rate of return on both submarkets, the non-CBD office rental market would be more profitable than the CBD market despite lower levels of the monthly rent and key deposit.     

Estimation of the Rental Adjustment Process

Rental adjustment equations have been estimated for a quarter century. In the United States, models have used the deviation of the actual vacancy rate from the natural rate as the main explanatory variable, while in the United Kingdom, drivers of the demand for space have dominated the estimation. The recent papers of Hendershott (1996) and Hendershott, Lizieri and Matysiak (HLM 1999) fall into the former category. We reestimate these equations using alternative formulations and present evidence that changes in real interest rates were not capitalized into Sydney and London real land prices. We then derive a model incorporating supply and demand factors within an Error Correction framework and show how the U.S. and U.K. traditions are special cases of this more general formulation. We next estimate a two-equation variant with a separate vacancy rate equation using data from the City of London office market. This model allows calculation of the underlying price (rent) and income (employment) elasticities and explains the data marginally better than the HLM model. Importantly, our model passes standard modern econometric requirements for unit roots and cointegration.     

Vacancy Rates and the Future of Office Rents

This research confirms the existence of a strong vacancy rental adjustment mechanism in the market for office space, such as has been found in housing markets. Using national time-series data, we find that real office rents drop approximately 2% annually, for every percentage point of "excess vacancy" in the market. We also find that the definition of "excess vacancy" has been trending upward over time. Using a recent vacancy forecast suggests that office income streams seem likely to decline in both real and nominal dollars over the next few years.     

Office Rent in the Chicago CBD

This study focuses on the Chicago CBD office market, an important market at the local, regional, national and international levels. The purpose of this study is to develop a hedonic regression model that explains the variation in office rent per square foot. Five functional forms (linear, reciprocal, logarithmic, semi-log and log-linear) of the model are considered. A generally log-linear model is determined to be the best model based on a series of Box-Cox/Box-Tidwell type transformations and likelihood ratio tests. The regression results reveal that the model has very high explanatory power. The methodology of this study differs substantially from that of previous studies on this topic. Perhaps most importantly, the unit of analysis is the office unit rather than the building. This choice suggested the use of specific lease terms for actual transactions and location of the unit within the building as new variables. Finally, the modeling of location of the building within the CBD was found to be a critical step.     

Clustering Methods for Real Estate Portfolios

A clustering algorithm is applied to effective rents for twenty-one metropolitan U.S. office markets, and to twenty-two metropolitan markets using vacancy data. It provides support for the conjecture that there exists a few major "families" of cities: including an oil and gas group and an industrial Northeast group. Unlike other clustering studies, we find strong evidence of bicoastal city associations among cities such as Boston and Los Angeles. We present a bootstrapping methodology for investigating the robustness of the clustering algorithm, and develop a means for testing the significance of city associations. While the analysis is limited to aggregate rent and vacancy data, the results provide a guideline for the further application of cluster analysis to other types of real estate and economic information.     

The Effect of Clustering on Office Rents: Evidence from the Amsterdam Market

This article examines the rent effects of office clustering in the Amsterdam office market for the period 2000–2005. We isolate the rent effects of location density based on geographic information system (GIS) methodology, while controlling for variations in object characteristics in a cross-sectional hedonic model. While controlling for the age, location and quality of the object, we find a strong positive effect of being located in dense office areas. We find that the vicinity of other office objects is priced into rent levels, regardless of market conditions. This article extends existing literature by examining the influence of clustering outside the United States, during changing economic tides and by application of novel methodology, based on objective clustering schemes, which can be replicated for other geographic areas.     

The Workings of the London Office Market

This paper presents estimates of an equilibrium-based dynamic adjustment model of the office market, using supply and demand relationships to link construction, absorption, vacancies and rents to employment growth and real interest rates. The model is estimated using data from the City of London office market over 1977–1996. The model tracks the market dynamically, and the severe 1985–1996 cycle is shown to be related to the cycle in employment growth and the movement of real interest rates. The latter directly affects both construction and real rent levels.     

The Cyclic Behavior of the National Office Market

A review of the post WWII data on national office building construction and vacancy, reveals a recurrent ten-twelve year cycle. Specifying and estimating a structural econometric model for these series leads to several conclusions about this commercial real estate sector. First, the office market appears to "clear" quite slowly, and long-run expectations play an important role in market behavior. Second, supply is definitely more responsive to market conditions than demand. Finally, a six-year forecast suggests that the current over-supply in the market will not go away as fast as in the past.     

National Vacancy Rates and the Persistence of Shocks in U.S. Office Markets

In this paper, we develop and estimate a model that decomposes the variance in office vacancy rates into market-specific, time-specific, and random components. The results indicate significant differences in natural vacancy rates across markets. We also find some persistence in deviations from these natural vacancy rates. The analysis is applied to both central business district (CBD) and suburban office markets. We find that natural vacancy rates differ across CBD markets and across suburban markets. Further, the persistence of disequilibrium in one CBD market seems to differ significantly from that in another. This is not shown to be true for suburban markets.     

The Economics of Architecture and Urban Design: Some Preliminary Findings

This paper makes a preliminary attempt to evaluate empirically the nature of the contribution of architectural quality to the value of buildings. An economic model is postulated that predicts equilibrium rent and vacancy behavior as a function of both design and non-design characteristics. Vacancies are created in equilibrium as a result of search and information costs and tenant heterogeneity and are observed by the landlord as price-inelastic demand behavior. Design quality is seen to influence both rent and vacancy behavior. Its effect, however, is dependent on characteristics both of the production and operating cost functions and of tenant demand for the design vs. non-design amenity. An important characteristic of the design amenity is that it is not, in general, independent of the production function for non-design amenities. The model is tested using disaggregate cross-sectional and longitudinal operating performance and amenity data from a set of 102 class A office buildings in Boston and Cambridge. Data on design quality for the set of buildings were provided by a detailed evaluation of each structure by a panel of architects. Results confirm a strong influence of design on rents; structures rated in the top 20% for design quality were predicted to extract almost 22% higher rents than those rated in the bottom 20%. In contrast, the data showed a weak relationship between vacancy behavior and design quality. Finally, good design was shown to cost more to produce on average, but not necessarily in every case. The magnitude of the point estimates of the rent, vacancy, and construction cost effects suggest that good design may not in fact be more profitable on average, but as with a lottery, may provide a small probability of a high return to the developer.     

Intrametropolitan Location and Office Market Dynamics

Theory and evidence point to interdependency between office location decisions and dynamic growth paths. For example, clerical and administrative support employees are suburbanizing relatively rapidly in most markets in response to changes in technology and transportation. This paper tests the hypothesis that both cross-sectional and dynamic variables are important determinants of dynamic patterns and office market forecasts.
County Business Patterns data at the county and town levels indicate substantial spatial specialization (i.e., agglomeration) by type of office activity. But these agglomerations do shift over time, as indicated by the maintained hypothesis. Our econometric estimates suggest that the demand for office space in submarkets is responsive to agglomerations by type of industry as well as to growth in FIRE employment. The supply of office space is responsive to lagged expected demand.     

Tax Structure and Natural Vacancy Rates in the Commercial Real Estate Market

A number of studies have postulated that the Economic Recovery Tax Act of 1981 (ERTA 1981) was responsible for the dramatic overbuilding that occurred between 1981 and 1986, primarily because returns became less sensitive to "real" demand. While there has been much research on how equilibrium or "natural" vacancy rates in the real estate market are determined, beginning with Rosen and Smith's seminal paper in 1983, virtually none of this work has dealt with the impact of the tax environment. This study makes an initial attempt to answer this question with respect to equilibrium vacancies resulting from tenant (or owner) turnover. A formal model is developed that considers as an objective function the landlord's desire to maximize his/her after-tax equity returns in an environment of monopolistic competition in which individual projects face downward-sloping demand curves, owing to market conditions and a degree of heterogeneity among tenants in search costs or some other characteristic. The natural vacancy rate is shown not to depend directly upon the tax environment, but to depend indirectly upon it only to the extent that equilibrium market rents are lowered. The nature of the vacancy response depends critically upon the shape of the tenant demand response relationship upon its transition to a lower-rent region. This response is interactive with the degree of turnover and supply responsiveness within individual markets.     

Leasing as a Lottery: Implications for Rational Building Surges and Increasing Vacancies

An expanded inventory demand framework is developed that focuses on the impacts of changes in the local leasing environment. We model the lease-up process as a lottery in which changes in turnover or absorption affect the probability of winning the leasing lottery. In this context, builders rationally respond to transitory, not just permanent, changes in the local market. Hence, factors such as temporary shocks to tenant turnover affect the decision to build. The magnitude of turnover-induced cycles can vary across markets depending upon the vintage of the existing building stock, the local absorption rate and the rent elasticity of demand for space. This framework, which refocuses attention on the local determinants of the developer's decision to build, hopefully will prove fruitful in future empirical efforts to explain development and vacancy behavior during the past decade.     

Rental Price Adjustment and Investment in the Office Market

This study presents estimates of the rental price adjustment mechanism and investment response in the office construction market using data from fourteen cities over the period 1979–1983. Market rents are seen to adjust in response to local as well as national economic conditions. Investment, as measured by building permits, responds strongly to rent in a two-stage regression model, as well as to the long-term growth rate of office employment. Tests for a cobweb-type overreaction by investors do not reveal any cyclical characteristics of the market, indicating that the effects of random demand shocks are not felt beyond the normal construction period.     

How “Local” are Local Office Markets?

This paper describes empirical investigations of the geographical extent of office markets in the United States during the 1980s. A mixed temporal autoregressive model was estimated for pooled downtown office markets and pooled suburban markets. Results indicate that while the temporal autoregressive effect is stronger for office market vacancies than is the effect of the national trend, their linkages to national trends are significant. However, a mixed spatial autoregression analysis of the data pooled over time indicates that the regional office vacancy effect is stronger than the national office vacancy effect in both downtown and suburban office markets.     

Office Rent Processes: The Case of U.S. Metropolitan Markets

This paper synthesizes elements of the traditional and contemporary theory of real estate markets to formulate an empirical framework for exploring metropolitan office rent processes. Such a framework is then applied to the analysis of office rents across 18 U.S. office markets during 1986–1995. The empirical results underscore the sluggishness of rental adjustments, highlight the extent of rental disequilibria across markets, and uncover the role of office employment factors (such as size, diversity, spatial organization, growth rates, and volatility), construction costs, interest rates, amenities, and zoning in shaping interarea differentials in the equilibrium component of office rents.     

Commercial Office Space: Testing the Implications of Real Options Models with Competitive Interactions

We test the implications of real option pricing models with competitive interactions for commercial real estate development. The competitive nature of a local commercial real estate market relies on a Herfindahl ratio derived from individual developers' shares of total office construction in their market. All else being equal, greater competition among local developers is associated with more building starts. Other variables suggested by the real options pricing model, including the volatility of local lease rates, are also found to be statistically important. In addition, we provide evidence consistent with greater competition attenuating the extent to which increases in volatility delay commercial real estate development.     

Chicago's Office Market: Price Indices, Location and Time

Conventional wisdom holds that overbuilding and high vacancy, coupled with curtailed tax benefits, have led to reduced office property values since the late 1980s. Yet assertions that office real estate values fell between the mid-1980s and mid-1990s are not supported everywhere by convincing evidence. This study offers a hedonic analysis of Chicago area office properties that sold from 1986 through 1993. Whereas earlier office market studies generally have been based on rents, this study focuses on variation in actual sale prices (although the prices were not adjusted for financing differences). The transaction-based index estimated here does not support the existence of a nominal office property price level decline beginning in the mid-to-late 1980s. In fact, the results show an upward trend in office property values after 1986, with nominal declines in office market price levels occurring only in the latter portion of the study period.