Term Structures in the Office Rental Market in Stockholm

This paper contains an empirical study of the rental term structure in a property market that included a dramatic boom and bust cycle. The study is applied to office leases in commercial properties located in Stockholm CBD, Sweden. The time period under study is 1977–1991. The number of observations (lease contracts) that we were able to make full use of in the regression analyses is n=861. For seven out of fifteen years studied, a significant term structure was observed. The estimated hedonic rent equation was also used to construct an office rental index.     

Rental Expectations and the Term Structure of Lease Rates

We consider the term structure of lease rates in a general setting where both rents and interest rates are stochastic. The framework is applicable to any leasing market, but we focus on real estate. We find that the ``expectations hypothesis", that is, forward rates are unbiased estimators of future rents, requires similar assumptions as in interest rate theory to hold. To study bias magnitude, simulations are performed using a parameterization of the general framework. Different realistic values for risk aversion and interest rate stochastics can generate widely different shapes of the term structure, holding objective expectations constant. Thus an expected increase in rent is consistent with a downward-sloping term structure and vice versa.     

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.     

Implicit Forward Rents as Predictors of Future Rents

This paper investigates the relation between the term structure of rents and future spot rents. A rich database of office rental agreements for various maturities is used to estimate the term structure of rents, and from this structure implicit forward rents are extracted. The data pertain to commercial properties in the three largest Swedish cities for the period 1998–2002. A positive relation between forward and spot rents is found in some regions, but forward rents underestimate future rent levels. Another contribution of the paper lies in the area of rental index construction. We provide evidence that rental indices should not only be quality constant ( i.e. , control for characteristics), but should also be maturity constant.     

Determinants of Cross-Sectional Variation in Discount Rates, Growth Rates and Exit Cap Rates

This study investigates the determinants of key input variables in valuers' discounted cash flow models used for estimating market values for offices. Data from 599 valuations in 2000 from Stockholm, Gothenburg and Malmö are used to explain variation in discount rates, expected growth rates in net operating income and exit cap rates. Our ability to explain the relatively wide variation in appraisal assumptions with plausible covariates generates confidence in the appraisal process. This has important implications because most value and returns indices of commercial real estate worldwide are appraisal based.