The Impact of Terrorism Fears on Downtown Real Estate Chicago Office Market Cycles

By Dermisi, Sofia V. | Journal of Real Estate Portfolio Management, January-March 2007 | Go to article overview

The Impact of Terrorism Fears on Downtown Real Estate Chicago Office Market Cycles


Dermisi, Sofia V., Journal of Real Estate Portfolio Management


Executive Summary.

This paper identifies the cyclical patterns of an office market under potential terrorism threat by comparing vacancy rates and rent per square foot trends before and after September 11, 2001. This study goes beyond identifying general market trends and focuses specifically on office trends among trophy, Class A, and Class B buildings in Chicago. The findings indicate that trophy buildings were severely impacted by 9/11 and did not recover until the end of 2005. Class A buildings were also significantly impacted, although less than the trophy buildings, while Class B experienced even less of an impact. In general, the Chicago office market cycles were estimated to be between 6.4 (sublease vacancy of Class B buildings) and 13 years (total vacancy of Class A buildings).

This study aims to identify the extent to which terrorism fears and the resulting economic recession after September 11, 2001 (9/11) impacted the Chicago downtown office market cycles of vacancy rate and rents (per square foot). The office market impact is estimated by using building-specific data that distinguish between classes (A and B) and trophy status, with a time horizon from 1997 through 2005. This study diversifies for the first time the effect of a severe external market shock (9/11) between "trophy," Class A, and Class B buildings in a very precise geographic area providing insight on the market tolerance by building class. Acknowledging that real estate markets are part of the economic system, there is a brief review of general economic cycle theories, as well as the interrelationship between real estate cycles and the economy.

The tools used to accomplish the aim of the study include statistical testing and a non-linear optimization model of Fourier spectrum analysis. The statistical tests indicated a significant difference between vacancies experienced before versus after 9/11 in contrast to rents. The Fourier results indicate that the Chicago downtown office market cycles span from 6.4 (sublease vacancy of Class B buildings) to 13 years (total vacancy of Class A buildings), depending on the market variable studied and building class. Trophy buildings seem to experience longer vacancy cycles (total and sublease) compared to Class B buildings and shorter rent cycles.

Literature Review

Economic, Real Estate, and Terrorism Cycles

Economists recognize four major cycles based on the study of a number of financial/economic indicators and international relations (Kondratieff, 1935; Modelski, 1987; Tylecote, 1994; Tvede, 1997; and Fekete, 2005): (1) short-wave cycles: a. Juglar's cycle with average duration of 7 to 11 years; b. Kitchin's cycle with average duration of 3 to 5 years; (2) medium-wave cycles: Kuznets' cycle of 15 to 25 years; (3) long-wave cycles: Kondratieff's cycle, which is approximately 47 to 60 years; and (4) extremely long-wave cycles: These cycles are based on international relations and span 100-120 years.

Acknowledging the existence of various length economic cycles, real estate researchers have directed their efforts to the study of two main areas: (1) the identification of real estate cycle lengths and (2) the relationship between real estate cycles and the national economy/business trends. In the first area, Wheaton's (1987) review of office construction activity in the United States between 1967 and 1986 revealed the existence of 10- to 12-year cycles. Earlier studies by Barras' (1983) on office-development cycles identified 10-year property oversupply cycles; the Grebler and Burns (1982) study of the non-residential construction activity in the U.S. identified four cycles, between 1950 and 1978. In addition in the first area, Brown and Liow's (2001) study of the commercial real estate and property stock prices in Singapore from 1975 to 1998 identified 8-year cycles for both markets. Another study, focusing on the values of commercial properties in the United Kingdom between 1956 and 1996, identified a fairly regular cyclical pattern of 7. …

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