The Rent Adjustment Process and the Structural Vacancy Rate in the Commercial Real Estate Market
Sivitanides, Petros S, The Journal of Real Estate Research
Abstract. Existing studies of the office-rent adjustment process employ empirical model specifications that assume an intertemporally constant structural vacancy rate. Such specifications, however, contradict prevailing theoretical definitions of the latter which point towards its intertemporal variability. Against this background, this study extends the traditional rent adjustment specification to account for an intertemporally variable structural vacancy rate. The empirical results suggest that the extended model may be more appropriate than the traditional one in explaining office rent changes during the period 1980-1988. They also suggest that the structural vacancy rate may indeed vary both through time and across markets.
During the 1980s, double-digit vacancy rates stimulated significant decreases in office space rents, thereby motivating a number of empirical studies focusing on the rent adjustment mechanism in the office space market (Hekman 1985; Rosen, 1984; Shilling, Sirmans and Corgel, 1987; Wheaton and Torto, 1988, 1994). The basic premise of most of these studies is that rent changes in the commercial real estate market are triggered by excess demand or excess supply, as measured by the deviation of the prevailing vacancy rate from a "natural" or "structural" vacancy rate. There are two prevailing definitions of the latter. First, according to some analysts, it is defined in a manner analogous to the natural unemployment rate as the vacant stock required to facilitate the search needs of tenants looking for office space as well as the search needs of landlords looking for tenants (Rosen and Smith, 1983). Second, according to some other analysts, it is defined as the optimal inventory of vacant units that maximizes landlords' anticipated profits and, as such, it depends on their expectations with respect to office space demand and the marginal cost of holding vacant units (Shilling et al., 1987).
All the up-to-date studies, with the exception of Wheaton and Torto (1988), assume that the structural vacancy rate is constant through time, without presenting any theoretically sound argument to justify such an assumption. It can in fact be argued that the definitions of the structural vacancy rate presented in these studies point towards its intertemporal variability as opposed to its intertemporal stability.
Against this background, this paper, first, extends the traditional rent adjustment model to account for an intertemporally variable structural vacancy rate; second, tests the extended model by estimating rent adjustment equations for twenty-four metropolitan areas; third, identifies intermetropolitan differences in the rent adjustment process; and, fourth, presents annual estimates of the structural vacancy rate during the period 1980-1988.
The findings of the paper should be viewed with caution because of the limited number of observations used for the estimation of the rent adjustment equations. Nevertheless they are enlightening in that they suggest that the proposed extended model may be more appropriate than the traditional model in explaining real rent changes in the commercial real estate market. Furthermore, the time-series estimates of the structural vacancy rate for nineteen metropolitan areas indicate that this may be quite variable both through time and across markets.
These findings are useful from an academic point of view because they advance an improved theoretical and empirical formulation that highlights the complexities of the rent adjustment process. They are also useful from a practical point of view in that they can help real estate investment analysts to better model and forecast rent changes in the commercial real estate market.
The issue of the rent adjustment process has attracted a great deal of attention, especially in the last decade (Rosen, 1984; Hekman, 1985; Shilling et al., 1987; Wheaton and Torto, 1988, 1994). …