Interactions within the Office Market Cycle in Great Britain

By McGough, Tony; Tsolacos, Sotiris | The Journal of Real Estate Research, July/August 1999 | Go to article overview

Interactions within the Office Market Cycle in Great Britain


McGough, Tony, Tsolacos, Sotiris, The Journal of Real Estate Research


Abstract. This article adopts an unrestricted vector autoregressive framework methodology to examine the cyclical activity of office property development in Great Britain. The empirical analysis provides supporting evidence for the significant influence of office rents on the rate of new office construction. Service sector output has a small impact on office development, whereas the results do not establish a relationship with employment and interest rates. The significance of rents is attributed to the tenure characteristics of the market and the important role of developers and property investors in initiating office projects in Great Britain. A period of up to three years appears to be the optimum period between the time that rental signals are generated and the time that buildings are put in place, as a response to those signals.

Introduction

Identifying the forces and mechanisms that influence the dynamics of the office development cycle is a major and topical research area that is inextricably linked to the volatility of office building construction and the well-publicized periods of overbuilding. Moreover, it is important to a better understanding of the key influences on office development in different geographical contexts and over time. Statistical work in the United States has identified a number of economic and other variables that are important in explaining the flow of new office construction. These include gross national product, employment, vacancy rate (or the gap between the actual and natural vacancy rates) and total office stock (Rosen, 1984; Hekman, 1985; and Wheaton, 1987). Kling and McCue (1987) found that the U.S. office construction cycle is influenced primarily by nominal interest rates and output. Money supply and prices were also responsible for the variation in office construction. Further research has investigated the role of market size and market growth in office development (Hekman, 1985; and Pollakowski, Wachter and Lynford, 1992).

Systematic statistical work on the office cycle in the British context has only recently been undertaken. Tsolacos, Keogh and McGough (1998) have found that the major influences in the cyclical pattern of office development in Great Britain are office rents and capital values. Moreover, employment in banking-finance-insurance and real interest rates also appears to exert an influence. Other research has examined the cyclical regularities of different variables and office development after filtering all raw data series to extract their cyclical component (Barras and Ferguson, 1987; and McGough and Tsolacos, 1995; 1997). McGough and Tsolacos found that gross domestic product, output of business and finance industries and employment in banking-finance-insurance are procyclical with the office development cycle. However, the strongest procyclicality was exhibited by office rents and capital values. Wheaton, Torto and Evans (1997) and Hendershott, Lizieri and Matysiak (1997) have examined the office development cycle in London. Both papers use a standard ordinary least squares procedure to estimate the proposed equations for office development. Wheaton et al.'s paper specifies the level of current construction on the contemporaneous values of rents, vacancy rates and replacement costs. This article, however, assumes instantaneous adjustments in the development market, which is at variance with the `time to build period' assumed in the study of Kling and McCue (1987). Hendershott et al.'s paper relates office completions to the gap between the actual and the estimated equilibrium rent (this relationship was extensively discussed in the context of economic and property market cycles in Born and Phyrr (1994)). This specification did not fully capture the cycle of office construction and was thus rectified with the incorporation of a dummy variable in 1989.

The aim here is to investigate further the economic relationship between office construction and the variables that theoretical reasoning and existing empirical findings identify as major influences on office development. …

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