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Natural Vacancy Rate

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Natural Vacancy Rate

The natural vacancy rate or structural vacancy rate is often used to in rental market analysis.

There are different definitions of the natural or normal vacancy rate but the substance of all is that it serves in as the equilibium vacancy rate in the rental property market, determining in this way the direction of property rent movements. In this sense understanding the definition and role of the normal vacancy rate is very important for commercial property investment analysis. The various definitions that have been presented in the literature include:

- The natural vacancy rate is the level that leaves landlords indifferent in terms of the vacant units held (Clapp 1993)

- Optimal inventory theory (Shilling, Sirmans and Gorgel, 1987). The structural vacant stock is analogous to the optimal inventory of capital goods, which is held by landlords in order to capitalize on future increases in rents.

- Search theory (Rosen and Smith, 1983.) The structural vacant stock is the stock required to allow normal search processes of firms looking for office space and landlords looking for tenants.

- Optimal vacancy duration (Hedershott and Haurin, 1988). The optimal vacant stock is determined by the optimal vacancy duration, which is the one that maximizes a landlord’s expected profit given expected rents and cost of holding vacant units.

Independently of the definition used, the interpretation of the natural vacancy rate in terms of rental market dynamics, is that when the nominal vacancy rate is above it the market is oversupplied and rents should be declining, while when the nominal vacancy rate is below it there is undersupply and rents should be moving up.

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