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Buying commercial real estate

Buying commercial real estate

Office market analysis needs to identify all demand and supply factors that determine the levels and prospects of a market’s most important indicators: its vacancy rate and rental level.

Furthermore, it is also important to be able to identify and quantify the structural dimensions of these two indicators, that is, the structural (or “normal”, as is often referred to in the literature) vacancy rate and implicit equilibrium rent, or in other words the equilibrium rent implied by prevailing office space demand and supply conditions. Quantifying these two indicators can provide significant clues in terms of how office market rents and vacancy rates are likely to move in the future.

Analysis For National Investment Strategies

Office market analysis needs to identify and examine the exogenous factors that determine variations in the normal vacancy rate and implicit equilibrium rent across local markets and through time, especially when analyzing several office markets for comparison and investment purposes. Although, it is not customary for typical office market studies, such an exercise can facilitate the estimation of the structural vacancy rate for each market, if appropriate cross-section data are available, when more advanced office market analysis is performed. Given such estimates, it will then be possible to cross-sectionally compare local office space markets in terms of degree of prevailing disequilibrium conditions. For example if a market’s estimated structural vacancy rate is 10% and the prevailing vacancy rate is 8%, this would suggest an under-supplied market in which rents should be rising. On the contrary if the estimated normal vacancy rate is 5% and the prevailing market vacancy rate is 8%, this would suggest an oversupplied market in which rents should be declining.

Office market analysis aiming at guiding property investors wishing to invest nationally, should also examine the exogenous factors that determine cross-sectional differences in equilibrium office rents across metropolitan markets. Such an analysis will provide a more accurate measure for comparative assessments regarding trends in office rents and potential property income across various local markets. Such understanding can eventually contribute to a more sophisticated and intelligent comparison of alternative locations and, therefore, a more prudent diversification of property investment portfolios. The derivation of theoretical models for such an analysis, though, requires first a thorough understanding of the intertemporal behavior of metropolitan office space markets and the degree to which these markets behave independently.

If for example, the majority of local office markets are at equilibrium and move simultaneously, then any cross-section differences in rents should simply be explained by differences in long-run equilibrium factors. The experience of the past thirty years, however, has shown that the office market is highly cyclical with long cycles. In addition it is generally accepted in the literature (Hekman, 1985) that local office markets may to a significant extent behave independently. Within this context rent growth, and therefore, valu appreciation and return prospects vary across metropolitan markets. That is why it makes sense for national office property investors to have reliable forecasts of rent growth across metropolitan markets, when trying to identify the best office markets.

Office Market Modeling

Within this context, the formulation of a model for the explanation of cross-section differentials in office space rents has to accordingly take into account the cyclical instability and the somewhat autonomous behavior characterizing local office space markets. Given these characteristics it is very likely that at a given point in time metropolitan property markets are at different stage of their cycle. Office market analysis needs to adopt therefore a disequilibrium modeling approach when analyzing and comparing different office markets for property investment purposes. Such a modeling will properly take into account differences in disequilibrium state across markets. Such differences can be accounted if the normal vacancy and the nominal vacancy of each market are known. To obtain estimates of a market’s structural vacancy rate a rent adjustment equation must be estimated.

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