Natural vacancy rates in global office markets

Date01 November 2006
Published date01 November 2006
AuthorBen Sanderson,Kieran Farrelly,Corin Thoday
Subject MatterProperty management & built environment
Natural vacancy rates in global
office markets
Ben Sanderson
PRUPIM, London, UK
Kieran Farrelly
Seven Dials Consulting, London, UK, and
Corin Thoday
RREEF, London, UK
Purpose – This paper seeks to contribute to knowledge of the dynamics of global office markets with
an assessment of the interaction of rental growth and vacancy rates across a sample of the world’s
leading office markets.
Design/methodology/approach – Econometric methods are used to estimate the relationship
between rental growth and vacancy rates (taking into account the possible simultaneity between the
two variables) and these equations are then used to estimate the natural vacancy rate at an individual
city level and collectively for the three regions assessed (Europe, Asia Pacific and North America). An
estimate is also made of the global natural vacancy rate.
Findings – The results suggest that estimates of natural vacancy rates vary significantly across the
world but these estimates can be helpful to those seeking to understand global office markets.
European markets in general have lower natural vacancy rates than those in North America. In Asia
Pacific markets there is a greater variation between markets. In general developed markets have lower
natural vacancy rates than developing ones. In developing markets the concept of a natural vacancy
rate is one that should be applied with care, given the weakness of data and the speed with which they
are undergoing structural change. When examining the differences in natural vacancy rates between
markets, it is clear that fundamental supply and demand factors are key in driving those differences.
Practical implications “Rule of thumb” estimates of natural vacancy rates are relatively
common. However, a robust methodology for calculating natural vacancy rates is a powerful
analytical tool for investors, occupiers and real estate advisors, as it enables a judgement of what
supply/demand balance will trigger rental growth.
Originality/value – In estimating the natural vacancy rate across a sample of the world’s leading
office markets the paper makes an original contribution to the understanding of global office markets
and in particular delivers an appreciation of how rental growth and vacancy rates interact.
Keywords Forecasting,Office buildings, World economy, Rentalvalue
Paper type Research paper
The importance of accurate forecasts in assisting in decision making for occupiers,
advisors and investors in real estate markets is well known. Previous researc h has
The current issue and full text archive of this journal is available at
Winner of the Society of Property Researchers Prize for Innovative Research.
The views expressed in this paper are those of the authors and do not necessarily represent
those of the organisations for whom they work. No reproduction of this paper or the data
contained within is allowed without the permission of the authors or the data providers. The
authors acknowledge the work of Farid Boumediene, PRUPIM in earlier drafts of this paper.
Received September 2005
Accepted January 2006
Journal of Property Investment &
Vol. 24 No. 6, 2006
pp. 490-520
qEmerald Group Publishing Limited
DOI 10.1108/14635780610708301
tended to focus on rental growth forecasting as a means of enhancing decision making
given the relative predictability of rental cycles. This contrasts with the well known
difficulties of forecasting yields. A range of different approaches to forecasting rents
across different sectors have been attempted with differing success. Tonelli et al., 2004
present a recent summary of the methodologies employed.
It is often the office sector which attracts the focus of research. This is due to the
greater availability of data over longer time series and across more locations for offices
compared to retail industrial and other sectors. It is also arguably because of the
greater interest in the office sector from investors. It is often typical, for example, in
emerging real estate investment locations for the office sector to attract the first wave
of institutional investment capital.
With real estate markets increasingly global there is an increased need forforecasting
capability to enhance decision making across a wider range of locations which creates
clear methodological challenges for researchers where data is scarce and markets are at
different stages of development. However if it is feasible, using quantitative techniques
can arguably help all involved understand both the future path of rental growth but also
the underlying behaviours and dynamics of the market. This paper seeks to contribute
to knowledge of global office markets using a concept familiar to those involved in the
real estate markets of the United States but less common in other markets. This concept
is the natural vacancy rate (NVR). By seeking to estimate the NVR across a sample of the
worlds leading office markets it is hoped to make a contribution to the understanding of
the dynamics of global office markets and in particular gain a better appreciation of how
rental growth and vacancy rates interact.
This paper takes the following format. Section 2 outlines the concept of the NVR;
section 3 describes the empirical framework used; section 4 outlines and describes the
data; section 5 presents the results, section 6 seeks explanations for the results with
conclusions in section 7.
Natural vacancy rates
The theory of NVRs is clearly explained by Anari and Hunt (2002) and Krainer (2001).
Both explain that the theory of NVRs is based around the principle that property
markets are characterised by frictions that tend to impede the process of market
clearing. In a completely efficient and frictionless market, markets would clear, supply
would instantly equal demand and vacancy rates would be zero. In reality property
markets are decentralized and characterised by frictions and inefficiencies so that it is
difficult at times to match vacant space to tenants. Landlords, of course, wish to lease
to tenants who are most willing to pay for their particular space and will set rents so
that not all tenants will find the lease attractive. Thus, as shown in Wheaton and Torto
(1988), even in equilibrium we should expect to observe some empty space.
Exactly how much empty space is “natural” for a market depends on how
responsive or elastic demand and supply are to economic shocks. On the demand side,
suppose, for example, that tenants are relatively insensitive to changes in rents. This
might occur because location is important for the tenants (law firms need to be close to
the courts, high-tech firms tend to cluster in regions with research universities). All
other things held constant, we might expect vacancy rates to be low in this type market
because tenants are basically “price takers”, meaning that the expected return to
searching for cheaper space is low. This situation is analogous to economic product
Natural vacancy

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