Where to locate a branch office? What size or type of building to develop on a specific site?

• 
  Where to locate a branch office?
  
• 
  What size or type of building to develop on a specific site?
  
• 
  What type of tenants to look for in marketing a particular building?
  
• 
  What the rent and expiration term should be on a given lease?
  
• 
  When to begin construction on a development project?
  
• 
  How many units to build this year?
  
• 
  Which cities and property types to invest in so as to allocate capital where rents are more likely to grow?
  
• 
  Where to locate new retail outlets and/or which stores should be closed?
  

• 
  Demand Side
  
• 
  Supply Side
  

Of the Space Usage Market relevant to some R.E. decision.

• 
  Specific micro-level analysis
  
  • 
    Applies to single property, site, or user
    
  • 
    E.g., feasibility analysis or site analysis for a development project
    
• 
  Broader, more general characterization of a space market
  
  • 
    Applies to an entire R.E. space market segment or submarket
    
  • 
    E.g., forecast of supply & demand (&/or rents and vacancy rates) in Chicago office market, or Class A office Mkt in downtown Chicago
    

Focus on latter type (market supply & demand)…

1. 
   Vacancy rate
   
2. 
   Market Rent
   
3. 
   Quantity of new construction starts
   
4. 
   Quantity of new construction completions
   
5. 
   Absorption of new space
   

• 
  Percentage of the stock of space that is currently not occupied
  

• 
  Vac.Rate = (Empty SF)/(Total SF) = 1 – Occup.Rate
  

• 
  Watch out for sub-lease space:
  

• 
  Space leased but unoccupied is vacant.
  

• 
  Vacancy Rate is an indicator of equilibrium (balance betw supply & demand in the space market)
  

• 
  Some vacancy is normal and natural in a market, due to:
  

• 
  Search time & moving costs (hence LT leases):
  
  • 
     Don’t take “first deal”
    
  • 
     Search for “good deal” (takes time to find)
    
• 
  “Overbuilding”:
  
  • 
     Impossible to perfectly predict demand growth
    
  • 
     “Lumpy supply”
    
• 
  The “natural vacancy rate”:
  
  • 
    Rate around which vacancy tends to cycle
    
  • 
    Rate that indicates supply/demand balance
    
  • 
    Above which rents fall, below which rents rise
    
  • 
    Tends to be higher in more volatile & faster-growth markets
    
  • 
    Tends to be lower in more supply-restricted markets
    

• 
  Rent on new leases in the market
  
• 
  Another equilibrium variable
  
• 
  Most important space market variable
  
• 
  Tricky to accurately quantify (private info,“apples vs oranges” problems)
  
• 
  Watch out for “asking rent” vs “effective rent”
  
  • 
    E.g., $10 rent but 1-yr abatement in 5-yr lease:
    
  • 
    What would you say is the “effective rent”?
    

• 
  Consider “real rent” – rent adjusted for general inflation (as better indicator of market trend)
  

• 
  Supply side variable
  
• 
  Starts & completions
  
  • 
    Starts  “Pipeline”
    
  • 
    Completions  Additions to supply side of mkt
    

• 
  Consider net addition to supply:
  
  • 
    Constr Completions – Demolition & Conversion Out
    
  • 
    Include re-habs & conversions in also
    

• 
  Change in occupied space
  
• 
  Demand side variable
  
• 
  “Gross absorption” = Total new lease signings
  
  • 
    Includes moves within the market
    
• 
  “Net absorption” = Net increase in occupied space
  
• 
  Net absorption more relevant for indicating market demand:
  
• 
  (Vacant SF)_t = (Vacant SF)_t-1 + (Constr)_t – (Net Absorption)_t
  

* * *
These market indicator variables:

• 
  Vacancy, Rent, Construction, Absorption
  

 Room for new development projects

Example market analysis:

Exhibit 6- : Annual construction, absorption, and vacancy in the US office market. 1994-98 are historical figures, 1999-2001 are forecasts. Source: LaSalle Advisors Investment Research, 1999 Investment Strategy Annual Report. © LaSalle Investment Management, reproduced by permission.

• 
  Geographic/Property type market segments (or sub-markets)
  
• 
  Time-frame of the study (historical, forecast to when?)
  

Example of geographic sub-markets: Atlanta office market

Exhibit 6- : Atlanta MSA Office Sub-markets, 1998. (Source: Lend Lease Real Estate Investments, Real Estate Outlook: 1999, based on data from Jamison Research and Lend Lease Investment Research. © Lend Lease, reproduced by permission. )

Market analysis methodology:

• 
  Simple trend extrapolation vs Structural analysis
  

• 
  Take advantage of inertia in space market (past partly predicts the future)
  
• 
  Consider trends and cycles
  
• 
  Potential to use statistical techniques (time-series analysis: autoregression, ARIMA, VAR, vector error-correction)
  
• 
  Potential to bring in capital market factors as predictors
  

• 
  Model the structure of the market (underlying determinants of supply & demand, e.g. population growth and employment growth)
  
• 
  Forecast the underlying determinants (e.g., economic base analysis like we talked about in Ch.3), then use model to predict space market.
  
• 
  Formal analysis requires:
  
  • 
    Demand model (including elasticities)
    
  • 
    Supply model (inclu elasticities & lags)
    
  • 
    Equilibrium model (including landlord behavior)
    
• 
  Useful for gaining fundamental understanding of the market, and making long-term forecasts
  
• 
  Used more in academic studies than business decisions
  

M
ore widely used in business decision-making are basic short-term (1-3 yr) structural market analyses…

Vacancy rate:

Numerical example:

• 
  Supply sensitivity  = 0.3
  
• 
  Demand sensitivity  = 0.3
  
• 
  Technology  = 200 SF/employee
  
• 
  Demand intercept  = 10 million SF
  
• 
  Rent sensitivity  = 0.3
  
• 
  Construction lag L = 3 years
  

Exhibit 6-5 Simulated Space Market Dynamics

• 
  The real estate cycle may be different from and partially independent of the underlying business cycle in the local economy.
  

• 
  The cycle will be much more exaggerated in the construction and development industry than in other aspects of the real estate market, such as rents and vacancy.
  

• 
  The vacancy cycle tends to slightly lead the rent cycle (vacancy peaks before rent bottoms).
  

• 
  New construction completions tend to peak when vacancy peaks.
  

What features of the above results do you think are due to myopia or purely adaptive behavior on the part of the market participants?