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• Real estate market analysis usually requires quantitative or qualitative • To evaluate a real estate space submarket, analysts tend to focus on a few
understanding (& prediction) of both the demand side and supply side of the primary indicators that characterize both the supply and demand sides of the
space usage market relevant to some real estate decision. submarket and the balance (equilibrium) between them.
– Vacancy rate
– The focus might be micro-level, such as a feasibility analysis for a specific
site or property – Market Rent
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– The vacancy rate reflects the balance between supply and demand.
– Market rent is another indicator of the balance between supply and demand
in a market.
– In most markets, it is normal for some vacancy to exist (the natural
vacancy rate) even when supply and demand are in balance.
– Can be tricky to measure because
• When actual vacancy rises above the natural vacancy rate, rents tend
to fall. • it is private information and
• When actual vacancy falls below the natural vacancy rate, rents tend
• lease terms may differ dramatically from tenant to tenant
to increase.
• Natural vacancy rate can be 6-12% • Result: Sometimes hard to get accurate “rent measures” – usually
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collected via surveys.
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– Of course, we need to consider the net addition to supply (after taking – Gross absorption – total amount of space leased, regardless of where tenants
come from
demolition and renovations into account).
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• The variables we just reviewed are commonly used indicators of supply/demand • Define the market carefully along geographic and usage dimensions,
conditions in space submarkets. recognizing that most metropolitan areas form markets that can be usefully
• The concept of “months supply” combines several of these variables to help us divided into smaller submarkets. The next slide describes how the Atlanta office
understand a market even better. market can be “divided.”
• By definition, months supply is the sum of current vacant space in the market
and new construction started but not completed, divided by 1/12 th of the annual
net absorption in the market. • Carefully consider the time period to be covered in the analysis
VacanctSpace ConstructionSpace – 5 – 10 years into the future is desirable
Months Supply
NetAbsorption /12 – 3 years is more feasible in most cases
• This measure tells how long it will take (in months) for all of the vacant space in • Recognize the differences between and the benefits of a simple trend
the market to be absorbed, driving the vacancy rate to zero. extrapolation and a structural analysis
– Analysts compare the months supply to the length of time it takes to – Trend extrapolation predicts the future purely based on historical trends and
complete new construction to see if the market can support a new project. If patterns
the months supply is much greater than the average construction period, the
market is “oversupplied.” Otherwise, it might be time to start a new project – Structural analysis attempts to predict the future by identifying and
in this market. quantifying the underlying determinants of market trends.
– Meaningless measure if net absorption is negative 9 10
– Compare the forecasted demand for space with the forecasted supply of
space to see if the market will be “over” or “under” supplied in the future.
• In tight markets (under supplied, landlord market), we expect to see higher rents
and lower vacancy rates.
• In loose markets (over supplied, tenant market), we expect to see lower rents and
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higher vacancy rates.
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Recent “Cool” Office Property Markets U.S. Office Market Vacancies 2002Q1 – 2005Q1
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U.S. Office Market Net Absorptions 2002Q1 – 2005Q1 Chicago Office Market (Downtown and Suburbs): 2005Q1
Chicago Office Market (Downtown and Suburbs): 2005Q1 Chicago Office Market (Downtown): 2005Q1
Net absorption rate for downtown 2005Q1 was -1 million sf. 17 Construction Activity Due to Become Available in 2005-2006: 4 million Sq 18
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Asking Net Rent Prices Chicago 2004 Chicago Market Break Down
• Predicted to fall further through 2005 given the high vacancy rates
• Large amount of activity by tenants to extend leases (look in lower rates while
they have the power).
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• Imminent Demand
– No signs of a dramatic increase in demand on the local level (no industry
shift moving towards chicago)
– U.S. economy may be “fragile” – oil prices/global economic uncertainty
acting on a drag on U.S. economy (see recent trend in stock prices)
– Demand predictions “moderate” at best
• Supply
– Lots of slack in the office market (vacancies high and construction
continuing)
– Rents will not pick up for awhile (good for tenants).
– Still profitable to build (new construction is filling up quickly (at expense of
existing properties) – however rents in new construction still low).
• I would not develop office space in chicago at this time! Interest rates likely to
Chicago unemployment rate not decline (as of yet) – looking for a recovery? 21 rise (to fight inflation) – decreases returns to owning (along with low rents and
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high vacancies).
• I would not develop office properties in Chicago at this time! Interest rates likely to rise
(to fight inflation) – decreases returns to owning (along with low rents and high
vacancies).
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Other Markets: Downtown Office Boston Other Markets: Downtown Office Boston
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• My macro assessment
– Business investment is most stable! Lots of capacity to expand – they are hesitant
given past mistakes (late 1990s) and oil/political uncertainty.