market equilibrium analysis · market equilibrium the theoretical balance where demand and supply...

Market Equilibrium Analysis

Richard L. Parli, MAIJuly 24, 2019

Denver, Colorado

Based on research done with Norman G. Miller, Ph.D.University of San Diego

The World of Market Analysis Wants to Know:

What exactly is

Market Equilibrium?

Market Equilibrium

What do the academics say?

Vacancy → Equilibrium → Rents

Market Equilibrium

What do the market analysts?

Vacancy → Equilibrium

Market Equilibrium

The theoretical balance where demand and supply for a

property, good, or service are equal. Over the long run,

most markets move toward equilibrium, but a balance is

seldom achieved for any period of time.*

* TARE, 14th ed., p. 306

Market Equilibrium

The theoretical balance where demand and supply for a

property, good, or service are equal. Over the long run,

most markets move toward equilibrium, but a balance is

seldom achieved for any period of time

Market Equilibrium

The theoretical balance where demand and supply for a

property, good, or service are equal with the only vacant

space being space needed to service the market friction of

normal tenant movements and space needed to

accommodate new demand coming into the market. Over

the long run, most markets move toward equilibrium, but a

balance is seldom achieved for any period of time.

•Dictionary of Real Estate Appraisal, Appraisal Institute, 6th ed., p. 139.

Market Equilibrium

The theoretical balance where demand and supply for a

property, good, or service are equal with the only vacant

space being space needed to service the market friction of

normal tenant movements and space needed to

accommodate new demand coming into the market. Over

the long run, most markets move toward equilibrium, but a

balance is seldom achieved for any period of time.

•Dictionary of Real Estate Appraisal, Appraisal Institute, 6th ed., p. 139.

Market Equilibrium

vacant…space needed to accommodate new demand

coming into the market.

AKA – Lag Vacancy*

The greater the growth rate of demand, the greater the vacancy rate for market in equilibrium.

* Fanning – MARE, 2nd Ed., p. 198

Market Equilibrium

…with the only vacant space being space needed to service

the market friction of normal tenant movements…

AKA – Frictional Vacancy

First identified in 1947 due to housing shortage following WWII.*

Linked “frictionally vacant units” to excess demand.

*Hauser, P.M. & Jaffe, A.J., “The Extent of the Housing Shortage”, Law & Contemporary

Problems; Winter 1947, Vol. 12 Issue 1, p 3

Frictional Vacancy

The amount of vacant space needed in a market for its orderly

operation. In a stabilized market, where supply and demand

are in balance, frictional vacancy allows for move-ins and

move-outs. In markets for income-producing property,

frictional vacancy measures the lost rental income as leases

roll over and expire. *

* TARE, 14th ed., p. 328

Frictional Vacancy

Frictional Vacancy

Supportable demand

The total supply that a given amount of demand can support;

equals measured demand plus an allowance for frictional

vacancy.

Supportable Demand

Frictional

Vacancy

Demand

Supportable

Demand

= Demand ÷ ( 1-Vf )

Market Equilibrium

The theoretical balance where demand and supply for a

property, good, or service are equal…

But Supportable Demand Includes Vacancy!

Does Supportable Demand Define Market Equilibrium?

i.e., does frictional vacancy define equilibrium vacancy?

Market Equilibrium

What do the academics say?

Vacancy → Equilibrium → Rents

Market Equilibrium

Equilibrium linked with Idle Assets and prices in 1968.*

• “Full Employment” is less than 100% due to frictional forces.

• “Full Employment” is defined by stable wages

*Friedman, Milton, “The Role of Monetary Policy”, The American Economic Review,

Volume LVIII, Number 1, March 1968, p. 8.

Market Equilibrium

What do market analysts say?

Vacancy → Equilibrium → Rents∕

Mueller, Glenn R., “Real Estate Rental Growth Rates in Physical Market Cycle”,

Journal of Real Estate Research," Volume 18, Number 1, 1999, p. 135.

Market Equilibrium (Proposed)

The balance of space where supply of a property type

exceeds demand by an amount of space that produces

stable rents.

or simply:

The relationship of demand and supply that results in real

rent stability.

•

Equilibrium Vacancy

The amount of vacancy that would be expected for a

given market when it is at a point of equilibrium.*

* From the revised MA & HABU Course

Equilibrium Vacancy (Proposed)

The amount of vacant space needed in a market to

achieve stabilized rents. In a stabilized market,

where supply and demand are in balance,

equilibrium vacancy is the vacancy that produces

no upward or downward pressure on rents.

5%

10%

15%

20%

25%

30%

$5.00/fs

$10.00/fs

$15.00/fs

$20.00/fs

$25.00/fs

$30.00/fs

Vac

ancy

Rat

e Re

al Re

nt/SF

Quarter

DENVER CLASS A OFFICE

Real Rent Vacancy Rate

5%

10%

15%

20%

25%

30%

$5.00/fs

$10.00/fs

$15.00/fs

$20.00/fs

$25.00/fs

$30.00/fs

Vac

ancy

Rat

e Re

al Re

nt/SF

Quarter

DENVER CLASS A OFFICE

Real Rent Vacancy Rate

Where’s the Equilibrium?

Ways to Measure Equilibrium Vacancy

1. Average of Long Term Vacancy (Normal Vacancy)

2. Regression to determine vacancy that produces

no change in rent

3. Graphic Interpretation

WASHINGTON, DC CLASS A OFFICE SPACE

Time Frame 80 quarters (1Q1993 – 4Q2012)

Office Buildings 196

Total RBA 52,782,623 square feet

Beginning Vacancy Rate 13.0%

Ending Vacancy Rate 10.3%

Vacancy Rate Range 5.4% - 14.4%

Average (Normal) Vacancy Rate 9.3%

Beginning Direct Avg. Rent $32.80 full service per square foot

Ending Direct Avg. Rent $52.88 full service per square foot

Average Direct Avg. Rent $41.77 full service per square foot

Direct Avg. Rent Range $29.90 - $53.30 full service per square foot

1

Equilibrium Vacancy Rate?

Rn = ƒ(E, Ve ̶ V)

where Rn is the rate of change of nominal rent, E is the

rate of change of total operating expenses (intended to

reflect the nominal price influences on Rn), and V is the

actual vacancy rate and Ve is the equilibrium rate.

Regression Approach

Rn = b0 – b1V + b2E

↓

Rr = b0 – b1V

↓

Ve = b0 ÷ b1

Regression Approach

Regression Results – DC Class A Office 1

Rn = b0 – b1V

CATEGORY COEFFICIENT t-STAT.

Intercept 0.029419 3.16284

Variable -0.25073 -2.57357

R2 0.079203 Vf 11.7%

2 1

Rr = b0 – b1V

CATEGORY COEFFICIENT t-STAT.

Intercept 0.021723175 2.303902564

Variable -0.223472577 -2.262832755

R2 0.062352489 Vf 9.7%

2

Ve = ±9.5%

CITY Chicago San Diego Atlanta Denver Dallas Charlotte Boston San Francisco Seattle

Quarters 2Q1996-4Q2013 2Q1999-4Q2013 1Q1996-4Q2013 4Q1999-4Q2013 1Q1996-4Q2013 1Q2000-4Q2013 1Q1998-4Q2013 1Q1997-4Q2013 1Q2000-4Q2013

Mean Vacancy Rate 14.1% 14.2% 14.7% 13.8% 20.1% 10.8% 8.2% 8.8% 10.1%

Graphic Interpretation ±15% ±16% ±15% ±13% ±18% ±10% ±8% ±10% ±8%

Regression Results - Nominal

Equilibrium Vacancy 15.9% 15.6% 15.8% 14.9% 21.8% 12.1% 9.1% 11.6% 10.7%

SUMMARY OF EQUILIBRIUM VACANCY RESULTS

Vacancy Hierarchy

FrictionalEquilibrium

Overall

Oversupplied Market

Vacancy Hierarchy

FrictionalEquilibrium Overall

Undersupplied Market

Vacancy Hierarchy

FrictionalEquilibrium Overall

Market in Equilibrium

When do rents actually move in a DCF?

What are some Unanswered Questions?

EXAMPLE - EAST END CLASS A OFFICE

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $39.00 $38.00 $37.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $39.00 $38.00 $37.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $39.00 $38.00 $37.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $40.00 $38.00 $36.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET

$30.00

$32.00

$34.00

$36.00

$38.00

$40.00

$42.00

4%

6%

8%

10%

12%

14%

16%

-3 -2 -1 0 1 2 3 4 5 6 7 8

Re

nta

l Rat

e

Vac

ancy

Rat

e

Year

East End Class A Office Space

Vacancy Rate Rental Rate

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $40.00 $38.00 $36.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $40.00 $38.00 $36.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET

$30.00

$32.00

$34.00

$36.00

$38.00

$40.00

$42.00

4%

6%

8%

10%

12%

14%

16%

-3 -2 -1 0 1 2 3 4 5 6 7 8

Re

nta

l Rat

e

Vac

ancy

Rat

e

Year

East End Class A Office Space

Vacancy Rate Rental Rate

?

Line Category Previous Year Last Year Current Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 City Employment 678,999 692,579 706,431 720,559 734,970 749,670 764,663 779,956

2 % housed in freestanding office 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80% 61.80%

3 Office employment 419,621 428,014 436,574 445,306 454,212 463,296 472,562 482,013

4 Average space/worker (sq. ft.) 261 261 261 261 261 261 261 261

5 Demand for citywide office space 109,521,181 111,711,604 113,945,836 116,224,753 118,549,248 120,920,233 123,338,638 125,805,411

6 % Capture by East End 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90% 31.90%

7 East End Office Demand 34,937,257 35,636,002 36,348,722 37,075,696 37,817,210 38,573,554 39,345,025 40,131,926

8 % Capture by Class A 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60% 29.60%

9 East End Class A Office Demand 9,939,858 10,138,655 10,341,428 10,548,257 10,759,222 10,974,406 11,193,894 11,417,772 11,646,128 11,879,050

10 Current East End Class A Supply 10,463,001 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

11 New East End Class A Supply 0 500,000 350,000 500,000 750,000 0 0 0 0 0

12 Total Supply 10,463,001 10,963,001 11,313,001 11,813,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001 12,563,001

13 Vacant Rate 5% 8% 9% 11% 14% 13% 11% 9% 7% 5%

14 Rental Rates $40.00 $40.00 $40.00 $38.00 $36.00 $36.00 $36.00 $38.00 $39.00 $40.00

EAST END CLASS A OFFICE MARKET – Ve = 10%

$30.00

$32.00

$34.00

$36.00

$38.00

$40.00

$42.00

4%

6%

8%

10%

12%

14%

16%

-3 -2 -1 0 1 2 3 4 5 6 7 8

Re

nta

l Ra

te

Va

can

cy R

ate

Year

East End Class A Office Space

Vacancy Rate Rental Rate

CITY Chicago San Diego Atlanta Denver Dallas Charlotte Boston San Francisco Seattle

Quarters 2Q1996-4Q2013 2Q1999-4Q2013 1Q1996-4Q2013 4Q1999-4Q2013 1Q1996-4Q2013 1Q2000-4Q2013 1Q1998-4Q2013 1Q1997-4Q2013 1Q2000-4Q2013

Mean Vacancy Rate 14.1% 14.2% 14.7% 13.8% 20.1% 10.8% 8.2% 8.8% 10.1%

Graphic Interpretation ±15% ±16% ±15% ±13% ±18% ±10% ±8% ±10% ±8%

Regression Results - Nominal

Equilibrium Vacancy 15.9% 15.6% 15.8% 14.9% 21.8% 12.1% 9.1% 11.6% 10.7%

SUMMARY OF EQUILIBRIUM VACANCY RESULTS

Ve = ±16%

Real Rent

How steep are the rent movements?

What are some Unanswered Questions?

What about Supportable Demand and

equilibrium vacancy?

What are some Unanswered Questions?

Supportable demand (new)

The total supply that a given amount of demand

can support; equals measured demand plus an

allowance for equilibrium vacancy. *

* Revised MA & HABU Course

THIS IS NOT THE END*

*You haven’t heard the last of me!

References

Parli, Richard L. & Miller, Norman G. "Revisiting the Derivation of an Equilibrium Vacancy Rate," Journal of Real Estate Portfolio Management, Vol. 20, Issue 3, 2014.

Parli, Richard L. & Miller, Norman G. “Market Equilibrium Analysis,” The Appraisal Journal”, Fall 2017.