Download Proposal: An Anatomy of Vacancy Rate in the Real Estate Market

What Can We Really Learn from Vacancy Behavior in the Real Estate Market?
A Theoretical Perspective
Yongping Liang* and Kerry D. Vandell†
Department of Real Estate and Urban Land Economics
School of Business
University of Wisconsin-Madison
975 University Avenue
Madison, WI 53706-1323
[email protected]
[email protected]
*
Yongping Liang is a Ph.D. student in the Department of Real Estate and Urban Land Economics,
University of Wisconsin-Madison.
†
Kerry D. Vandell is Tiefenthaler Professor in the Department of Real Estate and Urban Land
Economics, University of Wisconsin-Madison.
Abstract
Vacancy rates in real estate markets traditionally serve as important indicators of
market health. Yet the same vacancy rate across markets may have very different
implications because the underlying forces that induce vacancies may be very
different. In this paper we specify and solve a formal theoretical model of vacancy
behavior to analyze such differences. Our model is similar to other search models in
the real estate market in that potential tenants search existing landlords to find a match.
But our model is different from traditional search models in two respects: First, we
also consider potential builders in the market monitoring conditions for opportunities
for new development. Second, all market players face an uncertain economic
environment. In our dynamic model, equilibrium vacancy rates result from the
strategic interaction among the three types of players in the market (tenants, landlords,
builders). The vacancy rate in the current period will affect the decisions of match and
new development in the next period. The equilibrium rent level and number of new
units are also determined over time. This model has the virtue of allowing us to
“decompose” the vacancy rate into its constituent parts: (1) search - induced
vacancies, due to search costs in a “thin” market; (2) uncertainty – induced vacancies,
due to the option value of a match; (3) demand-side vacancies, the “excess demand”
by tenants considering their future space needs; and (4) supply-side vacancies, the
“over supply” resulting from competitive gaming among builders. The model will be
used to explain some anecdotal facts, e.g., the effects of lumpy supply (i.e., large
building size relative to the market) on vacancy rates, recent high “phantom” vacancy
rates, and the co-variation of vacancies with absorption. Simulations will evaluate
alternative market dynamics under varying conditions.
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