Chapter 6:
Real Estate Market Analysis
R.E. “Market Analysis” is a collection of practical analytical
tools and procedures designed to help answer decision
questions, such as:
 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?
Market Anlysis usually requires quantitative or qualitative
understanding (& prediction) of:
 Demand Side
 Supply Side
Of the Space Usage Market relevant to some R.E. decision.
Types of Market Analysis:
 Specific micro-level analysis
o Applies to single property, site, or user
o E.g., feasibility analysis or site analysis for a
development project
 Broader, more general characterization of a space market
o Applies to an entire R.E. space market segment or
submarket
o 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)…
Five major market indicators:
1. Vacancy rate
2. Market Rent
3. Quantity of new construction starts
4. Quantity of new construction completions
5. Absorption of new space
Vacancy Rate:
 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:
o 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:
o Search time & moving costs (hence LT leases):
  Don’t take “first deal”
  Search for “good deal” (takes time to find)
o “Overbuilding”:
  Impossible to perfectly predict demand
growth
  “Lumpy supply”
 The “natural vacancy rate”:
o Rate around which vacancy tends to cycle
o Rate that indicates supply/demand balance
o Above which rents fall, below which rents rise
o Tends to be higher in more volatile & faster-growth
markets
o Tends to be lower in more supply-restricted markets
Rent:
 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”
o E.g., $10 rent but 1-yr abatement in 5-yr lease:
o What would you say is the “effective rent”?
 Consider “real rent” – rent adjusted for general inflation
(as better indicator of market trend)
Construction:
 Supply side variable
 Starts & completions
o Starts  “Pipeline”
o Completions  Additions to supply side of mkt
 Consider net addition to supply:
o Constr Completions – Demolition & Conversion Out
o Include re-habs & conversions in also
Absorption:
 Change in occupied space
 Demand side variable
 “Gross absorption” = Total new lease signings
o 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
Can be used to help characterize & understand the current
market, and forecast how it may change relevant to R.E.
decisions.
e.g., The Months Supply measure:
MS 
Vac  Constr
NetAbsorp / 12
MS < Typical Construction Project Duration  Tight Market
 Room for new development projects
MS > Typ.Constr.Duration  May be some slack (but
consider natural vacancy rate).
Example market analysis:
Exhibit 6- 1: 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.
What type of decisions would such an analysis be relevant
for?…
Defining the scope of the market analysis…
 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- 2: 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
Trend extrapolation:
 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 errorcorrection)
 Potential to bring in capital market factors as predictors
Structural Analysis:
 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:
o Demand model (including elasticities)
o Supply model (inclu elasticities & lags)
o 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
More widely used in business decision-making are basic
short-term (1-3 yr) structural market analyses…
Exhibit 6-3: Generic framework of a basic short-term structural market analysis for real
estate
SUPPLY SIDE
DEMAND SIDE
Identify sources of space usage
demand
Inventory existing supply
Quantify relationship between
demand sources and quantity of
space usage
Inventory construction pipeline
Forecast demand sources
Forecast of new supply
Forecast of new demand
Forecast space shortfall or
surplus
Decision implicatons?
Major drivers of the demand side of the space market…
Exhibit 6-4: Major demand drivers by property type
Property Type
Demand Drivers
Residential single family
 Population
(Owner occupied)
 Household formation (child rearing
ages)
 Interest rates
 Employment growth (business &
professional occupations)
Residential multifamily
 Population
(Apartment renters)
 Household formation (non-childrearing ages)
 Local housing affordability
 Employment growth (blue collar
occupations)
Retail
 Aggregate disposable income
 Aggregate household wealth
 Traffic volume (specific sites)
Office
Employment in office occupations:
 Finance, Insurance, Real Estate
(FIRE)
 Business & professional services
 Legal services
Industrial
 Manufacturing employment
 Transportation employment
 Airfreight volume
 Rail & truck volume
Hotel & convention
 Air passenger volume
 Tourism receipts or number
visitors
A simple formal structural model of a space market…
Supply side:
C (t )   ( R(t  L)  K ), if R(t  L)  K ,
0, otherwise
S ( t )  S ( t  1)  C ( t )
(1)
(2)
Demand Side:
D( t )    R ( t )  N ( t )
(3)
OS ( t )  D( t  1)
(4)
Physics:
Vacancy rate:
v(t )  ( S (t )  OS (t )) / S (t )
Landlord behavior:
R(t )  R(t  1)(1  ((v(t )  V ) / V ))
Put these six equations together . . .
(5)
(6)
Numerical example:






 = 0.3
 = 0.3
 = 200 SF/employee
 = 10 million SF
 = 0.3
L = 3 years
Supply sensitivity
Demand sensitivity
Technology
Demand intercept
Rent sensitivity
Construction lag
Exhibit 6-5 Simulated Space Market Dynamics
100
0.800
90
0.700
80
60
0.500
50
0.400
40
0.300
Constr. MSF
Vac, Rent, Empl.
0.600
70
30
0.200
20
59
57
55
53
51
49
47
45
43
41
39
37
35
33
31
29
27
25
23
21
19
17
15
13
9
11
7
0.000
5
0
3
0.100
1
10
Year
EMPL
VAC%
RENT
CONST

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.
In the preceding model, were any of the market participants
forward-looking?
What features of the above results do you think are due to
myopia or purely adaptive behavior on the part of the market
participants?
In the real world, what factors or elements in the real estate
system will tend to be forward-looking?
In the real world, will it be possible to perfectly forecast the
future? Will some market participants likely be somewhat
myopic or adaptive in their behavior?