RENTAL MARKET DYNAMICS

The conventional economic framework of price determination through the interaction of supply and demand provides a very solid framework for understanding the disequilibrium state in which real estate markets very often fall and provide a powerful tool for understanding price dynamics and predicting the direction towards which property rents and values will move in the future depending on whether there is excess demand or excess supply of rental space or properties for sale.

The basic principle of rental market dynamics for both the residential and commercial property is that when the nominal vacancy rate is higher than the structural vacancy rate of that market, then there is excess supply of space and rents must be declining. On the contrary, when the nominal vacancy rate of the rental market under consideration is lower than the structural vacancy rate then there should be excess demand which pushes rents up.

As indicated above, the structural (or normal or natural) vacancy rate is an important concept in determining rental market dynamics. This is defined as the vacancy rate that is required for the normal operation of the market so that tenants looking for space can inspect a sufficient number of vacant units before deciding and landlords looking for tenants can allow for a sufficient number of prospective tenants to visit their property before committing to a specific tenant.

The structural vacancy rate is considered to vary across property types. Based on empirical estimations of rent adjustment equations for office it is estimated that the structural vacancy rate for office markets is higher than the residential market (4-5% compared to 7-12%).