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Rental price adjustment in the Canadian office market Greenfield, David Stewart 1988

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RENTAL PRICE ADJUSTMENT IN THE CANADIAN OFFICE MARKET By DAVID STEWART GREENFIELD B.Sc ( C i v i l Engineering), University of Alberta, 1981 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN FACULTY OF GRADUATE STUDIES (DEPARTMENT OF BUSINESS ADMINISTRATION) We accept t h i s thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA May 1988 © David Stewart Greenfield, 1988 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 i i ABSTRACT The rental price adjustment mechanism i s a fundamental component of the model for forecasting future o f f i c e space requirements. This i s an important area of study given the increasing significance of o f f i c e buildings i n the urban environment. This has resulted from the large growth in service oriented employment. Very l i t t l e academic work has been completed i n t h i s area because of the lack of s u f f i c i e n t data. To date, only the U.S. market has been examined. The objective of t h i s thesis i s model the rental price adjustment mechanism i n the Canadian o f f i c e market. The i n t e n t i s to further t e s t the theory i n t h i s area, provide a comparison with the results obtained i n the U.S., and provide some insight into the workings of the Canadian o f f i c e market. This thesis reviews the relevant l i t e r a t u r e on inventory theory, and empirical work performed on the housing market and on data from the U.S. o f f i c e market. The review points to a series of propositions about the rental price adjustment mechanism i n the o f f i c e market, the most important being the strong relationship between rents and vacancies. The extensions to the model developed i n t h i s paper are the s p e c i f i c a t i o n of the vacancy variable i n non l i n e a r terms and an attempt to include some proxy for growth expectations. The i i i model i s tested using data from Montreal, Toronto, Edmonton, Calgary, and Vancouver. The data has been co l l e c t e d primarily from the Royal LePage Market Survey. Visual inspection of the data uncovers unique c h a r a c t e r i s t i c s in each individual o f f i c e market. The underlying reasons point to the importance of integrating growth expectations in the model. The regression r e s u l t s support some degree of asymmetric price behaviour, however the s p e c i f i c a t i o n of the vacancy variable i n non l i n e a r terms i s not conclusive. I n f l a t i o n expectations seem to be important as landlords attempt to pass i n f l a t i o n a r y r i s e s on to the tenants. Operating costs and interest rates do not appear to be s i g n i f i c a n t factors i n the model. This leads to the conclusion that they are not important i n the cost of holding inventory i n the short run. F i n a l l y , the proxy used for growth expectations i s not s i g n i f i c a n t . The most l i k e l y reason for t h i s r e s u l t i s that the variable i s not properly s p e c i f i e d . The low explanatory power of the model may be attributed to the misspecification of the growth proxy and l i m i t a t i o n s in the data set. Both of these factors should be considered in future work in t h i s area. i v T A B L E OF CONTENTS P a g e A B S T R A C T i i T A B L E OF CONTENTS i v L I S T OF T A B L E S v i L I S T OF F I G U R E S v i i ACKNOWLEDGEMENTS i x CHAPTER 1.0 INTRODUCTION 1 2.0 L I T E R A T U R E REVIEW 9 2.1 INVENTORY THEORY 9 2.2 R E N T A L P R I C E ADJUSTMENT I N THE HOUSING MARKET 23 2.3 RENTAL P R I C E ADJUSTMENT I N THE O F F I C E MARKET 30 3.0 THE O F F I C E MARKET I N CANADA 41 3.1 MONTREAL 41 3.2 TORONTO 50 3.3 EDMONTON 57 3.4 CALGARY 6 5 3.5 VANCOUVER 7 3 4.0 4.1 DATA A N A L Y S I S THE P R I C E ADJUSTMENT MODEL 81 81 V 4.2 DATA 84 4.3 EMPIRICAL RESULTS 8 9 5.0 CONCLUSIONS 111 BIBLIOGRAPHY 117 v i LIST OF TABLES P r i c e Adjustment Model f o r the Canadian O f f i c e Market v i i L I S T OF F I G U R E S F i g u r e P a g e 2.1 C l a s s i c a l S u p p l y a n d Demand M o d e l 10 2.2 S u p p l y a n d Demand M o d e l w i t h I n v e n t o r y 17 3.1.1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s f o r M o n t r e a l 43 3.1.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s 46 f o r M o n t r e a l 3.1.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s f o r 47 M o n t r e a l 3 . 2 . 1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s f o r T o r o n t o 51 3.2.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s 53 f o r T o r o n t o 3.2.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s f o r 54 T o r o n t o 3 . 3 . 1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s f o r E d m o n t o n 58 3.3.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s 63 f o r E d m o n t o n 3.3.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s f o r 64 E d m o n t o n 3 . 4 . 1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s f o r C a l g a r y 66 3.4.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s 68 f o r C a l g a r y 3.4.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s f o r 69 C a l g a r y 3 . 5 . 1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s f o r V a n c o u v e r 74 v i i i 3.5.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s 78 f o r V a n c o u v e r 3.5.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s 79 f o r V a n c o u v e r 4.1 % N o m i n a l R e n t C h a n g e v s % V a c a n c y : C r o s s 91 S e c t i o n a l D a t a 4.2 % R e a l R e n t C h a n g e v s % V a c a n c y : C r o s s 92 S e c t i o n a l D a t a 4.3 % N o m i n a l a n d % R e a l R e n t C h a n g e v s % V a c a n c y : 93 M o n t r e a l 4.4 % N o m i n a l a n d % R e a l R e n t C h a n g e v s % V a c a n c y : 95 T o r o n t o 4.5 % N o m i n a l a n d % R e a l R e n t C h a n g e v s % V a c a n c y : 97 E d m o n t o n 4.6 % N o m i n a l a n d % R e a l R e n t C h a n g e v s % V a c a n c y : 98 C a l g a r y 4.7 % N o m i n a l a n d % R e a l R e n t C h a n g e v s % V a c a n c y : 1 0 1 V a n c o u v e r i x ACKNOWLEDGEMENTS The a u t h o r would l i k e t o thank D a r r e l l H u r s t o f R o y a l LePage L t d . and Ian B e v e r i d g e o f the B u i l d i n g Owners and Managers A s s o c i a t i o n f o r t h e i r a s s i s t a n c e i n the p r e p a r a t i o n o f t h i s t h e s i s . In a d d i t i o n , the au thor would l i k e t o acknowledge the s c h o l a r s h i p p r o v i d e d by the Canada Mortgage and Hous ing C o r p o r a t i o n . L a s t but not l e a s t , thanks t o D e n n i s , L a r r y and P i e t f o r k e e p i n g me on the r i g h t t r a c k . 1.0 INTRODUCTION 1 R e l a t i v e t o the housing market, there has been very l i t t l e e m p i r i c a l work done on the dynamics of the o f f i c e market. The few papers th a t have been w r i t t e n have a l l d e a l t w i t h c i t i e s i n the U.S..1 The o b j e c t i v e of t h i s t h e s i s i s to model the p r i c e adjustment mechanism i n the Canadian o f f i c e market. The a n a l y s i s should provide some f u r t h e r e m p i r i c a l evidence to t e s t the t h e o r i e s advanced i n t h i s area, provide an i n t e r e s t i n g comparison wi t h those r e s u l t s found i n the U.S., and provide some i n s i g h t i n t o the i n t e r n a l workings of the Canadian o f f i c e market. The o b j e c t i v e of t h i s t h e s i s begs the fundamental ques t i o n ; Why i s the study of the p r i c e adjustment process of i n t e r e s t ? The answer i s rooted i n the growing importance of the o f f i c e market. Semple and Green (1983) p o i n t out that modern cor p o r a t i o n s w i e l d a tremendous i n f l u e n c e over the economic, s o c i a l and p o l i t i c a l i n s t i t u t i o n s of s o c i e t y . This i n f l u e n c e may be thought as s p a t i a l l y concentrated where the headquarters of each fi r m i s l o c a t e d . Headquarters are most commonly found i n o f f i c e b u i l d i n g s c l u s t e r e d together i n large 'See K. Rosen (1984), J . Hekman (1985), and J.D. S h i l l i n g et a l . (1987) 2 urban areas. As a result, the size and nature of the o f f i c e market becomes important as i t represents the influence that a c i t y wields over i t s economic region. Furthermore, because of i t s physical presence, tendency to cluster, and a b i l i t y to concentrate employment a c t i v i t y in one area, the o f f i c e market has a major impact on the urban structure and s o c i a l f a b r i c of the c i t y . In the l a s t two decades the o f f i c e market in Canada has grown dramatically. A l o t of t h i s i s due to the burgeoning growth i n service oriented employment which has increased at the expense of a declining manufacturing sector. 2 In addition, studies show that the increase i n managerial and professional positions has actually increased the average amount of o f f i c e floorspace used by an employee.3 Therefore, the growth and impact of the o f f i c e building has made i t an important subject of study. One of the fundamental concerns i s accurately forecasting the amount of o f f i c e space that i s needed in a c i t y . Eger and Smith (1987) point out that predicting o f f i c e construction requires an understanding of the unique 2See D. Hooper et a l (1983) and G. Gad (1976) 3A consolidation of studies by the Toronto Planning Department (1960) (1970) (1980) (1983) (1984) (1985), the IBI Group (1975), and G. Gad (1971 - 72) show a trend towards increasing f l o o r space per worker in Toronto. 3 c h a r a c t e r i s t i c s o f the l o c a l market and i t s l i n k a g e s wi th the n a t i o n a l economy, the p a r t i c u l a r urban l o c a t i o n , the s i z e and growth o f the c i t y , the a v a i l a b i l i t y o f f u n d i n g , i n t e r e s t r a t e s , tax c o n c e s s i o n s , and a myr iad of o t h e r exogenous v a r i a b l e s a l l o p e r a t i n g on a r e a s o n a b l y t h i n market . The c o m p l e x i t y o f the t a s k has made f o r e c a s t i n g a hazardous p r o f e s s i o n . Whitehead (1987) and Hayes (1985) d i s c u s s the tendency o f d e v e l o p e r s t o o v e r r e a c t t o the t u r b u l e n t economic c y c l e s . Supply and demand f o r o f f i c e space o f t e n seem to pass each o t h e r l i k e p r o v e r b i a l s h i p s i n the n i g h t . One o f the most e s s e n t i a l components o f p r e d i c t i n g the f u t u r e f low o f o f f i c e space a re r e n t a l r a t e s and the mechanism by which they a d j u s t . * Rosen (1984) argues t h a t most c u r r e n t p r e d i c t i o n models f o r r e n t a l r a t e s r e l y on s i m p l e t r e n d l i n e t e c h n i q u e s which have l i t t l e or no economic o r s t a t i s t i c a l j u s t i f i c a t i o n . The mechanism by which r e n t s move i n the market goes beyond such a s imple "back of the enve lope" a n a l y s i s . In f a c t , as suggested by S h i l l i n g e t a l . (1987), the p r i c e ad justment mechanism r e p r e s e n t s one o f the more c l a s s i c a l prob lems i n economics . In a p e r f e c t w o r l d , w i t h no market f r i c t i o n s , u n c e r t a i n t y , o r impediments, f i r m s w i l l respond to *K. Rosen (1984) constructs an o f f i c e stock adjustment model and discusses a l l the various elements which are involved. 4 f l u c t u a t i o n s i n d e m a n d b y e i t h e r v a r y i n g p r i c e o r v a r y i n g o u t p u t . H o w e v e r , t h e i n t r o d u c t i o n o f m o r e r e a l i s t i c a s s u m p t i o n s c r e a t e s t h e o p p o r t u n i t y o r n e c e s s i t y f o r f i r m s t o h o l d i n v e n t o r y . T h i s s u b s t a n t i a l l y c h a n g e s t h e s u p p l y a n d d e m a n d d e c i s i o n p r o c e s s . F i r m s c a n r e a c t t o f l u c t u a t i o n s i n d e m a n d b y d r a w i n g d o w n o r b u i l d i n g u p i n v e n t o r y i n s t e a d o f v a r y i n g p r i c e o r o u t p u t . T h e o f f i c e m a r k e t i s a g o o d i l l u s t r a t i o n o f t h e u s e o f i n v e n t o r y i n t h e p r i c e a d j u s t m e n t p r o c e s s . T h e r e i s n o r m a l l y a 2 t o 4 y e a r l a g t i m e b e t w e e n t h e c o n c e p t i o n a n d c o m p l e t i o n o f a n o f f i c e b u i l d i n g . 5 T h i s f a c t p r e v e n t s d e v e l o p e r s f r o m i m m e d i a t e l y r e s p o n d i n g t o d e m a n d f l u c t u a t i o n s a n d c r e a t e s a f i x e d s u p p l y o f o f f i c e s p a c e i n t h e s h o r t r u n . T h e r e f o r e , i n o r d e r t o b u f f e r u n a n t i c i p a t e d e v e n t s , l a n d l o r d s m u s t k e e p a n i n v e n t o r y o f o f f i c e s p a c e . When a d e m a n d s h o c k h i t s , t h e l a n d l o r d h a s t h e c h o i c e t o v a r y t h e i n v e n t o r y l e v e l o r t h e l e v e l o f r e n t s . T h e c h o i c e w i l l d e p e n d o n h i s e x p e c t a t i o n s , t h e n a t u r e o f t h e p a r t i c u l a r o f f i c e m a r k e t , a n d t h e e x o g e n o u s f a c t o r s w h i c h e f f e c t i t . I n v e n t o r y o r v a c a n c i e s p r o v i d e a n a d d i t i o n a l b e n e f i t t o t h e o t h e r p a r t i c i p a n t s i n t h e o f f i c e m a r k e t . T h e y a l l o w t e n a n t s t o l o w e r s e a r c h c o s t s a n d t o move b e t w e e n l o c a t i o n s w i t h o u t p l a n n i n g f a r i n a d v a n c e . A s w e l l , t h e y p r o v i d e 5 S e e J . H e k m a n ( 1 9 8 5) 5 d e v e l o p e r s w i t h a d e g r e e o f f l e x i b i l i t y i n t i m i n g t h e a d d i t i o n o f f u t u r e s p a c e . T h e s i m p l e s t o r y a b o v e i n t u i t i v e l y p o i n t s t o a r e l a t i o n s h i p b e t w e e n r e n t s a n d v a c a n c i e s . T h e m e c h a n i s m b y w h i c h t h e y i n t e r a c t i s t h e e s s e n t i a l t o p i c o f t h i s t h e s i s . T h e f o l l o w i n g c h a p t e r p r o v i d e s a r e v i e w o f t h e r e l e v a n t a c a d e m i c l i t e r a t u r e i n t h e p r i c e a d j u s t m e n t a r e a t o p r o v i d e s u p p o r t f o r t h e e m p i r i c a l m o d e l u s e d i n t h e a n a l y s i s . T h r e e t o p i c s a r e e x a m i n e d . T h e f i r s t i s a r e v i e w o f b a s i c i n v e n t o r y t h e o r y t o i n v e s t i g a t e t h e b a s i c e c o n o m i c p r i n c i p l e s u n d e r l y i n g t h e p r i c e a d j u s t m e n t m e c h a n i s m . S e c o n d , t h e r e h a s b e e n a s i g n i f i c a n t a m o u n t o f l i t e r a t u r e w r i t t e n o n t h e p r i c e a d j u s t m e n t m e c h a n i s m i n t h e h o u s i n g m a r k e t . A r e v i e w o f t h i s w o r k i s d o n e f o r c o m p a r a t i v e i n s i g h t o n t h e o f f i c e m a r k e t m e c h a n i s m . F i n a l l y , t h e r e a r e t h r e e e m p i r i c a l s t u d i e s o n t h e p r i c e a d j u s t m e n t m e c h a n i s m i n t h e o f f i c e m a r k e t t h a t h a v e b e e n w r i t t e n . T h e s e a r e a l l r e v i e w e d . T o t e s t t h e p r i c e a d j u s t m e n t m o d e l i n t h i s t h e s i s , I h a v e c h o s e n 5 c i t i e s i n C a n a d a ; M o n t r e a l , T o r o n t o , E d m o n t o n , C a l g a r y , a n d V a n c o u v e r . T h e i n t e n t i s t o p r o v i d e a r e a s o n a b l y b r o a d c r o s s s e c t i o n o f t h e o f f i c e m a r k e t i n C a n a d a a n d t o l o o k a t c i t i e s w h i c h h a v e e x h i b i t e d i n t e r e s t i n g b e h a v i o u r o v e r t h e a n a l y s i s p e r i o d . 6 T o r o n t o and Montrea l r e p r e s e n t the economic power of E a s t e r n Canada and to a l a r g e ex ten t a l l o f Canada. Both c i t i e s have d i v e r s i f i e d economic bases which makes them p a r t i c u l a r l y s u i t a b l e f o r compar ison wi th some o f the l a r g e r U . S . c i t i e s . There i s an i n t e r e s t i n g l i n k between the o f f i c e markets i n Toronto and M o n t r e a l . Over the l a s t 4 0 y e a r s , t h e r e has been a s teady s h i f t o f c o r p o r a t e i n f l u e n c e from M o n t r e a l t o T o r o n t o . The cause and e f f e c t o f t h i s event has had an impact on the p r i c e adjustment mechanism i n bo th c i t i e s . C a l g a r y and Edmonton r e p r e s e n t the glamorous pe t ro leum i n d u s t r y i n Canada. Both a r e i n t e r e s t i n g c i t i e s t o s tudy because o f t h e i r i n c r e d i b l e growth i n the l a t e 1970 's and e a r l y 1 9 8 0 ' s . O f f i c e market growth i n t h e s e two c i t i e s s u r p a s s e d a l l p r e v i o u s r e c o r d s h e l d by any c i t y i n Nor th A m e r i c a . 6 F i n a l l y , Vancouver was chosen because i t i s the l a r g e s t c i t y i n western Canada and the t h i r d l a r g e s t c i t y i n Canada. S i m i l a r t o both C a l g a r y and Edmonton, Vancouver i s h e a v i l y dependent on the n a t u r a l r e s o u r c e i n d u s t r y . I n t e r e s t i n g l y , 6 J . Whitehead (1987) p r o v i d e s an e x c e l l e n t d e s c r i p t i o n o f the development i n d u s t r y i n C a l g a r y and Edmonton d u r i n g t h i s p e r i o d . 7 V a n c o u v e r h a s t h e t h i r d h i g h e s t r a t i o o f o f f i c e s p a c e p e r c a p i t a i n N o r t h A m e r i c a . 7 T h e b i g g e s t s t u m b l i n g b l o c k i n e x a m i n i n g t h e o f f i c e m a r k e t i n C a n a d a i s t h e l a c k o f c o m p r e h e n s i v e d a t a . U n l i k e t h e h o u s i n g m a r k e t , t h e r e i s n o g o v e r n m e n t a g e n c y l i k e t h e C a n a d a M o r t g a g e a n d H o u s i n g C o r p o r a t i o n (CMHC) c o l l e c t i n g u n b i a s e d d i s a g g r e g a t e d i n f o r m a t i o n o n a r e g u l a r a n d c o n s i s t e n t b a s i s . T h e m o s t c o m p r e h e n s i v e s o u r c e o f t i m e s e r i e s d a t a o n t h e o f f i c e m a r k e t i s t h e a n n u a l R o y a l L e P a g e M a r k e t S u r v e y . I h a v e u s e d t h i s a s my p r i m a r y s o u r c e o f d a t a a n d h a v e u s e d v a r i o u s o t h e r s o u r c e s s u c h a s t h e B u i l d i n g O w n e r s a n d M a n a g e r s A s s o c i a t i o n (BOMA) t o i m p r o v e t h e d a t a w h e r e p o s s i b l e . T h e t h i r d c h a p t e r r e v i e w s t h e o f f i c e m a r k e t i n e a c h o f t h e f i v e c i t i e s . A s a s t a r t i n g p o i n t f o r d i s c u s s i o n , t i m e s e r i e s d a t a o n n o m i n a l a n d r e a l r e n t s , a n d v a c a n c i e s h a s b e e n p l o t t e d f o r e a c h c i t y . 8 A f u r t h e r r e v i e w o f l o c a l a n d n a t i o n a l e v e n t s t h a t t o o k p l a c e d u r i n g t h e a n a l y s i s p e r i o d p r o v i d e s s o m e o f t h e e c o n o m i c a n d p o l i t i c a l u n d e r p i n n i n g s i n e a c h c i t y w h i c h w i l l h e l p s h e d some l i g h t o n t h e d a t a a n d t h e p r i c e a d j u s t m e n t m e c h a n i s m . 'See t h e V a n c o u v e r P l a n n i n g D e p a r t m e n t : Q u a r t e r l y R e v i e w 8 A n e x p l a n a t i o n o f t h e d a t a a n d i t s c o l l e c t i o n i s p r o v i d e d i n C h a p t e r 4 8 Chapter four develops the e m p i r i c a l model and discusses the data c o l l e c t i o n and i t s transformation f o r use i n the a n a l y s i s . A pooled cross s e c t i o n a l time s e r i e s r e g r e s s i o n i s conducted f o r the p r i c e adjustment model and the r e s u l t s are discussed i n the context of previous s t u d i e s and the unique c h a r a c t e r i s t i c s of each c i t y . The l a s t chapter presents some concluding remarks. The i n t e n t i s t o summarize the major p o i n t s i n the a n a l y s i s and review p o s s i b l e avenues of f u t u r e research. 9 2.0 LITERATURE REVIEW The l i t e r a t u r e r e v i e w i s d i v i d e d i n t o 3 s e c t i o n s . The f i r s t s e c t i o n d e a l s w i t h t h e l i t e r a t u r e on i n v e n t o r y t h e o r y . T h i s p r o v i d e s a g o o d e c o n o m i c b e n c h m a r k on w h i c h t o a s s e s s t h e t h e o r y on t h e p r i c e a d j u s t m e n t m echanism. The s e c o n d s e c t i o n r e v i e w s some o f t h e e m p i r i c a l s t u d i e s c o n d u c t e d f o r p r i c e a d j u s t m e n t m o d e l s i n t h e h o u s i n g m a r k e t . Much o f t h e w o r k done i n t h e o f f i c e m a r k e t r e l a t e s t o t h e t h e o r y p r o p o s e d f o r t h e h o u s i n g m a r k e t . F i n a l l y , t h e t h i r d s e c t i o n r e v i e w s 4 p a p e r s w h i c h s p e c i f i c a l l y a d d r e s s r e n t a l p r i c e a d j u s t m e n t i n t h e o f f i c e m a r k e t . 2.1 I n v e n t o r y T h e o r y The o f f i c e m a r k e t i s a g o o d e x a m p l e o f a n i n d u s t r y w h e r e t h e u s e o f i n v e n t o r y o r v a c a n c i e s i n d u c e s p e c u l i a r p r i c e r e s p o n s e s when t h e m a r k e t i s h i t w i t h a demand s h o c k . The r e s p o n s e d e v i a t e s f r o m t h e b e h a v i o u r t y p i c a l l y e x p e c t e d i n t h e c l a s s i c a l m o d e l o f s u p p l y and demand. To d i g r e s s f o r a moment, c o n s i d e r t h e h y p o t h e t i c a l m o n o p o l i s t i c f i r m i n F i g u r e 2.1 who f a c e s a f a l l i n g m a r g i n a l r e v e n u e (MR) c u r v e and a r i s i n g m a r g i n a l c o s t (MC) c u r v e . Assume t h a t t h e c o m m o d i t y p r o d u c e d i s c o m p l e t e l y d i v i s i b l e a n d t h a t o u t p u t and p r i c e c a n v a r y i n s t a n t a n e o u s l y . To m a x i m i z e p r o f i t , t h e f i r m w i l l p r o d u c e 10 F I G U R E 2.1 q Q q i q 11 o u t p u t , q Q where the two c u r v e s i n t e r s e c t , M R = M C . The p r i c e , pQ i s de termined by the demand curve a t t h i s o u t p u t . When f a c e d w i t h a p o s i t i v e demand shock , e, the f i r m must i n c r e a s e the ou tput t o q1 a t the new i n t e r s e c t i o n p o i n t . The p r i c e changes a c c o r d i n g l y . I f a f i r m s m a r g i n a l c o s t curve i s s t e e p , than t h e r e w i l l o n l y be a s m a l l change i n output w h i l e p r i c e r e s p o n s e w i l l be s t r o n g . The r e v e r s e w i l l o c c u r i f the s l o p e o f the MC i s f l a t . T h u s , f i r m s respond t o demand shocks by t r a d i n g o f f between p r i c e and o u t p u t . The c h o i c e i s d i c t a t e d by the s l o p e o f the MC c u r v e . C l a s s i c a l s u p p l y and demand models assume p e r f e c t l y d i v i s i b l e p r o d u c t s , no p r o d u c t i o n l a g s o r f r i c t i o n s , c o n t i n u o u s t r a n s a c t i o n s i n the market p l a c e and i n s t a n t a n e o u s p e r f e c t knowledge. The amount o f output taken a t any quoted p r i c e i s known i n s t a n t a n e o u s l y and demand s h i f t s a r e immedia te ly r e g i s t e r e d as a change o f s a l e s . S e l l e r s have the comple te i n f o r m a t i o n s e t which a l l o w s them t o r e v i s e and o b s e r v e the " t r u e " demand f u n c t i o n t h a t f a c e s them. S i n c e both ou tpu t and s a l e s a t the c o r r e c t p r i c e a r e a lways i n e q u i l i b r i u m t h e r e i s never any need f o r i n v e n t o r y . Of c o u r s e , the s c e n a r i o above i s f a r from r e a l i s t i c . A more r i g o r o u s model must c o n s i d e r the many c o n s t r a i n t s and i m p e r f e c t i o n s which f a c e f i r m s i n the r e a l w o r l d . F o r example, o f f i c e space i s o n l y d i v i s i b l e t o a l i m i t e d d e g r e e . A l t h o u g h 12 i t i s p o s s i b l e t o r e n t 1 s q u a r e f o o t o f s p a c e , e c o n o m i e s o f s c a l e a n d minimum t e n a n t r e q u i r e m e n t s make i t l u d i c r o u s t o c o n s i d e r s u c h an o c c u r r e n c e i n t h e m a r k e t . I n a d d i t i o n , s e a r c h c o s t s f o r b o t h l a n d l o r d s and t e n a n t s i n t h e o f f i c e m a r k e t p r e e m p t s c o n t i n u o u s t r a d i n g . T r a n s a c t i o n s i n t h e o f f i c e m a r k e t t h e r e f o r e i n v o l v e t h e e x c h a n g e o f f i n i t e q u a n t i t i e s o f r e n t a l s p a c e a t d i s c o n t i n u o u s and d i s c r e t e p o i n t s i n t i m e . A s a r e s u l t , l a n d l o r d s a r e a l w a y s b e t w e e n t r a n s a c t i o n s and t h e y c a n r a r e l y o b s e r v e c u r r e n t demand. When m a k i n g new p r i c e a n d q u a n t i t y a d j u s t m e n t s , t h e y may o n l y r e l y on p a s t c o n t r a c t s . The u n c e r t a i n t y c r e a t e d by t h e i m p e r f e c t i n f o r m a t i o n c r e a t e s t h e n e c e s s i t y f o r t h e l a n d l o r d t o f o r e c a s t f u t u r e demand. S t o c h a s t i c a s s u m p t i o n s n e e d t o be a d d e d t o t h e d e c i s i o n f r a m e w o r k . I t i s t h e i n t r o d u c t i o n o f u n c e r t a i n t y t h a t l e a d s u s t o t h e n e c e s s i t y f o r i n v e n t o r y . L e t u s r e t u r n t o t h e s i m p l e m o d e l w i t h t h e h y p o t h e t i c a l f i r m . To a d d t o t h e s t o r y , t h e f i r m must now f a c e an u n c e r t a i n demand s c h e d u l e . O n l y t h e p r o b a b i l i t y d i s t r i b u t i o n o f f u t u r e p r i c e a n d o u t p u t p a i r s a r e known. From E. S. M i l l s (1962) t h e demand f u n c t i o n becomes, X = / ( p, V, u ) w h e r e , X: q u a n t i t y demanded p e r u n i t t i m e p: p r i c e p e r u n i t o f q u a n t i t y V: vector of information and prediction variables u: random variable with zero mean and constant variance I f the model i s solved to maximize p r o f i t s subject to the demand function above and a normal cost function, the solution dictates that a firm should keep an optimum l e v e l of inventory 1. This contradicts the c l a s s i c a l notion of output and sales i n equilibrium at any point in time. To provide an i n t u i t i v e sense of the application of t h i s r e s u l t i n the o f f i c e market we examine the simple model developed by Gordon and Hynes (1962). In the o f f i c e rental market, the firm i s the landlord whose product i s vacant space. He i s uncertain as to when the space w i l l be rented. Assume that the p r o b a b i l i t y of renting in any time period, n i s a function of R, the rent asked, n = g(R). Time to re n t a l , T i s assumed to be related to through the geometric function, n = e "1/T.2 i f we compute the expected value of T we a r r i v e at (l-n)/n. If we ignore other costs and assume there i s no discount rate, p r o f i t maximization occurs when revenue i s maximized. The revenue function i s given by, 1For a discussion of t h i s r e s u l t see E.S. M i l l s (1962) i n t u i t i v e l y , the p r o b a b i l i t y of the space being rented i n an i n f i n i t e period i s 1 while the p r o b a b i l i t y of the space being rented instantaneously i s 0. 14 R L T T T T ( L - 1) + 1 where, L i s the term of the lease which i s treated as a given exogenous v a r i a b l e . 3 D i f f e r e n t i a t i n g t h i s function with respect to R provides the value R*, where p r o f i t i s maximized, R* = -g(R*) (g(R*) [L - 1] + 1} , g' (R*) Once the p r o f i t maximizing rent i s known i t i s possible to step back and solve for the associated occupancy or vacancy l e v e l present at t h i s rent, Expected Vacancy = 1 - Occupancy = 1 - L T T where n = g (R ) *-(L - 1) + 1 Expected Vacancy = 1 - Lg(R*) g(R*)[L - 1] + 1 This r e s u l t shows that as long as the landlord does not change his estimate of the p r o b a b i l i t y d i s t r i b u t i o n associated with 3 I f 7r i s the p r o b a b i l i t y of renting i n one month, then ( l - j r ) / * - i s the expected time i n which i t w i l l be rented. We assume we s t a r t renting at the beginning of a month. The t o t a l time between successive rents i s therefore, L + (l-7r)/7r. The proportion of time the space i s rented or occupied i s therefore, L/(L + /n) . Multiplying t h i s expression by R y i e l d s the revenue function. 15 the demand f u n c t i o n , t h e r e e x i s t s an optimum l e v e l o f v a c a n c i e s which maximizes h i s p r o f i t . The v a c a n c i e s h e l p t o b u f f e r the random demand shocks t h a t o c c u r and d e c r e a s e the need f o r sudden surges i n o u t p u t . The i n t e r e s t i n g r e s u l t i s t h a t now l a n d l o r d s can i n d i r e c t l y observe demand by watch ing vacancy l e v e l s . As l o n g as the expec ted demand f u n c t i o n does not change, the l a n d l o r d s i m p l y r e a c t s t o random demand shocks by o b s e r v i n g the d e v i a t i o n from the o p t i m a l vacancy l e v e l and than a c t s a c c o r d i n g l y t o r e t u r n t o t h i s l e v e l . The o p t i m a l vacancy l e v e l w i l l change as the l a n d l o r d c o n s t a n t l y rev iews h i s p a s t t r a n s a c t i o n s and o b s e r v a t i o n s i n the market and r e f o r m u l a t e s h i s assumpt ions about the f u t u r e . The n e c e s s i t y f o r i n v e n t o r y i s a l s o found i n the l i t e r a t u r e on s e a r c h mode ls . In the o f f i c e market we have l a n d l o r d s s e a r c h i n g f o r t e n a n t s and v i c e v e r s a . For a t e n a n t t h e r e a re c o s t s a s s o c i a t e d w i th r e l o c a t i n g . In a d d i t i o n , t o the d i r e c t c o s t s o f moving t h e r e a re s u b s t a n t i a l c o s t s i n c u r r e d i n a c q u i r i n g i n f o r m a t i o n about the market so the t e n a n t can f i n d the d e s i r e d s p a c e . The l a n d l o r d a l s o has h i g h i n f o r m a t i o n c o s t s and i s r e q u i r e d t o a d v e r t i s e i n o r d e r t o f i n d the d e s i r e d t e n a n t . The r e a l e s t a t e b rokerage i n d u s t r y i s used by bo th p a r t i e s f o r a l a r g e p a r t o f t h i s p r o c e s s . Capozza and Schwann (1986) ment ion t h a t t h i s s e a r c h b e h a v i o u r has 16 i m p l i c a t i o n s f o r ad justments i n the r e n t a l market . At any p o i n t , l a n d l o r d s w i l l want t o h o l d an o p t i m a l l e v e l o f v a c a n c i e s t o min imize s e a r c h c o s t s . The i n s i g h t p r o v i d e d by Gordon and Hynes (1962) and, Capozza and Schwann (1986) i s t h a t i n v e n t o r y o r vacancy i s a n e c e s s a r y and e f f i c i e n t r e s u l t i n a market where f i r m s a re f a c e d w i t h i m p e r f e c t i n f o r m a t i o n , u n c e r t a i n t y and s e a r c h c o s t s . I t p r o v i d e s the f i r m w i th an e f f e c t i v e mechanism t o smooth output f l u c t u a t i o n s and min imize s e a r c h c o s t s . To c a r r y on w i t h the s t o r y o f the p r i c e ad justment mechanism l e t s l o o k a t the e f f e c t on a f i r m when i t can h o l d i n v e n t o r y . B l i n d e r (1982) p r o v i d e s a n i c e i l l u s t r a t i o n o f t h i s i n c l u s i o n . F i g u r e 2.2 p r o v i d e s a p i c t u r e o f what i s o c c u r r i n g . When a f i r m can keep i n v e n t o r y i t i s no l o n g e r r e q u i r e d t o e q u i l i b r a t e o u t p u t , y w i t h the c u r r e n t q u a n t i t y demanded, x . Any excess output produced i s s i m p l y p l a c e d i n i n v e n t o r y . T h i s r e s u l t s t i l l a l l o w s f o r MR = MC which ensures p r o f i t m a x i m i z a t i o n f o r the f i r m . A f i r m s i m p l y d e c i d e s how much o u t p u t t o produce and how much i n v e n t o r y t o s e l l by c o n s i d e r i n g what B l i n d e r c a l l s the shadow p r i c e o f i n v e n t o r y , 5(N) . As the f i g u r e shows, x i s determined where MR = 6(N) . I n t u i t i v e l y , you s e l l a l l your i n v e n t o r y up t o the p o i n t where 17 FIGURE 2.2 MR, MC, 6 MC=C (y) 18 the incremental revenue received i s equal to the value of the unit value of the stock i n inventory. In a s i m i l a r manner, y i s determined where MC = S(N). I n t u i t i v e l y , you produce output and add to inventory u n t i l the incremental cost i s equal to the unit value of the stock in inventory. With t h i s picture in place, i t i s possible to observe what occurs when the firm i s faced with a demand shock, e that s h i f t s the marginal revenue curve to the r i g h t . Blinder shows through simple algebra that for any given MC curve the r e l a t i v e response of x and y depend on the s e n s i t i v i t y of 5(N) to the shock e. I f ds/de i s close to 1, than price and output response w i l l both be large. A l t e r n a t i v e l y , i f d5/de i s close to 0 than price and output response i s small and the firm w i l l r e l y on the inventory stock to buffer the demand shock. Thus, i f a firm can store output i t i s possible for both price and output responses to be small when faced with a demand shock. Blinder labels the phenomenon as "sticky prices". The trade off between price and output found i n the c l a s s i c a l model i s now no longer required. From t h i s simple picture, Blinder builds a th e o r e t i c a l model to say something about the price adjustment mechanism. He assumes a monopolistic firm who faces a stochastic demand function. The firm knows the p r o b a b i l i t i e s associated with demand but he must select both price and output before a c t u a l l y observing the demand shock for the current period. 19 Optimal firm behaviour i s obtained by maximizing the following equation, max {E(Revenues - Production Costs - Inventory Costs)} subject to the conditions that, 1. d(Inventory) = Output - Sales 2. MR = expected shadow value of Inventory, 6"(N) 3. MC = expected shadow value of Inventory, 5(N) 4- Expected shadow value appreciation of Inventory = the sum of expected marginal storage costs plus the i m p l i c i t i n t e r e s t cost of carrying inventories A model i s derived that sheds some l i g h t on the price adjustment mechanism when inventory and uncertainty are present i n the firms decision framework: 1. When output i s not inventoriable firms have no choice but to react to changes i n demand by trading o f f responses i n output or pric e . 2. I f output i s inventoriable, then price and output response can move i n tandem. Large p r i c e changes may be associated with large output changes. Conversely, both price and output may change very l i t t l e . Instead the 20 firm w i l l absorb demand shocks through inventory adjustment. 3. The t o t a l cost of holding inventory i s the opportunity cost associated with the l o s t revenue f o r f e i t e d in the current period and the d i r e c t storage costs. This must be balanced against the expected revenue i n a future period. As a res u l t , firms with r a p i d l y increasing marginal inventory holding costs are less l i k e l y to use inventory adjustment.* 4. Firms with constant marginal inventory holding costs who face tr a n s i t o r y demand shocks w i l l r e l y heavily on inventory to buffer the shock and w i l l vary price and output very l i t t l e . This behaviour w i l l reverse i f the shock i s persistent. 5. There exists a long run optimal inventory l e v e l which depends on production costs, the rate of interest, inventory holding costs, and the expected long run position of the demand curve. The short run desired *A.S. Blinder (1982) and L.J. Maccini (1981) assume increasing convex inventory cost functions. This seems to be a reasonable assumption. I n t u i t i v e l y , as the inventory l e v e l increases, the cost of holding that inventory should marginally increase. The s e n s i t i v i t y of the price adjustment response w i l l depend on the degree of convexity in a firms inventory cost function. 21 inventory w i l l deviate from the long run target dependent on the current expected demand. 6. Price changes should be sluggish in industries where output i s inventoriable. We should observe r e l a t i v e l y small re a l price changes. Nominal prices may s t i l l change to keep in step with i n f l a t i o n expectations. 7. The exclusion of negative inventory creates asymmetric price behaviour. There i s strong price response to pos i t i v e demand shocks when inventory i s low i n order to choke o f f demand and low price response to negative shocks. This results i n downward price r i g i d i t y . 5 8. Similar price adjustment behaviour should be observed for competitive firms as well. Even though firms are "price takers not price makers" i t does not prevent them from using inventory to buffer demand shocks and to p a r t i c i p a t e i n price speculation i n the short run. Capozza and Schwann (1986) point out that price dispersion, imperfect information and heterogeneous product helps i n d i v i d u a l firms to find market niches which creates a degree of monopolistic behaviour. 5 Y. Amihud & H. Mendelson (1980) and P.B. Reagan & M.L. Weitzman (1980) show the same r e s u l t . 22 B l i n d e r ' s c o n c l u s i o n i s t h a t i n v e n t o r y p r o v i d e s f l e x i b i l i t y i n d e a l i n g w i t h u n a n t i c i p a t e d e v e n t s . I t a l l o w s o u t p u t s m o o t h i n g a n d s p e c u l a t i v e b e h a v i o u r . The d i s c u s s i o n o f i n v e n t o r y t h e o r y a l l o w s u s t o make some p r o p o s i t i o n s a b o u t t h e r e n t a l o f f i c e m a r k e t : 1. The o f f i c e m a r k e t f a c e s a s h o r t r u n i n e l a s t i c s u p p l y a n d o p e r a t e s i n an u n c e r t a i n w o r l d s o i t i s r e a s o n a b l e t o o b s e r v e l a n d l o r d s h o l d i n g i n v e n t o r i e s o f v a c a n t s p a c e . 2. Wide u s e o f i n v e n t o r y a d j u s t m e n t r a t h e r t h a n p r i c e a n d o u t p u t r e s p o n s e s h o u l d p r o v i d e i n f o r m a t i o n on t h e i n v e n t o r y c o s t f u n c t i o n i n t h e o f f i c e m a r k e t . I n v e n t o r y a d j u s t m e n t i n d i c a t e s t h a t m a r g i n a l i n v e n t o r y h o l d i n g c o s t s i n t h e o f f i c e m a r k e t w i t h i n a f a i r l y b r o a d r a n g e o f v a c a n c i e s s h o u l d be s h o u l d be a l m o s t l i n e a r . 3. I n t h e s h o r t r u n t r a n s i t o r y demand s h o c k s s h o u l d be b u f f e r e d t h r o u g h i n v e n t o r y a d j u s t m e n t . 4. I n t h e s h o r t r u n , o p t i m a l v a c a n c i e s s h o u l d d e p e n d on i n v e n t o r y h o l d i n g c o s t s , t h e r a t e o f i n t e r e s t , a n d e x p e c t e d demand. T h i s may o r may n o t be t h e same a s t h e l o n g r u n d e s i r e d v a c a n c y r a t e . 23 5 . Inventory adjustment may h e l p to e x p l a i n s l u g g i s h p r i c e b e h a v i o u r i n the o f f i c e market . We may observe nominal p r i c e movements i n response t o r e v i s e d i n f l a t i o n e x p e c t a t i o n s but not n e c e s s a r i l y r e a l p r i c e movements. 6. In the o f f i c e market , n e g a t i v e i n v e n t o r y i s not p o s s i b l e so we s h o u l d observe s t r o n g p r i c e response t o p o s i t i v e demand shocks a t low i n v e n t o r y l e v e l s . 7. Normal ly l e a s e terms are f o r 5 y e a r terms o r l o n g e r . T h e r e f o r e we s h o u l d expect l a n d l o r d s t o h o l d v a c a n c i e s t o p a r t i c i p a t e i n p r i c e s p e c u l a t i o n . 2.2 R e n t a l P r i c e Adjustment i n the Hous ing Market Most o f the c u r r e n t o f f i c e market s t u d i e s use s i m i l a r models d e r i v e d f o r the h o u s i n g market . I w i l l rev iew two p a p e r s which a re most r e l e v a n t to the d i s c u s s i o n i n t h i s t h e s i s : Ken Rosen and Lawrence S m i t h , The P r i c e Adjustment P r o c e s s f o r  R e n t a l Hous ing and the N a t u r a l Vacancy R a t e . (1983) T h i s paper c o n f i r m s t h a t r e n t a l p r i c e changes are s i g n i f i c a n t l y a f f e c t e d by excess s u p p l y and demand around a d e s i r e d o r n a t u r a l vacancy r a t e i n the r e n t a l h o u s i n g market . 24 They define the natural vacancy rate as "that rate at which there i s no excess demand nor excess supply and hence the rent i s at i t s long run equilibrium position". The empirical r e s u l t s i l l u s t r a t e the c r u c i a l role of vacancies in the price adjustment process. In addition, the authors attempt to calculate the natural vacancy rates for 13 c i t i e s examined in the paper. The authors point out that within any given year the change i n housing stock i s only 1.5% - 2% so supply i s r e l a t i v e l y fixed i n the short run. I n e l a s t i c i t y of supply and market f r i c t i o n s provide the r a t i o n a l for a natural vacancy rate i n the same fashion as there i s a natural unemployment rate i n the labour market 6. Market f r i c t i o n s i n the housing market include the interaction of landlords and tenants to minimize search and recontracting costs, inventory holding costs, v a r i a b i l i t y of demand, cr e d i t imperfections and long term contracts. The authors posit a model that determines the r e a l rent changes within the c r i t i c a l zone of occupancy; dR = /( dE,V" - V ) where, dR: i s the rate of change in average nominal rents dE: i s the rate of change in t o t a l average operating costs where dE e s s e n t i a l l y r e f l e c t s nominal price influences on dR 6See also A. Alchian (1970) 25 V": i s t h e n a t u r a l v a c a n c y r a t e . O v e r t h e s h o r t r u n i t i s a s s u m e d t h a t t h e s u p p l y a n d d e m a n d f u n c t i o n s a r e e m b o d i e d i n t h i s t e r m . V: i s t h e c u r r e n t a v e r a g e v a c a n c y r a t e I n t h e e m p i r i c a l m o d e l t e s t e d t h e y a s s u m e d t h e n a t u r a l v a c a n c y r a t e , V" w a s c o n s t a n t o v e r t h e e s t i m a t i o n p e r i o d a l l o w i n g i t t o b e e m b o d i e d i n t h e c o n s t a n t t e r m . A n a d d i t i o n a l l a g g e d v a c a n c y v a r i a b l e w a s a d d e d t o c o r r e c t f o r a n y p o s s i b l e l a g g e d r e s p o n s e s . T h e m o d e l w a s t e s t e d u s i n g d a t a f r o m 17 U.S. c i t i e s f o r t h e p e r i o d 1 9 6 9 t o 1 9 8 0 . A n e s t i m a t i o n w a s m ade f o r e a c h i n d i v i d u a l c i t y a n d f o r a p o o l e d c r o s s s e c t i o n o f a l l c i t i e s . F o r 13 o f t h e c i t i e s , v a c a n c i e s w e r e s i g n i f i c a n t i n e x p l a i n i n g t h e p e r c e n t a g e c h a n g e i n r e n t s a t t h e 9 5 % c o n f i d e n c e l e v e l . T h e c r o s s s e c t i o n a l m o d e l h a d t h e f o l l o w i n g r e s u l t s : C o n s t a n t dE,.^ V V t. x R 2 C o e f f . 9.08 .05 - . 2 1 - . 2 8 .24 ( t ) ( 1 5 . 9 ) ( 2 . 5 1 ) ( 2 . 2 6 ) ( 3 . 1 6 ) U n f o r t u n a t e l y , t h e S S E a n d F s t a t i s t i c w e r e n o t p r o v i d e d . T h e r e s u l t s s e e m t o v e r i f y t h e e f f e c t o f v a c a n c y l e v e l s o n p r i c e a d j u s t m e n t s . U n f o r t u n a t e l y , f r o m t h e r e s u l t s i t i s n o t p o s s i b l e t o t e l l i f t h e r e i s a n y a s y m m e t r i c p r i c e b e h a v i o u r b e l o w a n d a b o v e t h e n a t u r a l v a c a n c y r a t e . 26 The a u t h o r s a l s o used the p r i c e ad justment model to e s t i m a t e a v a l u e f o r the n a t u r a l vacancy i n each c i t y . T h i s v a l u e was r e g r e s s e d a g a i n s t a s e r i e s o f independent v a r i a b l e s thought t o have some e x p l a n a t o r y v a l u e . Some of the r e s u l t s a r e r e l e v a n t t o the o f f i c e market d i s c u s s i o n . I t was found t h a t r e n t d i s p e r s i o n was s i g n i f i c a n t and had a p o s i t i v e e f f e c t on the n a t u r a l vacancy r a t e . T h i s sugges ts t h a t a l a r g e r range o f r e n t a l p r i c e s w i l l norma l ly i n c r e a s e the l e n g t h of t ime r e q u i r e d t o f i n d the d e s i r e d r e n t a l u n i t . T h i s would p l a c e p r e s s u r e on the n a t u r a l vacancy t o r i s e t o f a c i l i t a t e e a s i e r s e a r c h . Both t h e change i n h o u s i n g s t o c k and p o p u l a t i o n over the e s t i m a t e d p e r i o d were s i g n i f i c a n t and had a p o s i t i v e e f f e c t on the n a t u r a l v a c a n c y . T h i s i n d i c a t e s t h a t p r i c e s p e c u l a t i o n and h i g h e r e x p e c t a t i o n s o f f u t u r e demand a l l o w l a n d l o r d s t o i n c r e a s e the amount o f v a c a n t space they a r e w i l l i n g t o h o l d . Denn is A . C a p o z z a , New E v i d e n c e on Rents and V a c a n c i e s . (1980) T h i s paper t e s t s two a d d i t i o n a l e lements o f p r i c e ad justment t h e o r y which s h o u l d be embodied i n the model s p e c i f i c a t i o n ; p r i c e asymmetry and i n f l a t i o n e x p e c t a t i o n s . Capozza d e r i v e s a s i m p l e model o f the h o u s i n g market where l a n d l o r d s a re f a c e d w i th an u n c e r t a i n demand c u r v e . A l a n d l o r d s e t s r e n t s i n i t i a l l y , then o b s e r v e s the d u r a t i o n and l e v e l o f v a c a n c i e s b e f o r e h e r e a d j u s t s t h e m f o r t h e n e x t p e r i o d . A t n o t i m e c a n a l a n d l o r d r e n t m o r e u n i t s t h e n h e c u r r e n t l y h a s i n s t o c k . T h e s h o r t r u n s o l u t i o n y i e l d s t w o e q u a t i o n s f o r r e n t a d j u s t m e n t . E a c h a r e a p p l i e d d e p e n d e n t o n t h e w h e t h e r t h e c u r r e n t v a c a n c y l e v e l i s a b o v e o r b e l o w t h e l o n g r u n d e s i r e d v a c a n c y l e v e l , V". 7 F o r v a c a n c i e s l e v e l s b e l o w V", r e n t a l p r i c e c h a n g e s a r e d e p e n d e n t o n l y o n t h e v a c a n c y r a t e a n d t h e s l o p e o f t h e c u r v e i s r e l a t i v e l y s t e e p a s t h e v a c a n c y l e v e l d e c r e a s e s . F o r v a c a n c i e s a b o v e V", r e n t a l p r i c e c h a n g e s d e p e n d o n m a r g i n a l v a r i a b l e o p e r a t i n g c o s t s a n d t h e v a c a n c y r a t e . T h e s l o p e o f t h e c u r v e i s m u c h f l a t t e r t h a n t h e f o r m e r a s y o u i n c r e a s e v a c a n c i e s . I f y o u c o m b i n e t h e t w o e q u a t i o n s y o u c r e a t e a f u n c t i o n t h a t i s s i m i l a r t o t h e k i n k e d P h i l l i p s c u r v e . C a p o z z a d r a w s t h e f o l l o w i n g c o n c l u s i o n s : 1. T h e c h a n g e i n r e n t s i s a d e c r e a s i n g f u n c t i o n o f v a c a n c i e s . 2. S h o r t r u n d e m a n d s h i f t s s u g g e s t t h a t t h e r e i s a n o n l i n e a r o r i n v e r s e r e l a t i o n s h i p b e t w e e n c h a n g e s i n r e n t s a n d v a c a n c i e s . ' V a c a n c y l e v e l s b e l o w t h e l o n g r u n v a c a n c y l e v e l a r e c o n s i d e r e d t o b e t h e r a n g e o f f u l l o c c u p a n c y . 28 3. The relationship of rent changes to vacancies and operating costs i s asymmetric. Vacancies influence rent changes less at high vacancies and variable operating costs are only relevant at high vacancy l e v e l s 8 . Fixed operating costs are not part of the r e l a t i o n s h i p 9 . 4. In a world of ra t i o n a l expectations and persistent i n f l a t i o n , landlords w i l l t r y to set rents i n r e a l terms. As i n f l a t i o n has been prevalent since 1960 the rental price adjustment model should include a variable for i n f l a t i o n expectations to determine how well landlords have been able to keep pace with the price l e v e l . To t e s t the model, Capozza looked at the rental housing market i n Los Angeles using available data for the period 1952 - 1976. His pl o t of percentage change in rents against vacancy shows a d e f i n i t e non l i n e a r relationship that provides evidence of price asymmetry. A series of regressions are done using the percentage change i n nominal rents as the dependent varia b l e . The independent variables are a combination of vacancy variables and various proxies for i n f l a t i o n 8C.P. Rydell (1979) also argues that rents w i l l be in s e n s i t i v e to demand when vacancies are high. Vacancies bear the burden of the demand s h i f t s . 9To the extent that fixed operating costs are passed on to the tenant i n the o f f i c e market they may be relevant. See J.D S h i l l i n g et a l . (1987) expectations. The v a r i a b l e s used f o r i n f l a t i o n e x p e c t ation p r o x i e s are the long term government bond r a t e , i B o n d and a moving average of past i n f l a t i o n r a t e s , MAvg C P I. 1 0 The more p e r t i n e n t e m p i r i c a l r e s u l t s are given below: Constant V 1/ V i B o n d MAvg C P I R2 Coeff. 5.83 -1.14 .23 (t) (4.55) (-2.59) Coeff. -.60 8.51 .24 (t) (-.48) (2.67) Coeff. -5.65 10.83 .89 .82 (t) (6.58) (6.76) (8.47) Coeff. -1.25 4.91 .64 .83 (t) (-2.03) (3.04) (8.61) The r e s u l t s show th a t the inverse of vacancies, 1/V i s a b e t t e r s p e c i f i c a t i o n f o r the model. The s i g n i f i c a n c e o f the vacancy term and the explanatory power o f the model i s s u b s t a n t i a l l y improved by the a d d i t i o n o f the i n f l a t i o n 1 0E. Fama (1976) shows th a t i n t e r e s t r ates are a good proxy f o r i n f l a t i o n expectations. This f o l l o w s from the F i s h e i hypothesis t h a t a l l v a r i a t i o n i n the i n t e r e s t r a t e i s due to i n f l a t i o n a r y expectations s i n c e the r e a l r a t e i s constant. The moving average term was estimated using an ARIMA (0,1,1) time s e r i e s model. 30 expectation variable. It appears that landlords were able to pass 60% to 84% of the expected i n f l a t i o n over to tenants. There are other studies of rental price adjustment in the housing market 1 1. Several find empirical r e s u l t s which downplay the importance of vacancies in the rental price adjustment process. However, Capozza points out that t h i s may be due to s p e c i f i c a t i o n error in the regression model. For the most part, the housing market papers presented b r i e f l y here embody the evidence that i s consistent with the papers on the o f f i c e market and the arguments presented in t h i s t h e s i s . 2.3 Rental Price Adjustment i n the Of f i c e Market There are only 3 papers which have been written on the pr i c e adjustment mechanism i n the o f f i c e market. A l l have been completed within the l a s t few years and there i s c e r t a i n l y room for further and more rigorous analysis. As mentioned before the primary stumbling block to research in t h i s area appears to be a lack of good data sets. A fourth paper reviews some of the problems found in c o l l e c t i n g o f f i c e market data. uSee F. De Leeuw and N.F. Ekanem (1971), L.B. Smith (1974), A.A. Eubank and C.F. Sirmans (1979), R.C. F a i r (1972), and D.M. Blank and L. Winnick (1953) 31 Ken T.Rosen, Toward a Model of the O f f i c e B u i l d i n g  Sector.(1984) Rosen i s the f i r s t to t r y and b u i l d a complete model f o r f o r e c a s t i n g the behaviour of the r e n t a l o f f i c e market. He develops a s t a t i s t i c a l model of supply and demand where the key v a r i a b l e s are the stock of occupied space, the new c o n s t r u c t i o n flow, the vacancy r a t e , and the r e n t a l r a t e . P r e d i c t i n g o f f i c e demand r e q u i r e s e s t i m a t i n g the growth i n o f f i c e employment and pr o p e r l y s p e c i f y i n g the r e n t a l p r i c e adjustment mechanism t o estimate fut u r e r e n t s . O f f i c e employment i s the key demand v a r i a b l e . Rosen uses employment i n the Finance, Insurance and Real Estate s e c t o r s as a proxy f o r o f f i c e employment. 1 2 The r e n t a l p r i c e adjustment mechanism i s posed i n a s i m i l a r fashion t o t h a t suggested by Rosen and Smith (1983) f o r the housing market. The vacancy r a t e a f f e c t s r e n t s i n a non l i n e a r fashion. Rents f a l l ( r i s e ) more r a p i d l y the f u r t h e r you move from the optimal vacancy r a t e . His model t h e r e f o r e takes the form; dR = /( Vt - V\, d P ^ ) where, dR: i s the change i n average nominal re n t s See H. K e l l y (1983) f o r a d i s c u s s i o n of t h i s assumption. 32 V"t: i s the optimal normal vacancy rate. 1 3 Vt: i s the current vacancy rate dPt.1: i s the change in the consumer price l e v e l to adjust nominal rent changes to rea l rent changes. This appears to be the proxy for i n f l a t i o n expectations Rosen used a f a i r l y extensive data set from the San Francisco O f f i c e Space Network. Data i s for the period 1961 to 1983. In h i s empirical model he assumed that the optimal vacancy rate was the average rate over the period, 7%. The re s u l t s were as follows; Constant (Vfc - 7%) dP^ R2 Coeff. 1.53 -2.09 1.82 .55 (t) (-39) (-2.72) (3.08) Unfortunately, there i s no further s t a t i s t i c a l information to provide further diagnostics. Although there i s d e f i n i t e l y some sig n i f i c a n c e in the c o e f f i c i e n t s there are some apparent weaknesses in the analysis. F i r s t , the assumption of a constant optimal vacancy rate i s probably a misspecification given the extensive period of estimation. Second, although he mentioned i n the paper there i s a nonlinear r e l a t i o n s h i p 13K. Rosen posits that V",. = /( i , E(Rt) ) which implies that higher i n t e r e s t costs w i l l lower the normal vacancy rate and higher expected rents should raise the normal vacancy through price speculation. Expected demand flows through the rent variable. 33 between rent changes and vacancies the model does not test t h i s r e s u l t . The c o e f f i c i e n t on the price l e v e l variable i s rather i n t e r e s t i n g . The value, 1.82 implies that landlords were able to pass on rental increases that exceeded the rate of i n f l a t i o n . This may be a result of long lease terms and the necessity to c a p i t a l i z e i n f l a t i o n a r y increases over the f u l l l i f e of the lease. John Hekman, Rental Price Adjustment in the O f f i c e  Market. (1985) The main focus i n t h i s paper i s the proposition that developers over respond to high rents i n the short run and formulate s u p e r f i c i a l l y high expectations of p r o f i t opportunities. His approach embodies a model of rental price adjustment. Hekman makes the important point that the o f f i c e markets between various c i t i e s can be extremely heterogeneous. The primary demand variable, the growth rate of o f f i c e employment w i l l vary between c i t i e s depending on the industry focus and the composition of employment. When estimating any model of the o f f i c e market i t i s important to use a cross sectional analysis and capture any l o c a l e f f e c t s . Hekman assumes that the o f f i c e market i s competitive and that each landlord i s a price taker. Since supply of 34 o f f i c e space i s determined by past investment d e c i s i o n s and does not respond to current rents i t i s reasonable to assume t h a t supply i s f i x e d i n the short run. Rent changes are t h e r e f o r e a f f e c t e d only by the forces of demand. His model of rent adjustment i s d i f f e r e n t from Rosen i n tha t the dependent v a r i a b l e i s the absolute value of rent r a t h e r than the change i n r e n t ; R = /( V , GNP, E i f Ui ) where, R: i s the r e a l rent f o r c l a s s A downtown b u i l d i n g s under c o n s t r u c t i o n . Quoted nominal r a t e s are adjusted by the current p r i c e l e v e l V: i s the current vacancy l e v e l i n e x i s t i n g Class A downtown o f f i c e b u i l d i n g s . GNP: i s the gross n a t i o n a l product. This i s a measure of n a t i o n a l demand. E t: i s the l e v e l of employment i n SMSA i . This v a r i a b l e i s meant t o provide a c o n t r o l f o r c i t y s i z e . UL: i s the l e v e l of unemployment i n SMSA i . This v a r i a b l e i s intended to capture l o c a l demand e f f e c t s . The data i s taken from The O f f i c e Network: N a t i o n a l O f f i c e Market Report. Data i s from 14 U.S. c i t i e s and the pe r i o d i s from 1979 to 1983. The r e s u l t s of the e m p i r i c a l t e s t s on the cross s e c t i o n a l time s e r i e s model are as f o l l o w s ; 35 Constant V GNP E U R 2 C o e f f . -4.47 -.0019 3.64 .00017 .012- .37 (t) (-1.88) (-2.41) (2.26) (4.54) (.80) F = 9.70 E l a s t i c i t i e s : E(R,V) = -.08, E(R,GNP) = 4.45, E(R,E) = .24 The r e s u l t s again show the s i g n i f i c a n c e of v a c a n c i e s i n dete r m i n i n g r e n t s . A l l the other v a r i a b l e s have the c o r r e c t s i g n and are s i g n i f i c a n t with the e x c e p t i o n of the unemployment v a r i a b l e . T h i s v a r i a b l e i s n e i t h e r s i g n i f i c a n t nor does i t have the c o r r e c t s i g n . Although s p e c i f i e d d i f f e r e n t l y than Rosen, the e l a s t i c i t i e s p r o v i d e some i n s i g h t on the p r i c e adjustment process. The vacancy e l a s t i c i t y i m p l i e s t h a t i f you double vaca n c i e s , r e n t s w i l l o n l y drop by 8%. T h i s seems t o be c o n s i s t e n t with the p r o p o s i t i o n of p r i c e r i g i d i t y a t hi g h v a c a n c i e s , however, t h i s e l a s t i c i t y would p r e d i c t the same low p r i c e response i f v a c a n c i e s suddenly decrease. T h i s i s not the expected r e s u l t i f you have a l a r g e p o s i t i v e demand shock. The l a r g e GNP e l a s t i c i t y suggests t h a t r e n t s are s t r o n g l y a f f e c t e d by s h i f t s i n the n a t i o n a l economy. The employment e l a s t i c i t y suggests t h a t r e n t s w i l l only i n c r e a s e 24% as f a s t as c i t y s i z e . Given the theory presented i n t h i s chapter i t would seem t h a t Hekman i s not p r o p e r l y s p e c i f y i n g the r e n t a l p r i c e adjustment model. Although h i s r e s u l t s are s i g n i f i c a n t they do 36 not provide d e f i n i t i v e v e r i f i c a t i o n to some of the propositions on adjustment. In addition, the estimation period, 1979 to 1983 would seem to be a b i t short for a rigorous empirical test even though Hekman maintains the data set i s superior to any so far tested. James S h i l l i n g , C. Simians and John Corgel, Price Adjustment  for Rental O f f i c e Space. (1987) The paper r a t i o n a l i z e s the o f f i c e market model in l i g h t of the current l i t e r a t u r e on inventory. 1. Vacancies allow landlords f l e x i b i l i t y i n reacting to unanticipated events. 2. Differences in the marginal costs of holding vacancies, and fluctuations in expected demand explain variations in the normal vacancy rate. Price adjustment should be strongest when vacancies are below the natural vacancy rate and weakest when they are above. This assumes that marginal costs of holding vacancies are r e l a t i v e l y constant over the range of vacancies in the short run. Some good i n t u i t i v e insights into the o f f i c e market are covered i n t h i s paper. As o f f i c e space i s produced slowly, 37 o f t e n s t a r t i n g 2 t o 3 y e a r s i n a d v a n c e o f o p e n i n g i t i s o p t i m a l f o r b o t h l a n d l o r d s a n d t e n a n t s t o h a v e v a c a n c i e s t o r e s p o n d t o u n a n t i c i p a t e d d e m a n d . 1 * V a c a n c i e s may a l s o p r o v i d e t e n a n t s w i t h l o w e r s e a r c h c o s t s a n d r e m o v e t h e r e q u i r e m e n t t o c o m m i t t o s p a c e l o n g i n a d v a n c e o f t h e m o v e . I n t h e h o u s i n g m a r k e t t h e l e v e l o f v a c a n c i e s r e q u i r e d f o r t h i s c o n s t r a i n t may b e s m a l l . 1 5 No s t u d y h a s s h o w n w h e t h e r t h i s r e s u l t c a r r i e s t o t h e o f f i c e m a r k e t a s w e l l . T h e a u t h o r s s u g g e s t t h e i n v e n t o r y h o l d i n g c o s t f u n c t i o n i s f a i r l y c o n s t a n t i n t h e s h o r t r u n . T h i s i m p l i e s t h a t t h e l e v e l o f v a c a n t s p a c e i s n o t c r i t i c a l . F a c e d w i t h a t e m p o r a r y d e m a n d s h o c k a n d t h e p r o s p e c t o f l o n g l e a s e s l a n d l o r d s may b e b e t t e r t o w a i t a n d s i t o n t h e v a c a n t s p a c e u n t i l a f u t u r e p e r i o d w h e n r e n t s a r e h i g h e r . T h e m o d e l u s e d b y t h e a u t h o r s i s s i m i l a r t o t h e o n e u s e d b y R o s e n a n d S m i t h ( 1 9 8 3 ) i n t h e h o u s i n g m a r k e t ; dR = / ( d E , V " - V ) w h e r e , dR: t h e r a t e o f c h a n g e i n r e a l r e n t s . T h e c o n s u m e r p r i c e i n d e x i s u s e d t o a d j u s t n o m i n a l r e n t s d E : t h e r a t e o f c h a n g e i n t o t a l r e a l f i x e d a n d v a r i a b l e o p e r a t i n g c o s t s 1 6 u S e e a l s o A. A l c h i a n & W.R. A l l e n (1982) 1 5 A. A l c h i a n & W.R. A l l e n (1982) e s t i m a t e t h a t 3% o f r e n t p a i d b y a p a r t m e n t d w e l l e r s c o v e r s t h e c o s t o f v a c a n t a p a r t m e n t s p a c e . 1 6 I n t h i s m o d e l d E i s n o l o n g e r m e a s u r i n g t h e n o m i n a l p r i c e c h a n g e i n r e n t s a s i t w a s i n t h e R o s e n a n d S m i t h m o d e l . I n s t e a d , t h e v a r i a b l e m e a s u r e s t h e d e g r e e t o w h i c h m a r g i n a l 38 V": t h e n o r m a l v a c a n c y r a t e . O v e r t h e s h o r t r u n i t i s a s s u m e d t h a t t h e s u p p l y a n d d e m a n d f u n c t i o n s a r e e m b o d i e d i n t h i s t e r m . V: t h e c u r r e n t v a c a n c y r a t e I n t h e e m p i r i c a l t e s t , t h e a u t h o r s a l s o a d d a n i n t e r a c t i o n t e r m , d R * V t o t e s t a n y n o n l i n e a r i t i e s i n t h e r e l a t i o n s h i p a n d a l a g g e d v a c a n c y v a r i a b l e t o c a t c h l a g g e d r e s p o n s e . T h e d a t a u s e d c o m e s f r o m t h e B u i l d i n g O w n e r s a n d M a n a g e r s A s s o c i a t i o n (BOMA) E x p e r i e n c e E x c h a n g e R e p o r t . 17 C i t i e s i n t h e U.S. a r e t e s t e d f o r t h e p e r i o d 1 9 6 0 t o 1 9 7 5 a n d t h e d a t a l o o k s a t d o w n t o w n o f f i c e s p a c e b e t w e e n 5 0 , 0 0 0 a n d 6 0 0 , 0 0 0 s q u a r e f e e t . T h e m o d e l w a s t e s t e d f o r e a c h c i t y . No c r o s s s e c t i o n a l a n a l y s i s w a s d o n e t o t a k e a d v a n t a g e o f a l a r g e r d a t a s e t . T h e g e n e r a l r e s u l t s s h o w d E a s a n i n s i g n i f i c a n t v a r i a b l e . T h i s i n d i c a t e s t h a t f i x e d a n d v a r i a b l e o p e r a t i n g c o s t a r e n o t a s i g n i f i c a n t c o m p o n e n t o f i n v e n t o r y h o l d i n g c o s t s . T h e l a g g e d v a r i a b l e w a s n o t s i g n i f i c a n t . T h e i n t e r a c t i o n t e r m w a s s i g n i f i c a n t i n m o s t c i t i e s i n d i c a t i n g t h a t t h e r e l a t i o n s h i p b e t w e e n r e n t c h a n g e s a n d v a c a n c i e s i s n o n l i n e a r . U n f o r t u n a t e l y , t h i s r e s u l t w a s n o t e m p h a s i z e d b y t h e a u t h o r s . T h e v a c a n c y v a r i a b l e w a s s i g n i f i c a n t f o r a l l o f t h e c i t i e s a n d t h e R 2 / s w e r e a l l i n t h e .7 t o .98 r a n g e . A n o p e r a t i n g c o s t s a f f e c t i n v e n t o r y h o l d i n g c o s t s w h i c h i n t u r n a f f e c t t h e p r i c e a d j u s t m e n t m e c h a n i s m . C h a n g e s i n o p e r a t i n g c o s t s s h o u l d n o t a f f e c t r e n t s i f t h e l e a s e s a r e f u l l y n e t u n l e s s t h e f i x e d p o r t i o n ( l i k e r e a l e s t a t e t a x e s w h i c h h a v e t o b e p a i d w h e t h e r s p a c e i s v a c a n t o r n o t ) i s a s i g n i f i c a n t f a c t o r . 39 a t t e m p t w a s a l s o made t o v e r i f y t h e n o r m a l v a c a n c y r a t e f o r e a c h c i t y i n a f a s h i o n s i m i l a r t o R o s e n a n d S m i t h ( 1 9 8 3 ) , h o w e v e r , t h e r e s u l t s w e r e i n s i g n i f i c a n t a n d s o m e w h a t i n c o n c l u s i v e . A. E g e r a n d J . G. S m i t h , T h e D e l p h i A p p r o a c h : A S u r v e y o f  C a n a d i a n O f f i c e C o n s t r u c t i o n i n 1 9 8 6 . ( 1 9 8 7 ) A l t h o u g h t h i s p a p e r d o e s n o t d e a l d i r e c t l y w i t h p r i c e a d j u s t m e n t i t p r o v i d e s some g o o d d i s c u s s i o n o n c h a r a c t e r i s t i c s o f t h e o f f i c e m a r k e t a n d some o f t h e d a t a c o l l e c t i o n p r o b l e m s . T h e m a j o r p r o b l e m w i t h e m p i r i c a l s t u d i e s i n t h i s a r e a i s t h e c o l l e c t i o n o f r e n t a l p r i c e d a t a . T h e r e i s a t r e m e n d o u s r a n g e o f r e n t a l c o n t r a c t s i n t h e m a r k e t a n d o n e m u s t b e c a r e f u l w h e n u s i n g s e c o n d a r y d a t a s o u r c e s . S i n c e m o s t s o u r c e s p r o v i d e a v e r a g e r e n t s o n e m u s t e n s u r e t h a t t h e d a t a i s c a r e f u l l y s e l e c t e d . F o r e x a m p l e , e x i s t i n g r e n t s a r e n o t n e c e s s a r i l y i n d i c a t i v e o f c u r r e n t m a r k e t r e n t s . L e a s e s a r e u s u a l l y f o r 5 y e a r p e r i o d s a n d t h e r e f o r e r e f l e c t o l d r e n t s . T h u s o n l y q u o t e d a s k i n g r e n t s o r r e c e n t l y c o n t r a c t e d l e a s e s s h o u l d b e u s e d . I n a d d i t i o n , a t t e n t i o n s h o u l d b e p a i d t o t h e t y p e o f t e n a n t b e h i n d t h e r e n t a l c o n t r a c t . T h e r e i s a r e a l d i s p a r i t y b e t w e e n r e n t s p a i d b y a n c h o r t e n a n t s a n d t h e p o s t e d m a r k e t r e n t p a i d b y s p e c u l a t i v e t e n a n t s . A n c h o r t e n a n t s t y p i c a l l y p a y 2 0 % - 3 0 % l e s s t h a n m a r k e t r e n t s , t y p i c a l l y o c c u p y 4 0 % - 6 0 % o f t h e t o t a l b u i l d i n g s p a c e a n d o f t e n h a v e 40 lease terms up to 20 years with l i t t l e rent escalation. F i n a l l y , rents w i l l range substantially through the various classes of o f f i c e space and through the various locations of the o f f i c e space in the c i t y . These points indicate a need to qu a l i f y the type of tenant, the quality and location of space, and the contract date of the lease when recording the rental p r i c e . Another major discrepancy in rental data i s the common use of tenant inducements in the current o f f i c e market. Free rent and cash inducements can reduce the e f f e c t i v e rent to as l i t t l e as 50% of the posted market rent. 1 7 The authors suggest that t h e i r Delphi model which uses a survey of 135 public and private developers in 6 Canadian c i t i e s i s a better method of recording actual behaviour and data than c o l l e c t i n g secondary data from industry sources of questionable v a l i d i t y . One of the i n t e r e s t i n g findings of t h e i r survey i s that vacancy rates within a range of 5% to 15% are deemed to be normal. Rates may vary within t h i s range for as long as 18 months before i t w i l l a f f e c t expectations. 1 7See P. Goldstein (1985) and the Toronto Planning Department: 1986 Quinquennial Review. 41 3.0 THE O F F I C E MARKET I N CANADA T h i s c h a p t e r r e v i e w s t h e o f f i c e m a r k e t s i n f i v e C a n a d i a n c i t i e s ; M o n t r e a l , T o r o n t o , E d m o n t o n , C a l g a r y , a n d V a n c o u v e r . A s a s t a r t i n g p o i n t f o r d i s c u s s i o n , t i m e s e r i e s p l o t s h a v e b e e n c o n s t r u c t e d w i t h t h e d a t a o n n o m i n a l a n d r e a l r e n t s , a n d v a c a n c i e s f o r e a c h c i t y . 1 A f u r t h e r r e v i e w o f e v e n t s t h a t t o o k p l a c e d u r i n g t h e a n a l y s i s p e r i o d p r o v i d e s some o f t h e e c o n o m i c a n d p o l i t i c a l u n d e r p i n n i n g s i n e a c h c i t y w h i c h w i l l h e l p s h e d some l i g h t o n t h e d a t a a n d t h e p r i c e a d j u s t m e n t m e c h a n i s m . 3.1 M o n t r e a l T h e t i m e s e r i e s p l o t f o r M o n t r e a l i s s h o w n i n F i g u r e 3 . 1 . 1 . N o m i n a l r e n t s i n c r e a s e c o n s i s t e n t l y t h r o u g h t h e l a t e 1 9 7 0 ' s a n d e a r l y 1 9 8 0 ' s i n r e s p o n s e t o t h e r a p i d l y d e c l i n i n g v a c a n c y r a t e . H o w e v e r , when t h e v a c a n c y r a t e c l i m b s t o 1 6 % i n 1 9 8 3 , t h e n o m i n a l r e n t s l e v e l o f f f o r a 3 y e a r p e r i o d b e f o r e c l i m b i n g a g a i n when t h e v a c a n c y l e v e l d r o p s t o 1 1 % . T h e m o s t c u r i o u s f e a t u r e o f t h e p l o t i s t h e b e h a v i o u r o f r e a l r e n t s . R e a l r e n t s s h o u l d i n d i c a t e t h e t r u e p r i c e a d j u s t m e n t A n e x p l a n a t i o n o f t h e d a t a a n d i t s c o l l e c t i o n i s p r o v i d e d i n C h a p t e r 4. 42 m e c h a n i s m . B e t w e e n 1977 a n d 1 9 8 2 v a c a n c y r a t e s d r o p p e d r a p i d l y t o a n a l l t i m e l o w o f 1%. S t r a n g e l y e n o u g h r e a l r e n t s d o n o t r e s p o n d t o t h e s h a r p d i p . T h e o r y p r e d i c t s t h a t r e a l r e n t s s h o u l d i n c r e a s e r a p i d l y t o c h o k e o f f d e mand a n d m a i n t a i n a n e q u i l i b r i u m v a c a n c y l e v e l . F u r t h e r m o r e , i n 1 9 8 3 , when v a c a n c i e s b e g i n t o c l i m b t h e r e i s a n i m m e d i a t e d r o p i n r e a l r e n t s . No p r i c e r i g i d i t y i s o b s e r v e d . O n l y when t h e v a c a n c y d r o p s t o 1 1 % i n 1 9 8 6 d o r e a l r e n t s f i n a l l y b e g i n t o c l i m b b a c k t o p r e 1 9 8 2 l e v e l s . T h e R o y a l L e P a g e M a r k e t S u r v e y a n d o t h e r v a r i o u s s o u r c e s w e r e u s e d t o p r o v i d e a g l i m p s e o f t h e b a c k g r o u n d e v e n t s o c c u r r i n g i n t h e a n a l y s i s p e r i o d . T h e c i t y o f M o n t r e a l was h i s t o r i c a l l y t h e c o m m e r c e h u b o f C a n a d a . H o w e v e r , o v e r t h e y e a r s , t h i s e c o n o m i c p o w e r h a s b e e n g r a d u a l l y e r o d e d a n d T o r o n t o h a s e m e r g e d a s t h e new d o m i n a n t f i n a n c i a l a n d c o m m e r c i a l f o c u s . T h e m o s t d r a m a t i c s h i f t o c c u r r e d i n t h e 1 9 7 0 ' s a s a d i r e c t r e s u l t o f s i g n i f i c a n t p o l i t i c a l c h a n g e s i n t h e p r o v i n c e o f Q u e b e c . I n 1 9 7 6 , t h e P a r t i Q u e b e c o i s g o v e r n m e n t u n d e r R e n e L e v e s q u e was e l e c t e d w i t h a m a n d a t e t o s e p a r a t e Q u e b e c f r o m t h e r e s t o f C a n a d a . T h e r a d i c a l g o v e r n m e n t i m m e d i a t e l y p r o p o s e d t o make f r e n c h t h e o n l y b u s i n e s s l a n g u a g e a n d s u g g e s t e d a p o s s i b l e n a t i o n a l i z a t i o n D. C a p o z z a ( 1 9 8 0 ) p o i n t s o u t t h a t l a n d l o r d s o p e r a t i n g i n a n i n f l a t i o n a r y w o r l d w i l l r e s p o n d t o r e a l r e n t l e v e l s . 3 S e e R.K S e m p l e a n d W.R. S m i t h ( 1 9 8 1 ) 43 F I G U R E 3.1.1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s MONTREAL 0 Nominal Rent + Real Rent (81 -=1 CO) O Vacancy S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y 44 o f s e l e c t e d p r o d u c t a n d s e r v i c e i n d u s t r i e s . " ^ T h e s e e v e n t s h a d a p r o f o u n d e f f e c t o n t h e c o n f i d e n c e o f b u s i n e s s e s o p e r a t i n g i n M o n t r e a l . C r o w n c o r p o r a t i o n s l i k e CN a n d A i r C a n a d a a n d n a t i o n a l c o r p o r a t i o n s l i k e CP who w e r e a l l h e a d q u a r t e r e d i n M o n t r e a l w e r e f a c e d w i t h t h e p o t e n t i a l p r o s p e c t o f h a v i n g t o o p e r a t e t h e i r C a n a d i a n o p e r a t i o n s f r o m a f o r e i g n c o u n t r y . I n a d d i t i o n t o t h e p o l i t i c a l s i t u a t i o n i n t h e l a t e 1 9 7 0 ' s , t h e r e w e r e o t h e r f a c t o r s a t w o r k . P r o v i n c i a l t a x e s i n Q u e b e c w e r e t h e h i g h e s t i n C a n a d a a n d t h e r e w e r e n u m e r o u s p u b l i c a n d p r i v a t e s e c t o r s t r i k e s . O v e r a l l , t h e b u s i n e s s c l i m a t e was e x t r e m e l y s h a k e n a n d i t t r i g g e r e d a m a s s e x o d u s o f c o r p o r a t i o n s a n d p r o f e s s i o n a l e m p l o y e e s o u t o f Q u e b e c . A s a n e x a m p l e , i n 1 9 7 7 , t h e M o n t r e a l b u s i n e s s c o m m u n i t y was s t u n n e d b y t h e d e c i s i o n b y S u n L i f e A s s u r a n c e C o . , a n 8 b i l l i o n d o l l a r c o m p a n y , t o move t h e i r m a s s i v e h e a d q u a r t e r s a n d o p e r a t i o n s t o T o r o n t o . T h e i r r e a s o n was t h e c o m p a n i e s d i s f a v o u r w i t h t h e p r o p o s e d l a n g u a g e B i l l 1 0 1 . 5 O v e r a l l , b e t w e e n 1 9 7 1 a n d 1 9 8 1 , S t a t i s t i c s C a n a d a r e c o r d e d a s h i f t o f o v e r 5 0 , 0 0 0 f i n a n c e a n d s e r v i c e j o b s o u t o f M o n t r e a l . ^ ^ S e e V a n c o u v e r S u n M a r c h 1 2 , 1 9 8 3 5 S e e V a n c o u v e r S u n M a r c h 1 2 , 1 9 8 3 a n d R.K. S e m p l e & M.B. G r e e n ( 1 9 8 3 ) f o r a d i s c u s s i o n o f c o r p o r a t e r e l o c a t i o n s i n C a n a d a . ^ S e e D. H o o p e r e t a l . ( 1 9 8 3 ) . M o s t o f t h i s e m p l o y m e n t a p p e a r s t o h a v e m o v e d t o T o r o n t o a s t h e y s h o w e d a n e t g a i n o f 4 9 , 2 0 0 j o b s i n t h e s e t w o s e c t o r s i n t h e same p e r i o d . 45 T h e e f f e c t o n t h e M o n t r e a l o f f i c e m a r k e t was s i g n i f i c a n t . A s s h o w n i n F i g u r e 3 . 1 . 3 , a b s o r p t i o n o f s p a c e d r o p p e d f r o m o v e r 1 , 5 0 0 , 0 0 0 s q f t i n 1 9 7 6 t o 6 0 0 , 0 0 0 s q f t i n 1 9 7 7 . T h i s t r e n d c o n t i n u e d t o p e r s i s t i n t o t h e m i d 1 9 8 0 ' s . L e a s e c o n t r a c t s d r o p p e d f r o m t h e n o r m a l 7 - 1 0 y e a r t o 3 - 5 t e r m s a n d many w e r e w r i t t e n w i t h e s c a p e c l a u s e s a l l o w i n g t e n a n t s t o c a n c e l t h e c o n t r a c t s h o u l d t h e p r o v i n c e s e p a r a t e . New o f f i c e c o n s t r u c t i o n d r o p p e d t o a s l o w t r i c k l e b e t w e e n 1 9 7 6 a n d 1 9 8 2 . D e v e l o p e r s w e r e l i k e l y r e s i s t a n t t o s t a r t s p e c u l a t i v e p r o j e c t s p e n d i n g t h e o u t c o m e o f t h e s e p a r a t i o n r e f e r e n d u m i n 1 9 8 0 a n d t h e r e s u l t s o f t h e p r o v i n c i a l e l e c t i o n i n 1 9 8 1 . T h e R o y a l L e P a g e M a r k e t S u r v e y ( 1 9 7 6 ) s u g g e s t s t h a t t h i s w as e x a c e r b a t e d b y new z o n i n g b y l a w s p a s s e d i n l a t e 1 9 7 6 t h a t r e s t r i c t e d h i g h r i s e d e v e l o p m e n t i n t h e d o w n t o w n c o r e . F i g u r e 3.1.2 s h o w s t h a t t o t a l o f f i c e s p a c e i n c r e a s e d o n l y s l i g h t l y d u r i n g t h i s p e r i o d . T h e s h a r p d i p i n v a c a n c y l e v e l s w a s o b v i o u s l y f r o m e x t r e m e l y l o w l e v e l s o f new s u p p l y a n d n o t f r o m o v e r h e a t e d d e m a n d . T h e p r i c e a d j u s t m e n t m e c h a n i s m i n M o n t r e a l b e t w e e n 1 9 7 6 a n d 1 9 8 2 b e c o m e s a l i t t l e m o r e t r a n s p a r e n t w i t h t h i s i n f o r m a t i o n . T h e e f f e c t o f r e d u c e d b u s i n e s s c o n f i d e n c e c o m b i n e d w i t h a d e c r e a s e i n new c o n s t r u c t i o n may e x p l a i n t h e 'The R o y a l L e P a g e M a r k e t S u r v e y ( 1 9 7 8 ) r e p o r t s t h a t a n i n f o r m a l s u r v e y o f c o n t r a c t s s h o w s a d e c r e a s e i n t h e a v e r a g e t e r m o f l e a s e s a n d t h e common i n c l u s i o n o f e s c a p e c l a u s e s . 46 FIGURE 3.1.2 Time S e r i e s : T o t a l O f f i c e Space and V a c a n c i e s MONTREAL a S o u r c e : R o y a l LePage M a r k e t S u r v e y 47 FIGURE 3.1.3 Time S e r i e s : Absorption and Vacancies MONTREAL 76 77 78 79 80 81 82 83 84 85 86 87 Year O Absorption + Voconcy Rate Source: Royal LePage Market Survey 48 l o w r e s p o n s e o f r e a l r e n t s i n t h e f a c e o f l o w v a c a n c y l e v e l s . T h e R o y a l L e P a g e M a r k e t S u r v e y ( 1 9 7 9 ) s u g g e s t s t h a t r e a l r e n t l e v e l s may h a v e f a l l e n e v e n f u r t h e r i f n o t f o r t h e e x t r e m e l y l o w n u m b e r o f a v a i l a b l e c o n t i g u o u s C l a s s A s p a c e o v e r 5 0 , 0 0 0 s q f t . w h i c h a l l o w e d f o r some n o m i n a l r e n t e s c a l a t i o n d u r i n g t h e p e r i o d . T h e doom a n d g l o o m i n M o n t r e a l s e e m e d t o r e c e d e a f t e r t h e r e f e r e n d u m was d e f e a t e d a n d t h e r e e l e c t i o n o f t h e PQ i n 1 9 8 1 . T h e b u s i n e s s c o m m u n i t y s e e m e d t o g a i n c o n f i d e n c e i n w h a t a p p e a r e d t o be a m o r e m o d e r a t e g o v e r n m e n t . T h e o f f i c e m a r k e t r e s p o n d e d w i t h a n a n n o u n c e m e n t b y b o t h T r i z e c C o r p . a n d M a r a t h o n R e a l t y t o b u i l d t w o new m a j o r o f f i c e p r o j e c t s . U n f o r t u n a t e l y , t h e r e n e w e d c o n f i d e n c e was n o t i m m e d i a t e l y f e l t a s M o n t r e a l s u f f e r e d f r o m t h e n a t i o n a l r e c e s s i o n b e t w e e n 1 9 8 2 a n d 1 9 8 4 . A s F i g u r e 3.1.2 a n d 3.1.3 s h o w , v a c a n c y l e v e l s i n c r e a s e d d r a m a t i c a l l y t h r o u g h a c o m b i n a t i o n o f r a p i d d r o p s i n a b s o r p t i o n a n d i n c r e a s e s i n new s u p p l y . A l o t o f e x i s t i n g t e n a n t s c h o s e t o u p g r a d e t o n e w e r e n e r g y e f f i c i e n t C l a s s A s p a c e a n d t a k e a d v a n t a g e o f d e p r e s s e d r e n t l e v e l s . T h i s l e f t a l o t o f o l d e r s u b s t a n d a r d s p a c e v a c a n t t h a t c a r r i e d t h r o u g h t o q 1 9 8 4 w h e n t h e e c o n o m y b e g a n t o t u r n a g a i n . A f t e r 1 9 8 4 , t h e o f f i c e m a r k e t r e g a i n e d some s t r e n g t h . A p r o b u s i n e s s a t t i t u d e a p p e a r s t o h a v e r i s e n o u t o f t h e p r o v i n c i a l g o v e r n m e n t s S P E C S F o r a d i s c u s s i o n o f t h i s p o i n t s e e t h e R o y a l L e P a g e M a r k e t S u r v e y ( 1 9 8 5 ) 49 a n d QSSP p r o g r a m s a n d M o n t r e a l ' s r e n e w e d s t r e n g t h a s a r e g i o n a l c e n t r e . ^ T h i s c o m b i n e d w i t h r e l a t i v e l y c h e a p l a n d p r i c e s i n M o n t r e a l d r a m a t i c a l l y i n c r e a s e d t h e a d d i t i o n o f new o f f i c e space.^® F i g u r e 3.1.3 s h o w s t h a t a b s o r p t i o n a l s o i n c r e a s e d i n t h i s p e r i o d . B o t h r e a l a n d n o m i n a l r e n t a l r a t e s r o s e a f t e r 1 9 8 5 i n s p i t e o f t h e f a c t t h a t t h e v a c a n c y l e v e l o n l y d r o p p e d t o 1 1 % . T h i s may be a n i n d i c a t i o n o f a n i n c r e a s e i n t h e n o r m a l v a c a n c y l e v e l . I t h a s b e e n s u g g e s t e d t h a t n o r m a l v a c a n c y l e v e l s h a v e i n c r e a s e d i n a l l c i t i e s b e c a u s e o f a f i l t e r i n g p r o c e s s i n t h e o f f i c e m a r k e t . T h e d e m and f o r new e n e r g y e f f i c i e n t a n d m o d e r n b u i l d i n g s h a s c r e a t e d a s u r p l u s o f o l d e r s u b s t a n d a r d s p a c e w h i c h i s n o t c o n s i d e r e d t o be s u i t a b l e a n y l o n g e r . I t s a d d i t i o n t o t h e c i t i e s v a c a n c y l e v e l i s n o t f e l t t o b e s i g n i f i c a n t . T h e S P E C S p r o g r a m e n a b l e s p r i v a t e c o m p a n i e s t o q u a l i f y f o r t a x e x e m p t i o n s i f t h e y i n v e s t i n o t h e r p r i v a t e Q u e b e c c o m p a n i e s who a r e n o t g o i n g p u b l i c . T h e Q S S P , t h e Q u e b e c S t o c k S a v i n g s P r o g r a m a l l o w s t a x i n c e n t i v e s f o r i n v e s t m e n t s i n new s h a r e s o f Q u e b e c c o m p a n i e s p r o v i d i n g t h e y a r e h e l d f o r t w o y e a r s ( R o y a l L e P a g e M a r k e t S u r v e y 1 9 8 6 ) . " ^ R o y a l L e P a g e r e p o r t s t h a t i n 1 9 8 5 t h e a v e r a g e l a n d p r i c e s i n M o n t r e a l w e r e $ 2 0 0 p e r s q f t a s c o m p a r e d t o $ 7 5 0 p e r s q f t i n T o r o n t o a n d $ 6 2 5 p e r s q f t i n V a n c o u v e r . 11 T n e T o r o n t o P l a n n i n g D e p a r t m e n t : 1 9 8 6 Q u i n q u e n n i a l R e v i e w d i s c u s s e s a r i s e i n t h e n o r m a l v a c a n c y r a t e f r o m 5% t o 1 0 % i n t h e c i t y o f T o r o n t o . 50 3.2 T o r o n t o T h e t i m e s e r i e s d a t a f o r T o r o n t o i s s h o w n i n F i g u r e 3 . 2 . 1 . T h e r e a r e t w o i n t e r e s t i n g f e a t u r e s i n t h i s p l o t . B e t w e e n 1 9 6 8 a n d 1 9 7 9 , t h e r e i s t r e m e n d o u s s t a b i l i t y i n t h e r e a l r e n t l e v e l e v e n t h o u g h v a c a n c y l e v e l s f l u c t u a t e b e t w e e n 1% a n d 1 0 % d u r i n g t h e p e r i o d . O n l y d e c r e a s e s o f t h e v a c a n c y r a t e b e l o w 5% s e e m t o e l i c i t s m a l l s h a r p i n c r e a s e s i n r e a l r a t e s . T h i s s u g g e s t s a n o r m a l v a c a n c y l e v e l n e a r 5%. T h e s t a b i l i t y o f t h e r e a l r e n t a l r a t e a l s o s u g g e s t s t h a t l a n d l o r d s w e r e s u c c e s s f u l i n c a p i t a l i z i n g i n f l a t i o n i n t o n o m i n a l r a t e i n c r e a s e s . B e t w e e n 1 9 7 9 a n d 1 9 8 3 , t h e v a c a n c y r a t e d r o p p e d w e l l b e l o w t h e 5% n o r m a l v a c a n c y l e v e l a n d a s e x p e c t e d t h e r e was a c o r r e s p o n d i n g s h a r p r i s e i n b o t h n o m i n a l a n d r e a l r e n t a l r a t e s . A f t e r 1 9 8 3 , b o t h n o m i n a l a n d r e a l r a t e s p l u n g e d w i t h 1 o t h e n a t i o n a l r e c e s s i o n . R e a l r a t e s d i d n o t r e t u r n f u l l y t o t h e p r e v i o u s e q u i l i b r i u m l e v e l . T h i s may be e v i d e n c e o f p r i c e r i g i d i t y a n d i n d i c a t e s p e c u l a t i v e b e h a v i o u r o n t h e p a r t o f l a n d l o r d s . G e n e r a l l y t h e d a t a f o r T o r o n t o a p p e a r s t o be r e a s o n a b l y c o n s i s t e n t w i t h t h e o r e t i c a l e x p e c t a t i o n . L A T h e r e n t a l d a t a f o r t h e p e r i o d 1 9 8 3 t o 1 9 8 7 was a d j u s t e d b y R o y a l L e P a g e t o a c c o u n t f o r t e n a n t i n d u c e m e n t s . A s u r v e y o f t e n a n t i n d u c e m e n t s was u s e d a s t h e m e a s u r e o f a d j u s t m e n t . T h i s i s a p a r t i a l e x p l a n a t i o n f o r t h e p l u n g e i n b o t h n o m i n a l a n d r e a l r a t e s . ( T o r o n t o P l a n n i n g D e p a r t m e n t : 1 9 8 6 Q u i n q u e n n i a l R e v i e w ) 51 FIGURE 3.2.1 Time S e r i e s : R e n t s and V a c a n c i e s TORONTO 40 S o u r c e : R o y a l LePage M a r k e t S u r v e y 52 T h e c o n s i s t e n c y o f t h e p r i c e a d j u s t m e n t m e c h a n i s m i n T o r o n t o i s p r o b a b l y d u e t o t h e s i z e o f t h e c i t y a n d t h e r e l a t i v e l y s t a b l e e c o n o m i c g r o w t h r e s u l t i n g f r o m a d i v e r s i f i e d b a s e . I n t e r m s o f s i z e , T o r o n t o ' s i n v e n t o r y o f d o w n t o w n o f f i c e s p a c e r a n k e d t h i r d i n 1 9 8 6 , e x c e e d e d o n l y b y New Y o r k a n d C h i c a g o . I t i s t h e o n l y C a n a d i a n c i t y t o a c h i e v e a n y s t a t u r e i n t h i s r a n k i n g . S i n c e 1 9 5 0 , T o r o n t o h a s e x p e r i e n c e d r a p i d g r o w t h i n b o t h o f f i c e f l o o r s p a c e a n d o f f i c e e m p l o y m e n t . I n 1 9 5 1 , o f f i c e s p a c e i n M e t r o T o r o n t o s t o o d a t 8 , 0 0 0 , 0 0 0 s q f t a n d h a s d o u b l e d i n e v e r y d e c a d e t o o v e r 9 0 , 0 0 0 , 0 0 0 s q f t t o d a y . F i g u r e 3.2.2 s h o w s t h e g r o w t h o f t o t a l o f f i c e s p a c e i n T o r o n t o b e t w e e n 1 9 6 8 a n d 1 9 8 7 . O f f i c e e m p l o y m e n t i n T o r o n t o was b e t w e e n 5 0 , 0 0 0 a n d 8 0 , 0 0 0 i n 1 9 5 1 a n d h a s b l o s s o m e d t o c l o s e t o 5 0 0 , 0 0 0 i n 1 9 8 6 . 1 4 T h i s g r o w t h h a s b e e n l a r g e l y f u e l e d b y t h e a s c e n d a n c y o f T o r o n t o t o t h e r o l e o f C a n a d a ' s m o s t i m p o r t a n t b u s i n e s s c e n t r e . 1 " ' T h i s i s a t r e n d w h i c h b e g a n i n t h e l a t e 1 9 3 0 ' s a n d s h a r p l y a c c e l e r a t e d i n t h e 1 9 7 0 ' s a n d 1 9 8 0 ' s w h e n t h e r e w a s a S e e t h e T o r o n t o P l a n n i n g D e p a r t m e n t ( 1 9 8 7 ) f o r a s t a t i s t i c a l d i s c u s s i o n o n t h e m a j o r o f f i c e c e n t r e s i n N o r t h A m e r i c a b e t w e e n 1 9 8 0 a n d 1 9 8 5 . 1 4 S e e G. G a d ( 1 9 7 6 ) a n d T o r o n t o P l a n n i n g D e p a r t m e n t : 1 9 8 6 Q u i n q u e n n i a l R e v i e w 1 5 S e e D. K e r r ( 1 9 8 2 ) , a n d G. Gad a n d D. H o l d s w o r t h ( 1 9 8 4 ) 53 F I G U R E 3.2.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s TORONTO S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y F I G U R E 3.2.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s TORONTO ~t i i i i i i i 1 i 1 1 1 1 1 1 1 1 1 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 63 84 B5 86 87 Year • Absorption +• Vacancy Rate S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y 55 s h i f t o f c o r p o r a t e p o w e r f r o m M o n t r e a l t o T o r o n t o . T h e r e a r e a c o u p l e o f o t h e r e v e n t s w h i c h s h o u l d be n o t e d i n a s s e s s i n g t h e p r i c e a d j u s t m e n t m e c h a n i s m b e t w e e n 1 9 7 6 a n d 1 9 8 2 ; o f f i c e s u b u r b a n i z a t i o n a n d t h e d e c e n t r a l i z a t i o n i n i t i a t i v e s e t o u t o n t h e T o r o n t o C o r e A r e a P l a n o f 1 9 7 6 . T o r o n t o h a s e x h i b i t e d s t r o n g g r o w t h i n s u b u r b a n o f f i c e s p a c e . I n 1 9 7 0 , 8 2 % o f t h e o f f i c e s p a c e i n T o r o n t o was i n t h e C e n t r a l D i s t r i c t ( C D ) . 1 7 Gad ( 1 9 8 5 ) n o t e s t h a t t h i s s h a r e d e c r e a s e d t o 6 4 % i n 1 9 8 4 . T h e g r o w t h o f s u b u r b a n l o c a t i o n s h a s b e e n e n c o u r a g e d b y t h e C o r e A r e a P l a n a d o p t e d b y t h e c i t y o f "I Q T o r o n t o i n 1 9 7 6 . N o t w i t h s t a n d i n g t h i s p r o p o r t i o n a l s h i f t , X D S e e R.K. S e m p l e a n d M.B. G r e e n ( 1 9 8 3 ) . T h e f e d e r a l g o v e r n m e n t p r o v i d e d 47 c h a r t e r s t o f o r e i g n f i n a n c i a l i n s t i t u t i o n s i n F e b r u a r y 1 9 8 2 . T h e m a j o r i t y o f h e a d q u a r t e r s s e t u p b y t h e f o r e i g n b a n k s s u b s e q u e n t l y l o c a t e d i n T o r o n t o . 1 7 ^ ' T h e C e n t r a l D i s t r i c t i n c l u d e s t h e f i n a n c i a l c o r e a n d s e v e r a l m i d t o w n b u s i n e s s a r e a s c l o s e t o t h e d o w n t o w n a r e a . 1 p T h e o b j e c t i v e o f t h e C o r e A r e a P l a n was t o d i v e r t o f f i c e a c t i v i t i e s f r o m t h e c o r e a r e a t o t h e 3 s u b u r b a n n o d e s ; M i s s i s s a u g a C i t y C e n t r e , Y o n g e S h e p p a r d D i s t r i c t , a n d S c a r b o r o u g h Town C e n t r e . T h e i n t e n t was f o u r f o l d : 1. T o s t a b i l i z e o r r e d u c e d o w n t o w n l a n d r e n t s . 2. T o r e d u c e r e d e v e l o p m e n t p r e s s u r e o n h i s t o r i c b u i l d i n g s . 3. S a v e c o r e r e s i d e n t i a l a r e a s f r o m c o m m e r c i a l d e v e l o p m e n t . 4. T o e a s e t h e p r e s s u r e o n d o w n t o w n t r a n s p o r t a t i o n f a c i l i t i e s a n d i n c r e a s e t h e u t i l i z a t i o n o f t h e " b a c k h a u l " T h e P l a n s u g g e s t e d d o w n z o n i n g c o r e a r e a s , p r o v i d i n g d e n s i t y t r a n s f e r s i n e x c h a n g e f o r t h e p r e s e r v a t i o n o f h i s t o r i c d o w n t o w n b u i l d i n g s a n d i m p r o v i n g t h e s u b u r b a n a r e a t r a n s p o r t a t i o n s t r a t e g y . ( T o r o n t o P l a n n i n g D e p t . : 1 9 8 6 Q u i n q u e n n i a l R e v i e w ) 56 t h e r e h a s b e e n c o n t i n u e d a b s o l u t e g r o w t h i n t h e CD. T h e e n d r e s u l t h a s b e e n t h e c r e a t i o n o f t w o d i s t i n c t o f f i c e m a r k e t s i n T o r o n t o . T h e r e n t d i f f e r e n t i a l b e t w e e n t h e t w o m a r k e t s s h o u l d e f f e c t t h e p r i c e a d j u s t m e n t m e c h a n i s m b y c r e a t i n g some h u r d l e p o i n t w h e r e f i r m s a r e e n c o u r a g e d t o s h i f t b e t w e e n t h e t w o m a r k e t s . B o t h C o d e ( 1 9 8 3 ) a n d Gad ( 1 9 8 5 ) h a v e f o u n d t h a t t h e r e n t d i f f e r e n t i a l h a s t o be f a i r l y s i g n i f i c a n t b e f o r e s u b s t a n t i a l s h i f t i n g w i l l t a k e p l a c e . T h e s t r o n g i n f o r m a t i o n l i n k s t h a t e x i s t i n t h e c o r e m a i n t a i n a s t r o n g r a t i o n a l e f o r f i r m s t o c o n t i n u e t o l o c a t e t h e r e . 1 9 A m o r e i m p o r t a n t e f f e c t o f t h e C o r e A r e a P l a n o n t h e p r i c e a d j u s t m e n t m e c h a n i s m may h a v e b e e n t h e s c a r c i t y o f b u i l d a b l e o f f i c e s p a c e c r e a t e d t h r o u g h z o n i n g r e s t r i c t i o n s . G a d ( 1 9 8 5 ) s u g g e s t s t h e r e s u l t i n g c o n s t r i c t i o n o f new o f f i c e s p a c e c o m b i n e d w i t h t h e i n f l u x o f c o r p o r a t i o n s f r o m M o n t r e a l a n d t h e e x p a n s i o n o f f o r e i g n b a n k s a r e t h e m o s t l i k e l y c a u s e s o f s h a r p r e d u c t i o n s i n t h e v a c a n c y r a t e a n d r e a l r e n t i n c r e a s e s i n 1 9 7 9 t h r o u g h 1 9 8 2 . T h e T o r o n t o P l a n n i n g D e p a r t m e n t : 198 6 Q u i n q u e n n i a l R e v i e w m a i n t a i n s t h a t t h e n o r m a l v a c a n c y r a t e i n T o r o n t o h a s i n c r e a s e d f r o m 5% i n 1 9 7 6 t o 1 0 % i n 1 9 8 5 . T h e e v e r i n c r e a s i n g x yW.R. C o d e ( 1 9 8 3 ) f o u n d t h a t a r e n t d i f f e r e n t i a l o f $ 1 1 . 0 0 was r e q u i r e d b e f o r e f i r m s b e g i n t o move o u t o f t h e c o r e . 57 g r o w t h o f e m p l o y m e n t i n t h e p r o f e s s i o n a l s e r v i c e s e c t o r , a n o t i c e a b l e r i s e i n t h e F l o o r S p a c e R a t i o f o r o f f i c e w o r k e r s a n d t h e f i l t e r i n g o f o l d b u i l d i n g s f o r new m o d e r n b u i l d i n g s h a s i n c r e a s e d t h e demand f o r o f f i c e s p a c e i n t h e d o w n t o w n c o r e . T h i s h a s i n s p i r e d c o n f i d e n t g r o w t h e x p e c t a t i o n s w h i c h s e e m t o h a v e i n c r e a s e d t h e a c c e p t e d n o r m a l v a c a n c y r a t e a n d t h e a c c e p t e d r e a l r e n t l e v e l . T h i s may be a p a r t i a l e x p l a n a t i o n f o r t h e r e l u c t a n c e o f r e a l r e n t s t o f a l l b a c k t o t h e p r e 1 9 7 9 l e v e l s . 3.3 E d m o n t o n T h e t i m e s e r i e s p l o t f o r E d m o n t o n i s s h o w n i n F i g u r e 3 . 3 . 1 . I n 1 9 7 6 , t h e 4% v a c a n c y l e v e l a p p e a r s t o h a v e p r o m p t e d a s h a r p i n c r e a s e i n b o t h n o m i n a l a n d r e a l r e n t l e v e l s . F o l l o w i n g t h a t y e a r , v a c a n c y l e v e l s h o v e r e d a r o u n d 7% t o 9% u n t i l 1 9 8 1 a n d r e a l r e n t s c o n t i n u e d t o i n c r e a s e a l b e i t a t a r e d u c e d r a t e . B e t w e e n 1 9 8 1 a n d 1 9 8 7 t h e v a c a n c y r a t e s r o s e t o a l e v e l b e t w e e n 1 9 % a n d 2 1 % . N o m i n a l r e n t s c o n t i n u e d t o r i s e O f f i c e e m p l o y m e n t i n T o r o n t o h a s i n c r e a s e d 5 7 % b e t w e e n 1 9 7 1 a n d 1 9 8 5 w h i l e m a n u f a c t u r i n g e m p l o y m e n t h a s a c t u a l l y e x h i b i t e d d e c l i n i n g g r o w t h . B e t w e e n 1 9 7 5 a n d 1 9 8 5 , t h e FSW i n d e x i n c r e a s e d 1 4 % i n T o r o n t o . T h i s i m p l i e s t h a t i n c r e a s e d o f f i c e s p a c e c a n b e a c c o m m o d a t e d w i t h d i m i n i s h i n g i m p a c t s o n t h e t r a n s p o r t a t i o n s y s t e m . 58 F I G U R E 3.3.1 T i m e S e r i e s : R e n t s a n d V a c a n c i e s EDMONTON S B 87 Nominol Rent •+ Reol Rent (81=100) © Vacancy S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y 59 u n t i l 1 9 8 3 . R e a l r e n t s f e l l i n 1 9 8 2 , h o w e v e r , t h e y c u r i o u s l y c l i m b e d s h a r p l y i n 1 9 8 3 d e s p i t e t h e s t e e p i n c r e a s e i n v a c a n c y . T h e r e a f t e r , n o m i n a l a n d r e a l r e n t s f e l l u n t i l f i n a l l y l e v e l i n g o u t i n 1 9 8 7 . T h e f a c t t h a t r e a l r e n t s i n 1 9 8 7 e q u a l e d t h o s e i n 1 9 7 7 e v e n t h o u g h t h e v a c a n c y r a t e was 1 8 % s u g g e s t s some p r i c e r i g i d i t y o c c u r r e d . I n t e r e s t i n g l y e n o u g h , o v e r t h e 10 y e a r p e r i o d , e v e n t h o u g h v a c a n c y l e v e l s f l u c t u a t e d b e t w e e n 4% a n d 2 1 % t h e r e a l r e n t l e v e l h a s r e m a i n e d w i t h i n a n a r r o w r a n g e . T h i s b e h a v i o u r w o u l d s e e m t o i n d i c a t e t h a t t h e n o r m a l v a c a n c y l e v e l i s s o m e w h a t h i g h e r i n E d m o n t o n t h a n t h a t o b s e r v e d 7 1 T o r o n t o o r M o n t r e a l o v e r t h e same p e r i o d . T h i s s e e m s c o n s i s t e n t f o r h i g h r i s k c i t i e s w i t h s i n g l e r e s o u r c e b a s e d e c o n o m i e s . L a r g e r b u f f e r s t o c k s a r e n e e d e d t o w e a t h e r t h e t u r b u l e n t boom a n d b u s t c y c l e s . E d m o n t o n i s o n e o f t w o A l b e r t a c i t i e s who d e p e n d o n t h e h e a l t h o f t h e p e t r o l e u m i n d u s t r y . H o w e v e r , E d m o n t o n i s d i f f e r e n t t h a n C a l g a r y . E d m o n t o n i s t h e c a p i t a l o f A l b e r t a s o u n l i k e C a l g a r y , i t e n j o y s some s t a b i l i t y f r o m t h e p r o v i n c i a l g o v e r n m e n t b u r e a u c r a c y . I n a d d i t i o n , C a l g a r y i s t h e h e a d o f f i c e a n d f i n a n c i a l c e n t r e o f t h e p e t r o l e u m i n d u s t r y . E d m o n t o n , o n t h e o t h e r h a n d i s l o c a t e d c l o s e r t o t h e o i l r i c h n o r t h a n d t h e r e f o r e p r o v i d e s b r o a d e r s u p p o r t s e r v i c e s f o r t h e 5% a p p e a r s t o be t h e n o r m a l r a t e i n T o r o n t o i n t h e p e r i o d p r i o r t o 1 9 8 1 . S p e c u l a t i o n now s u g g e s t s t h i s r a t e may h a v e m o v e d c l o s e r t o 1 0 % . ( S e e T o r o n t o P l a n n i n g D e p a r t m e n t : 1 9 8 6 Q u i n q u e n n i a l R e v i e w ) 60 p e t r o l e u m i n d u s t r y . Many o f t h e e x p l o r a t i o n a n d g e o p h y s i c a l o p e r a t i o n s a r e b a s e d i n E d m o n t o n a n d m o s t o f t h e m a j o r a s s e m b l y , i n s t a l l a t i o n a n d s e r v i c i n g o f o i l f i e l d e q u i p m e n t t a k e s p l a c e i n t h e c i t y . T h e r e f o r e , t h e E d m o n t o n o f f i c e m a r k e t s e r v i c e s t w o m a j o r t e n a n t m a r k e t s ; t h e s t a b l e p r o v i n c i a l g o v e r n m e n t a n d t h e f l u c t u a t i n g p e t r o l e u m i n d u s t r y . T h e R o y a l L e P a g e M a r k e t S u r v e y p r o v i d e s a g o o d r e v i e w o f t h e e v e n t s t h a t h a v e a f f e c t e d t h e E d m o n t o n o f f i c e m a r k e t o v e r t h e l a s t 10 y e a r s . I n 1 9 7 6 , o v e r 5 0 % o f t h e C l a s s A s p a c e was b e i n g u t i l i z e d b y t h e A l b e r t a g o v e r n m e n t . H o w e v e r , t h i s p a t t e r n was b e i n g t e m p e r e d b y t h e e m e r g e n c e o f t h e p e t r o l e u m i n d u s t r y a s a s i g n i f i c a n t e c o n o m i c f o r c e i n t h e 1 9 7 0 ' s . S y n c r u d e , a new m u l t i b i l l i o n d o l l a r h e a v y o i l p l a n t l o c a t e d i n F o r t M c M u r r a y was i n i t i a t e d i n 1 9 7 4 . T h e h e a d o f f i c e f o r t h e c o n s o r t i u m was s e t u p i n E d m o n t o n b r i n g i n g many new p r o f e s s i o n a l e m p l o y e e s i n t o t o w n . T h e A l a s k a - M a c k e n z i e p i p e l i n e was a n n o u n c e d a n d a l l t h r o u g h t h e l a t e 1 9 7 0 ' s , e x t e n s i v e e n g i n e e r i n g a n d c o n s t r u c t i o n p r e p a r a t i o n s w e r e b e i n g m ade. T h e N o r t h E a s t r e g i o n o f B.C. o p e n e d u p f o r f u r t h e r n a t u r a l r e s o u r c e e x p l o r a t i o n w h i c h a d d e d t o e x p l o r a t i o n a c t i v i t y i n t h e o i l a n d g a s s e c t o r w h i c h was a l r e a d y r e a c h i n g a l l t i m e h i g h s . I n 1 9 7 8 , t h e f r e n z y o f p e t r o l e u m a c t i v i t y s t i m u l a t e d a r e s p o n s e by t h e d e v e l o p m e n t c o m m u n i t y t o i n c r e a s e t h e o f f i c e s p a c e i n E d m o n t o n b y 2 , 3 0 0 , 0 0 0 s q f t b y 1 9 8 0 . T o t a l b u i l d i n g p e r m i t s i n 1 9 7 8 e x c e e d e d $ 1 , 0 0 0 , 0 0 0 , 0 0 0 f o r t h e f i r s t 61 t i m e . I n 1 9 7 9 , E d m o n t o n p r o s p e r e d f r o m t w o m a j o r d i s c o v e r i e s ; t h e E l m w o r t h g a s f i e l d a n d t h e W e s t P e m b i n a O i l f i e l d . T h e l a t t e r was o n e o f t h e m o s t s i g n i f i c a n t d e v e l o p m e n t s w i t h i n t h e p r e v i o u s 10 y e a r s . I n t h a t same y e a r , 5 m u l t i b i l l i o n d o l l a r h e a v y o i l m e g a p r o j e c t s a n d t w o m a j o r p e t r o c h e m i c a l p l a n t s w e r e i n l a t e s t a g e s o f d e s i g n . A s u r v e y c o n d u c t e d b y A l b e r t a B u s i n e s s D e v e l o p m e n t a n d T o u r i s m s h o w e d t h a t t h e r e w e r e 3 1 1 p r o j e c t s p l a n n e d o r u n d e r w a y t o t a l l i n g m o r e t h a n $ 2 2 , 0 0 0 , 0 0 0 , 0 0 0 i n c a p i t a l e x p e n d i t u r e s . T h e e m p l o y m e n t i m p a c t o f t h i s a c t i v i t y was m o r e t h a n 1 3 , 0 0 0 p e r m a n e n t j o b s . A d d i n g t o t h e a l r e a d y s t i m u l a t e d o f f i c e m a r k e t was a n a n n o u n c e m e n t i n 1 9 7 9 b y s e v e r a l m a j o r b a n k s t o s p l i t A l b e r t a i n t o n o r t h e r n a n d s o u t h e r n r e g i o n s . E d m o n t o n was f i n a l l y g o i n g t o g a i n a t o e h o l d i n t h e f i n a n c i a l s e c t o r , t h e j e w e l o f t h e d o w n t o w n o f f i c e t e n a n t s . B y 1 9 8 1 , t h e E d m o n t o n e c o n o m y was a t i t s h e i g h t . I m m i g r a t i o n t o E d m o n t o n e x c e e d e d 2,000 p e o p l e p e r m o n t h a n d t h e c i t y h a d r e c o r d e d b u i l d i n g p e r m i t s i n e x c e s s o f $ 1 , 0 0 0 , 0 0 0 , 0 0 0 p e r y e a r f o r t h e l a s t f o u r y e a r s . A n a d d i t i o n a l 5 , 0 0 0 , 0 0 0 s q f t o f o f f i c e s p a c e w e r e s c h e d u l e d f o r c o m p l e t i o n o v e r t h e n e x t 5 y e a r s . T o g e t h e r g o v e r n m e n t a n d o i l i n d u s t r y f u n c t i o n s w e r e a b s o r b i n g o f f i c e s p a c e a t t h e r a t e o f 1 , 0 0 0 , 0 0 0 s q f t a y e a r . T h i s was r e m a r k a b l e f o r a p r a i r i e c i t y w h i c h h a d l e s s t h a n 6 , 0 0 0 , 0 0 0 s q f t o f o f f i c e s p a c e 5 y e a r s e a r l i e r . T o t a l e m p l o y m e n t g r o w t h i n t h e c i t y s i n c e 1 9 7 1 was u p a 62 w h o p p i n g 6 8 % , s e c o n d o n l y t o C a l g a r y o u t o f a l l o t h e r C a n a d i a n c i t i e s d u r i n g t h e same p e r i o d . T h e o v e r a l l e f f e c t o n t h e E d m o n t o n o f f i c e m a r k e t b e t w e e n 1 9 7 6 a n d 1 9 8 1 i s b e s t i l l u s t r a t e d i n F i g u r e 3.3.2 a n d F i g u r e 3 . 3 . 3 . T h e demand a n d s u p p l y o f new s p a c e w e r e b o t h i n c r e a s i n g a t a r a p i d r a t e i n t h e l a t e 1 9 7 0 ' s . U n f o r t u n a t e l y f o r t h e c i t y , s o much o f t h e h e a t e d a c t i v i t y was t o b e v e r y s h o r t l i v e d . I n 1 9 8 2 , a f t e r t h e c o l l a p s e o f t h e p e t r o l e u m i n d u s t r y , a l l m e g a p r o j e c t s w e r e p u t o n h o l d a n d t h e o f f i c e m a r k e t i n E d m o n t o n p l u n g e d i n t o d e p r e s s i o n . I n 1 9 8 3 , t h e v a c a n c y r a t e r o s e f r o m 1 2 % t o n e a r 2 0 % w i t h t h e c o m p l e t i o n o f l a g g e d b o o m t i m e c o n s t r u c t i o n . R e n t a l r a t e s i n c r e a s e d w i t h o n e l a s t s u r g e i n t h a t y e a r a s a b s o r p t i o n r o s e s l i g h t l y o n e l a s t t i m e . B y 1 9 8 5 c o r e v a c a n c i e s w e r e s t i l l a t 1 9 % , h o w e v e r , t h e o v e r a l l c i t y v a c a n c y was o n l y b e i n g h e l d down b y t h e g o v e r n m e n t d i s t r i c t w h o s e v a c a n c y s t o o d a t 1 2 . 3 % . R e n t a l i n d u c e m e n t s w e r e b e i n g o f f e r e d t h a t r e d u c e d t h e q u o t e d f a c e r e n t a l r a t e f r o m $ 1 2 t o $14 p e r s q f t t o $2 t o $3 p e r s q f t . 2 3 New c o n s t r u c t i o n w a s s t i l l c o m i n g o n t h e m a r k e t y e t no new m a j o r l e a s e c o m m i t m e n t s w e r e b e i n g made. T h e a v e r a g e d e a l was o n l y 2 , 0 00 t o 3 ,000 s q f t . T h e c a n c e l l a t i o n o f t h e P e t r o l e u m T h e l a r g e s t g a i n s w e r e made i n t h e F i n a n c e , I n s u r a n c e , R e a l E s t a t e a n d p r o f e s s i o n a l s e r v i c e s s e c t o r s . (D. H o o p e r e t a l . 1 9 8 3 ) T h i s may p a r t i a l l y e x p l a i n t h e r e l u c t a n c e o f n o m i n a l a n d r e a l r e n t s t o f a l l s i g n i f i c a n t l y i n t h i s p e r i o d . 63 F I G U R E 3.3 .2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s EDMONTON Yeor Total Office S p a c e Vacancy Rate S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y 64 FIGURE 3.3.3 Time S e r i e s : A b s o r p t i o n and V a c a n c i e s EDMONTON S o u r c e : R o y a l LePage M a r k e t S u r v e y 65 G a s R e v e n u e T a x (PGRT) a n d $ 7 0 0 , 0 0 0 , 0 0 0 i n g o v e r n m e n t a i d i n 1 9 8 6 h a d l i t t l e d i r e c t b e n e f i t o n t h e o f f i c e m a r k e t . T h e o n l y r e a l a c t i v i t y s e e m e d t o be t e n a n t s u p g r a d i n g f r o m i n f e r i o r s p a c e o r m o v i n g t o d o w n s i z e t h e i r o p e r a t i o n s . I n 1 9 8 7 , 10 y e a r l e a s e s w e r e common w i t h i n d u c e m e n t p a c k a g e s t o t a l l i n g $ 4 0 t o $ 5 0 p e r s q f t . O n l y t h e p r o v i n c i a l g o v e r n m e n t p r o v i d e d a n y s p a r k t o t h e m a r k e t b y p r e l e a s i n g 4 0 0 , 0 0 0 s q f t o f s p a c e i n a b u i l d i n g t o be c o m p l e t e d i n 1 9 9 0 . 3.4 C a l g a r y T h e t i m e s e r i e s p l o t f o r C a l g a r y i s s h o w n i n F i g u r e 3 . 4 . 1 . C a l g a r y i s a n i n t e r e s t i n g c a s e . B e t w e e n 1 9 7 6 a n d 1 9 8 0 t h e v a c a n c y l e v e l was b e l o w 5%. T h r o u g h o u t t h i s w h o l e p e r i o d , t h e r e a l r e n t l e v e l was r i g i d l y s t a b l e a t $ 1 1 . 0 0 p e r s q f t . I t s e e m s t o i n d i c a t e a n i n c r e d i b l y l o w n o r m a l v a c a n c y l e v e l . T h i s i s e v e n m o r e i n c r e d i b l e c o n s i d e r i n g C a l g a r y ' s d e p e n d e n c e o n o n e r e s o u r c e . One w o u l d e x p e c t t h e n o r m a l v a c a n c y r a t e t o b e s o m e w h a t h i g h e r . T h e e x p l a n a t i o n may be i n l o o k i n g a t t h e y e a r s p r i o r t o 1 9 7 6 . T h e L a r k e n O f f i c e S p a c e R e v i e w ( 1 9 8 5 ) s h o w s t h a t o v e r a l l v a c a n c y l e v e l s i n C a l g a r y h a d b e e n l o w s i n c e 1 9 6 5 . 2 ^ A b s o r p t i o n was r e l a t i v e l y c o n s i s t e n t o v e r t h e C a l g a r y e n j o y e d t w o d e c a d e s o f s t e a d y e c o n o m i c a n d d e m o g r a p h i c g r o w t h . T h e m a j o r r e c e s s i o n t h a t h i t N o r t h A m e r i c a i n 1 9 7 4 a n d 1 9 7 5 h a d l i t t l e e f f e c t o n t h e c i t y . ( J . W h i t e h e a d 1 9 8 7 ) FIGURE 3 . 4 . 1 Time S e r i e s : Rents and Vacanc ies CALGARY Source: Royal LePage Market Survey 67 same p e r i o d . T h e s t a b i l i t y o f t h e m a r k e t o b v i o u s l y e n t r e n c h e d a l o w v a c a n c y l e v e l i n t o e x p e c t a t i o n s a n d t h e r e f o r e s t a b l e r e n t l e v e l s w e r e a l l o w e d t o e x i s t . G i v e n t h e f r e n z y i n t h e p e t r o l e u m m a r k e t i n t h e l a t e 1 9 7 0 ' s i t i s s t i l l s t r a n g e t h a t e x p e c t a t i o n s t o o k s o l o n g t o c h a n g e . F i g u r e 3.4.2 a n d 3.4.3 s h o w b o t h t o t a l o f f i c e a n d a b s o r p t i o n i n c r e a s i n g a t s i g n i f i c a n t r a t e s a f t e r 1 9 7 8 . T h e c h a n g e i n t h e m a r k e t s e e m s t o o c c u r i n 1 9 8 1 w h e n b o t h n o m i n a l a n d r e a l r e n t s s k y r o c k e t e d . T h e c a t a l y s t f o r t h i s r e a c t i o n a p p e a r s t o be t h e h u g e l e a p i n a b s o r p t i o n i n 1 9 8 1 ; o v e r 5 , 0 0 0 , 0 0 0 s q f t o f s p a c e i n o n e y e a r . T h e boom was s h o r t l i v e d a s v a c a n c y r a t e s b e g a n t o c l i m b i n 1 9 8 2 a n d s h o t u p t o 2 2 % i n 1 9 8 3 . T h e r e was a n i m m e d i a t e s o b e r i n g e f f e c t o n r e n t s a s t h e y p l u m m e t e d u n t i l 1 9 8 5 w h e r e t h e y f i n a l l y a p p e a r e d t o l e v e l o f f . Some f o r m o f p r i c e r i g i d i t y s e e m s t o b e i n e f f e c t b e t w e e n 19 8 4 a n d 1 9 8 7 a s r e a l r e n t l e v e l s s t i l l e x c e e d e d t h e p r e 1 9 8 1 l e v e l w h i l e t h e v a c a n c y r a t e r e m a i n e d o v e r 1 6 % . T h i s m u s t be t e m p e r e d b y t h e t e n a n t i n d u c e m e n t a c t i v i t y w h i c h h a s e x i s t e d i n t h e m a r k e t e v e r s i n c e 1 9 8 2 . E v e n t s i n t h e 1 9 7 0 ' s l e a d t o t h e boom y e a r s t h a t e x i s t e d i n C a l g a r y ' s o f f i c e m a r k e t . I n 1 9 7 0 , a l l r e s o u r c e i n d u s t r i e s i n W e s t e r n C a n a d a w e r e a c t i n g a t o r n e a r c a p a c i t y a n d a l l o v e r C a n a d a b u o y a n t c o m m o d i t y p r i c e s b e g a n t o f o r c e w a g e s a n d i n f l a t i o n u p . When OPEC a c t e d u n i l a t e r a l l y i n 1 9 7 3 t o r a i s e 68 FIGURE 3.4.2 S o u r c e : R o y a l LePage M a r k e t S u r v e y 69 F I G U R E 3.4.3 T i m e S e r i e s : A b s o r p t i o n a n d V a c a n c i e s CALGARY 76 77 78 79 80 81 82 83 84 85 86 87 Year O Absorption +• Vacancy Rate S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y 70 o i l p r i c e s i t h i t m o s t o f t h e C a n a d i a n e c o n o m y q u i t e h a r d a s e n e r g y c o n s e r v a t i o n p r o g r a m s w e r e p u t i n t o e f f e c t . A t i g h t e n i n g o f t h e m o n e t a r y s y s t e m b r o u g h t h i g h i n t e r e s t r a t e s w h i c h b r o u g h t m o s t o f t h e c o u n t r y t o a s t a n d s t i l l i n 1 9 7 4 ( W h i t e h e a d 1 9 8 7 ) . C a l g a r y a n d E d m o n t o n w e r e t h e o n l y e x c e p t i o n t o t h e r u l e . T h e e f f e c t o f i n c r e a s e d o i l p r i c e s p r o v i d e d a n e l e c t r i f y i n g j o l t t o t h e p e t r o l e u m i n d u s t r y i n b o t h c i t i e s . T h e P r o v i n c i a l G o v e r n m e n t u n d e r P e t e r L o u g h e e d saw t h e o p p o r t u n i t y t o c r e a t e g r e a t w e a l t h i n t h e p r o v i n c e . T h e y i m m e d i a t e l y l a u n c h e d i n i t i a t i v e s t o r a l l y t h e b u s i n e s s c o m m u n i t y a n d p r o m o t e d b i l l i o n s o f d o l l a r s w o r t h o f m e g a p r o j e c t s . T h e e n t h u s i a s m h a d a t r e m e n d o u s i m p a c t o n t h e c o n f i d e n c e l e v e l o f i n v e s t o r s a n d b u s i n e s s m e n . E v e r y o n e s e e m e d t o b e c o m e m y o p i c i n t h e i r v i s i o n o f t h e f u t u r e a n d t h e r e was a b e l i e f t h a t no e x t e r n a l e v e n t c o u l d s t o p t h e momentum ( W h i t e h e a d 1 9 8 7 ) . T h e boom i n t h e p e t r o l e u m i n d u s t r y f i l t e r e d t h r o u g h t o b o t h r e s i d e n t i a l a n d c o m m e r c i a l p r o p e r t y m a r k e t s . L i k e E d m o n t o n , C a l g a r y e x p e r i e n c e d 4 y e a r s w h e r e a n n u a l b u i l d i n g p e r m i t s e x c e e d e d $ 1 , 0 0 0 , 0 0 0 , 0 0 0 . I n f a c t , t h e p e a k was c l o s e t o $ 3 , 0 0 0 , 0 0 0 , 0 0 0 i n 1 9 8 1 ( C i t y o f C a l g a r y B u i l d i n g P e r m i t s S t a t i s t i c a l S u m m a r i e s 1 9 7 9 - 8 4 ) . Many o f t h e new j o b s c r e a t e d i n C a l g a r y d u r i n g t h e boom p e r i o d w e r e s e r v i c e o r i e n t e d 71 p o s i t i o n s w h i c h w e r e d r a w n t o d o w n t o w n l o c a t i o n s . 2 5 T h i s h a d a p r o f o u n d e f f e c t o n t h e o f f i c e m a r k e t . A s F i g u r e 3.4.2 a n d F i g u r e 3.4.3 s h o w , b o t h s u p p l y a n d demand s p i r a l e d u p a f t e r 1 9 7 7 . O v e r 2 1 , 0 0 0 , 0 0 0 s q f t o f o f f i c e s p a c e w e r e a d d e d t o e x i s t i n g i n v e n t o r y b e t w e e n 1 9 7 6 a n d 1 9 8 5 ( L a r k e n O f f i c e S p a c e R e v i e w 1 9 8 5 ) . T h i s was t h e l a r g e s t r e l a t i v e s u r g e i n o f f i c e c o n s t r u c t i o n e v e r e x p e r i e n c e d i n N o r t h A m e r i c a ( W h i t e h e a d 1 9 8 7 ) . M u c h o f t h e s u r g e i n o f f i c e s p a c e was d u e t o s p e c u l a t i v e d e v e l o p m e n t . D e v e l o p e r s w e r e c o n v i n c e d t h a t new o f f i c e c o n s t r u c t i o n , r e g a r d l e s s o f t h e l o c a t i o n a n d t y p e , w a s a s o u n d i n v e s t m e n t . F o r a w h i l e t h i s may h a v e b e e n t r u e , h o w e v e r t o o many d e v e l o p e r s t h o u g h t t h e same way a n d a c t e d a c c o r d i n g l y . T h e f r e n z y i n t h e m a r k e t was e x a c e r b a t e d b y a c t i o n s a t t h e l o c a l g o v e r n m e n t l e v e l . T h e C i t y o f C a l g a r y h a d no m a s t e r p l a n a n d l i t t l e o r no z o n i n g b y l a w s f o r t h e d o w n t o w n c o r e a n d o v e r r e a c t i o n s b y a l l p a r t i c i p a n t s a l l o w e d i n d i s c r i m i n a n t u s e a n d d e n s i t y i n many i n s t a n c e s ( W h i t e h e a d 1 9 8 7 ) . T h e boom e n d e d i n t h e e a r l y 1 9 8 0 ' s a s t h e p e t r o l e u m i n d u s t r y b e g a n t o s h r i n k . A d d i n g t o t h e d e m i s e was t h e B e t w e e n 1 9 7 1 a n d 1 9 8 1 C a l g a r y l e a d t h e c o u n t r y i n e m p l o y m e n t g r o w t h w i t h a 9 2 % i n c r e a s e . F i n a n c e , I n s u r a n c e a n d R e a l E s t a t e s e c t o r s g r e w 1 1 5 . 6 % , S e r v i c e e m p l o y m e n t g r e w 9 9 % a n d C o n s t r u c t i o n e m p l o y m e n t g r e w b y 1 3 8 % . ( S t a t i s t i c s C a n a d a C a t . 7 2 - 0 0 2 ) 72 i n t r o d u c t i o n o f t h e N a t i o n a l E n e r g y P o l i c y ( N . E . P . ) a n d t h e i n t r o d u c t i o n o f r e s t r i c t i v e m o n e t a r y p o l i c y . I n t h e o i l a n d g a s i n d u s t r y , t h e c o l l a p s e o f i n v e s t o r c o n f i d e n c e , h i g h d e b t l o a d s , s h r i n k i n g m a r k e t s , h i g h e r t a x e s a n d r e d u c e d c a s h f l o w s b r o u g h t t h e p r o v e r b i a l " h o u s e o f c a r d s " c r a s h i n g down ( H a y e s a n d J e n i s h 1 9 8 3 ) . Some s e c t o r s o f t h e o i l i n d u s t r y e x p e r i e n c e d 5 0 % r e d u c t i o n s i n e m p l o y m e n t . F r o m 1 9 8 2 t h r o u g h 1 9 8 3 , 4 4 , 0 0 0 j o b s w e r e l o s t i n t h e c i t y ( C i t y o f C a l g a r y I n f o P a k 1 9 8 5 ) . M i g r a t i o n s i n t o C a l g a r y f l i p p e d f r o m a n e t p o s i t i v e i n f l o w o f 2 3 , 7 8 3 i n 1 9 8 1 t o a n e t n e g a t i v e o u t f l o w o f 1 2 , 7 3 0 i n 1 9 8 2 ( C i t y o f C a l g a r y I n f o P a k 1 9 8 5 ) . T h e r e v e r b e r a t i o n s w e r e f e l t i m m e d i a t e l y i n t h e o f f i c e m a r k e t a s a b s o r p t i o n i n 1 9 8 2 d r o p p e d t o 2 0 0 , 0 0 0 s q f t i n 1 9 8 2 f r o m o v e r 5 , 0 0 0 , 0 0 0 s q f t i n 1 9 8 1 . W i t h a l l t h e s p e c u l a t i v e b o o m t i m e c o n s t r u c t i o n c o m i n g o n s t r e a m , t h e r e was 8 , 5 0 0 , 0 0 0 s q f t o f v a c a n t s p a c e i n 1 9 8 2 . W i t h m o r e s p a c e t o come i n f o l l o w i n g y e a r s i t i s l i t t l e w o n d e r t h a t r e n t a l i n d u c e m e n t s b e c a m e c o m m o n p l a c e t h r o u g h o u t t h e c i t y a n d t e n a n t s w e r e a b l e t o u p g r a d e s u b s t a n t i a l l y a t l i t t l e a d d i t i o n a l c o s t . S i n c e 1 9 8 1 t h e r e h a s b e e n l i t t l e new g r o w t h i n t h e o f f i c e m a r k e t . H o w e v e r , f o u r new o f f i c e t o w e r s h a v e r e c e n t l y s t a r t e d i n t h e d o w n t o w n c o r e . I t a p p e a r s d e v e l o p e r s a r e p l a y i n g t h e e x p e n s i v e game o f " m u s i c a l b u i l d i n g s " a s m o s t t e n a n t s a r e c o m i n g f r o m o l d e r e x i s t i n g s p a c e i n t h e c i t y ( C a n a d i a n B u i l d i n g F e b r u a r y 1 9 8 8 ) . 73 3.5 V a n c o u v e r T h e t i m e s e r i e s p l o t f o r V a n c o u v e r i s s h o w n i n F i g u r e 3 . 5 . 1 . V a n c o u v e r i s a r e s o u r c e c i t y l i k e C a l g a r y a n d E d m o n t o n a n d t h e v a c a n c y l e v e l s e e m s t o e x h i b i t t h e same w i d e v a r i a t i o n . What i s d i f f e r e n t i n t h i s c a s e i s t h e f l u c t u a t i o n i n t h e r e a l r e n t l e v e l . B e t w e e n 1 9 7 1 a n d 1 9 7 6 t h e v a c a n c y r a t e f l u c t u a t e s w e l l b e l o w 5% a n d r e a l r e n t s r e s p o n d w i t h f a i r s t a b i l i t y t h r o u g h o u t t h e p e r i o d . H o w e v e r , when t h e v a c a n c y r a t e s o a r e d i n 1 9 7 7 , t h e r e a l r e n t l e v e l i m m e d i a t e l y b e g a n t o s i n k . T h e r e a p p e a r s t o be no e v i d e n c e o f a n y p r i c e r i g i d i t y . I n f a c t , t h e r e a l r e n t l e v e l k e p t d r o p p i n g e v e n w h i l e t h e v a c a n c y f e l l . F i n a l l y , when t h e v a c a n c y l e v e l b o t t o m e d o u t i n 1 9 8 1 a t 1 % , r e a l r e n t s b e g a n t o c l i m b a g a i n . T h e o p t i m i s m w a s s h o r t l i v e d . I n 1 9 8 3 , when v a c a n c y r a t e s c l i m b e d b a c k t o 8% t h e r e a l r e n t l e v e l a g a i n d r o p p e d a n d c o n t i n u e d t o f a l l b a c k t o t h e 1 9 8 0 l e v e l a s v a c a n c i e s t o p p e d o u t a t 1 9 % . A g a i n , t h e r e i s n o e v i d e n c e o f a n y p r i c e r i g i d i t y . I t a p p e a r s t h a t V a n c o u v e r l a n d l o r d s u s e g u e r r i l l a t a c t i c s i n t h e i r a p p r o a c h t o t h e m a r k e t . T h e y a t t a c k q u i c k l y a n d a b r u p t l y w i t h l a r g e r e n t i n c r e a s e s i n v e r y l o w v a c a n c y p e r i o d s y e t r e t r e a t s w i f t l y w h e n t h e v a c a n c i e s c l i m b a g a i n . S p e c u l a t i o n d o e s n o t s e e m t o b e p a r t o f t h e i r b e h a v i o u r . B . C . ' s e c o n o m y h a s g r o w n a n d p r o s p e r e d o n t h e s t r e n g t h o f i t s n a t u r a l r e s o u r c e b a s e . I n d u s t r i e s s u c h a s f o r e s t r y , 74 FIGURE 3.5.1 Time S e r i e s : R e n t s and V a c a n c i e s VANCOUVER Nominal Rent Real Rent (81-100) Vacancy S o u r c e : R e a l E s t a t e B o a r d o f G r e a t e r V a n c o u v e r 75 m i n i n g , a g r i c u l t u r e a n d f i s h i n g h a v e h i s t o r i c a l l y p r o v i d e d t h e d r i v i n g f o r c e ( B . C . C e n t r a l C r e d i t U n i o n : E c o n o m i c A n a l y s i s o f B r i t i s h C o l u m b i a 1 9 8 8 ) . G e n e r a l l y , V a n c o u v e r e n j o y e d r e a s o n a b l y s t a b l e e m p l o y m e n t g r o w t h i n t h e 1 9 6 0 ' s a n d 1 9 7 0 ' s . I n 1 9 6 1 t h e p r i v a t e s e c t o r e m p l o y m e n t i n G r e a t e r V a n c o u v e r was 2 0 6 , 0 0 0 . T h i s i n c r e a s e d t o 4 9 0 , 0 0 0 b y 1 9 8 1 (GVRD 1 9 8 6 ) . T h e m o s t p r o n o u n c e d e m p l o y m e n t g r o w t h i n t h e V a n c o u v e r CMA was i n t h e F i n a n c e , R e a l E s t a t e , I n s u r a n c e a n d p e r s o n a l b u s i n e s s s e r v i c e s e c t o r s w h i c h a l l c o n t r i b u t e h e a v i l y t o o f f i c e s p a c e d e m a n d . T h e s e s e c t o r s m o r e t h a n t r i p l e d i n t h e p e r i o d (GVRD 1 9 8 6 ) . T h e C i t y o f V a n c o u v e r i s s u e d l i c e n s e s t o 1,800 f i r m s w i t h d o w n t o w n a d d r e s s e s e n g a g e d i n b u s i n e s s a n d p r o f e s s i o n a l s e r v i c e s i n 1 9 7 1 a n d t o 3,500 f i r m s i n 1 9 8 0 ( V a n c o u v e r P l a n n i n g D e p a r t m e n t 1 9 8 1 b ) . D e s p i t e t h e o v e r a l l g r o w t h i n t h e 1 9 7 0 ' s t h e r e w e r e some f u r t h e r e c o n o m i c a n d p o l i t i c a l e v e n t s w h i c h a f f e c t e d t h e o f f i c e m a r k e t . A f t e r t h e t r e m e n d o u s s u r g e i n o f f i c e s p a c e e x p e r i e n c e d i n 1 9 7 3 t h e r e was a c o n c e r n t h a t t h e d o w n t o w n c o r e w a s b e c o m i n g t o o l a r g e . A s t r a t e g y f o r g r o w t h m a n a g e m e n t , T h e L i v e a b l e R e g i o n 1 9 7 6 - 1 9 8 6 , was p r e p a r e d b y t h e G r e a t e r V a n c o u v e r R e g i o n a l D i s t r i c t i n 1 9 7 5 (GVRD 1 9 7 5 ) . I t s i n t e n t I n t h e V a n c o u v e r M e t r o p o l i t a n a r e a , t h e r e was 1 5 0 % a b s o l u t e g r o w t h i n m a n a g e r i a l p o s i t i o n s a n d b e t w e e n 3 0 % a n d 1 3 0 % g r o w t h i n v a r i o u s p r o f e s s i o n a l c a t e g o r i e s . C l e r i c a l p o s i t i o n s g r e w b y 6 0 % ( D. L e y 1 9 8 5 ) . 76 was t o c o n t r o l g r o w t h i n t h e d o w n t o w n by " t a k i n g m o r e j o b s o u t t o w h e r e p e o p l e l i v e " . S i m i l a r t o T o r o n t o t h i s was t o be a c c o m p l i s h e d t h r o u g h d e c e n t r a l i z a t i o n s t r a t e g i e s . One o f t h e C i t y ' s a c t i o n s was t o l o w e r a l l o w a b l e d e n s i t y i n c e r t a i n z o n e s i n t h e c o r e ( M e t r o t r e n d s 1 9 7 5 ) . T h i s c o m b i n e d w i t h r i s i n g l a n d c o s t s , a n d d e c r e a s e d a c c e s s t o t h e c o r e h e l p e d t r i g g e r i n c r e a s e d g r o w t h i n t h e s u b u r b a n o f f i c e m a r k e t . T h e t i m e s e r i e s p l o t i n F i g u r e 3.5.1 d o e s n o t i n d i c a t e a n y s u b s t a n t i a l e f f e c t o n t h e p r i c e a d j u s t m e n t m e c h a n i s m . T h e c o n t i n u e d d r o p i n r e a l r e n t s i n t h e l a t e r 1 9 7 0 ' s d e s p i t e f a l l i n g v a c a n c i e s may be d u e t o d e c r e a s i n g i n v e s t o r c o n f i d e n c e s p u r r e d o n b y t h e l e f t w i n g p o l i t i c a l s i t u a t i o n a n d t h e e v e r i n c r e a s i n g l a b o u r p r o b l e m s i n t h e p r o v i n c e . 2 ^ T h e r e c o r d o f l a b o u r p r o d u c t i v i t y i n B.C. was o n e o f t h e w o r s t i n C a n a d a . F o r e i g n i n v e s t m e n t i n t h e r e s o u r c e i n d u s t r y d r o p p e d s i g n i f i c a n t l y a s a r e s u l t o f t h e u n c e r t a i n e c o n o m i c e n v i r o n m e n t ( R o y a l L e P a g e M a r k e t R e p o r t 1 9 7 9 ) . T h e boom h i t V a n c o u v e r i n 1 9 8 0 a n d 1 9 8 1 . T h e S o c r e d p r o v i n c i a l g o v e r n m e n t r e s t o r e d t h e c o n f i d e n c e o f b o t h t h e l o c a l a n d i n t e r n a t i o n a l b u s i n e s s c o m m u n i t y . T h e f o r e s t r y ' T h e r e a p p e a r e d t o be g r o w i n g t r e n d t o w a r d s B r i t i s h C o l u m b i a b e c o m i n g a " c l a s s a d v e r s a r y " P r o v i n c e . T h i s r e s u l t e d f r o m t h e i n c r e a s i n g number o f s i t u a t i o n s w h e r e , f o r e x a m p l e , i t w a s l a b o u r v e r s u s m a n a g e m e n t a n d m u n i c i p a l p o l i t i c i a n s a g a i n s t d e v e l o p e r s . ( R o y a l L e P a g e M a r k e t S u r v e y 1 9 7 9 ) 77 i n d u s t r y was p e r f o r m i n g w e l l w i t h a s t r o n g h o u s i n g m a r k e t i n t h e U.S. a n d w i t h t h e d e c l i n i n g C a n a d i a n d o l l a r . M i n i n g a n d c o a l p r o d u c t s w e r e i n s t r o n g demand f r o m t h e P a c i f i c R i m . A s F i g u r e 3.5.1 a n d F i g u r e 3.5.3 s h o w , t h e o f f i c e m a r k e t r e s p o n d e d w i t h p e a k a b s o r p t i o n r a t e s o f 1 , 9 0 0 , 0 0 0 s q f t a n d s h a r p i n c r e a s e s i n r e a l r e n t s . T h e r e c e s s i o n s t a r t e d i n 1 9 8 2 w i t h a s l u m p i n h o u s i n g s t a r t s i n b o t h B.C. a n d t h e U.S.. T h e r e d u c e d d e m a n d f o r f o r e s t r y p r o d u c t s c o m b i n e d w i t h a m a j o r l a b o u r d i s p u t e i n 1 9 8 1 s e e m e d t o c u r t a i l t h e e c o n o m i c e x p a n s i o n a n d i n v e s t o r c o n f i d e n c e . I n 1 9 8 3 , t h e r e c e s s i o n h a d r e a l l y h i t . E m p l o y m e n t i n V a n c o u v e r d r o p p e d t o 4 2 3 , 0 0 0 f r o m a h i g h o f 4 9 0 , 0 0 0 i n 1 9 8 1 (GVRD 1 9 8 6 ) . T h e o f f i c e m a r k e t e x p e r i e n c e d d r a s t i c d i p s i n d e m a n d a n d h a d t o s h o u l d e r m a s s i v e a d d i t i o n s o f new s p a c e . 2 ^ A l t h o u g h b y 1 9 8 4 , t h e e c o n o m y was s h o w i n g s i g n s o f r e c o v e r i n g , t h e m a s s i v e g l u t o f s p a c e i n t h e o f f i c e m a r k e t p u s h e d v a c a n c y l e v e l s u p c l o s e t o 2 0 % . N o m i n a l r e n t l e v e l s b e g a n t o f a l l a n d a s i n t h e o t h e r c i t i e s , t e n a n t i n d u c e m e n t s b e c a m e c o m m o n p l a c e . T h e b e h a v i o u r o f t h e m a r k e t i n 1 9 8 7 s e e m s t o i n d i c a t e some s t a b i l i z a t i o n . T h e l a s t o f t h e b o o m t i m e o f f i c e s p a c e came o n s t r e a m i n 1 9 8 5 s o a b s o r p t i o n was a b l e t o f i n a l l y s l o w t h e I n 1 9 8 4 , 1 , 3 0 0 , 0 0 0 s q f t o f s p a c e came o n s t r e a m . T h i s w a s t h e l a r g e s t c o m p l e t i o n s i n c e 1 9 7 3 . ( C i t y o f V a n c o u v e r P l a n n i n g D e p a r t m e n t : Q u a r t e r l y R e v i e w 1 9 8 4 ) 78 F I G U R E 3.5.2 T i m e S e r i e s : T o t a l O f f i c e S p a c e a n d V a c a n c i e s VANCOUVER i i i i i i i i i 1 1 75 76 77 78 79 80 81 82 83 84 85 86 87 Year • Total Off ice S p a c e + Vacancy Rate S o u r c e : R o y a l L e P a g e M a r k e t S u r v e y 79 FIGURE 3.5.3 Time S e r i e s : Absorption and Vacancies VANCOUVER 1.8 1.7 1-6 H 1.5 1.4 1.3 -1.2 -1.1 -1 0.9 0.8 0.7 -0.6 -0.5 75 76 77 78 'T-IS eo 81 82 83 84 85 Year O Absorption Vacancy Rate Source: Royal LePage Market Survey 80 r i s e i n v a c a n c y . A l o t o f t h e a c t i v i t y i n t h e o f f i c e m a r k e t s e e m e d t o b e t e n a n t s m o v i n g t o new c h e a p e r s p a c e o r d o w n s i z i n g . I n 1 9 8 7 , t h e f o r e s t r y a n d m i n i n g i n d u s t r i e s b o t h p i c k e d u p a n d t h e c o n f i d e n c e h a s s h o w n t h r o u g h i n c r e a s e d a b s o r p t i o n a n d some s t a b i l i z a t i o n o f r e a l r e n t s ( R o y a l L e P a g e M a r k e t R e p o r t 1 9 8 8 ) . 8 1 4.0 DATA A N A L Y S I S T h i s c h a p t e r i s d i v i d e d i n t o 3 s e c t i o n s . T h e f i r s t d e v e l o p s t h e e m p i r i c a l m o d e l t h a t w i l l b e u s e d t o t e s t t h e d a t a o n t h e C a n a d i a n o f f i c e m a r k e t . T h e s e c o n d s e c t i o n d e s c r i b e s t h e s o u r c e s f o r t h e d a t a a n d a n y o f t h e t r a n s f o r m a t i o n s t h a t w e r e n e c e s s a r y t o m ake t h e d a t a s u i t a b l e f o r t h e e m p i r i c a l m o d e l . F i n a l l y , t h e l a s t s e c t i o n d i s c u s s e s t h e r e s u l t s o b t a i n e d f r o m t h e e m p i r i c a l a n a l y s i s . A n a t t e m p t h a s b e e n made t o r e l a t e t h e r e s u l t s t o p r e v i o u s w o r k t h a t h a s b e e n d o n e a n d t o t h e c h a r a c t e r i s t i c s o f t h e o f f i c e m a r k e t i n e a c h c i t y u n d e r s t u d y . 4.1 T h e P r i c e A d j u s t m e n t M o d e l F o l l o w i n g t h e a r g u m e n t s r a i s e d i n t h e L i t e r a t u r e R e v i e w t h e e m p i r i c a l m o d e l s h o u l d c o n s i d e r t h e f o l l o w i n g f a c t o r s : 1. I n t h e s h o r t r u n t h e s u p p l y o f new o f f i c e s p a c e i s r e l a t i v e l y f i x e d . A n y p r i c e a d j u s t m e n t s w i l l b e d u e t o c h a n g e s i n d e m a n d . 2. F o r t h e r e a s o n s g i v e n b y C a p o z z a ( 1 9 8 0 ) a n d t h o s e b r i e f l y s u g g e s t e d b y S h i l l i n g e t a l . ( 1 9 8 7 ) , we s h o u l d o b s e r v e a s y m m e t r i c p r i c e b e h a v i o u r . L a r g e p r i c e i n c r e a s e s s h o u l d b e o b s e r v e d i n r e s p o n s e t o l a r g e 82 po s i t i v e demand shocks. Negative demand shocks should r e s u l t i n r e l a t i v e price r i g i d i t y . None of the authors who have done empirical work in the o f f i c e market have adequately investigated t h i s behaviour. The vacancy variable should be transformed to account for the non l i n e a r i t y . Capozza (1980) suggests the kinked response around the normal vacancy rate indicates a function of the form, 1/Vacancy. The period under study from 1968 to 1987 was an i n f l a t i o n a r y environment. Landlords most l i k e l y attempted to pass through i n f l a t i o n a r y increases to tenants through nominal rent increases. As suggested by Capozza (1980) and Rosen (1985) the model should include a proxy variable for i n f l a t i o n expectations. A l l the l i t e r a t u r e suggests that marginal operating costs should a f f e c t price response i f they have a s i g n i f i c a n t impact on the marginal cost of holding inventory. S h i l l i n g et a l . (1987) have included the change i n t o t a l operating costs as an independent variable. Price asymmetry suggests the existence of an optimum or normal vacancy l e v e l . Although previous authors recognise a normal vacancy l e v e l they have either 83 ignored i t or assumed that i t i s constant over the period. However, the factors which determine the normal vacancy rate are unlikel y to remain constant over a long period. Office demand expectations and uncertainty, interest rates, and marginal operating costs w i l l vary over time. This suggests that the model may be improved by introducing them as independent variables. 6. From the discussion by Hekman (1985) the l o c a l factors i n each c i t y suggests the need for a pooled cross sectional time series analysis. Dummy variables should be used for each c i t y . The base model used in t h i s empirical analysis w i l l be that suggested by Rosen and Smith (1983) and l a t e r used by S h i l l i n g et a l . (1987) f o r the o f f i c e market; dR = / ( V" - V, dE ) The model should incorporate additional independent variables as suggested by the points mentioned above. Therefore the model which w i l l be empirically tested w i l l be; dLnRENT = Constant + Y.aixi + b^NVAC + b2E(dLnINF) + b 3E (dLnEMP) + b4dLnOP + b 5I + <= where, 84 dLnRENT: x i : INVAC: E(dLnlNF): E(dLnEMP): dLnOP: the %change i n average gross nominal or re a l rents 1 a dummy variable for each c i t y the inverse of vacancy to account for the asymmetric price response a proxy for i n f l a t i o n expectations a proxy for the demand expectations in the o f f i c e market the %change in average nominal or real operating costs the l e v e l of nominal or real i n t e r e s t rates. 4.2 D a t a Empirical t e s t i n g of the price adjustment model i s performed using data from Toronto, Montreal, Calgary, Edmonton, and Vancouver. These c i t i e s provide a f a i r l y complete cross section of the Canadian o f f i c e market. With the exception of Vancouver, the data for each c i t y has come from Royal LePage's annual o f f i c e market survey and the Experience Exchange Report prepared by the Building Owners and Managers Association (BOMA). These two sources represent *To remove c o l l i n e a r i t y that exists between variables moving with i n f l a t i o n i t may be more appropriate to specify the model in rea l rather than nominal terms. 85 the most comprehensive sources of time series data covering a meaningful analysis period. Unfortunately, there are some li m i t a t i o n s to each of the sources. Both sources record aggregated average figures which often does not adequately represent the d i v e r s i t y that can exist within each o f f i c e market. Eger and Smith (1987) have pointed out the potential p i t f a l l s of unqualified aggregated data from secondary sources. In addition, the Royal LePage survey i s prepared by a rea l estate company involved in the o f f i c e market. They use the information primarily for marketing purposes. Since Royal LePage i s not an independent source and the survey methodology i s not stated, i t i s d i f f i c u l t to assess the quality of the data. The data c o l l e c t e d i n the Experience Exchange Report comes from a formal survey conducted each year by BOMA. Although BOMA i s an independent industry association, the l i m i t a t i o n to t h i s source i s the small sample of o f f i c e buildings used i n the survey i n Canada. Notwithstanding the li m i t a t i o n s mentioned above, the data i s the best available at t h i s time. My perception i s that these secondary sources are becoming more rigorous in t h e i r c o l l e c t i o n methodology and they should become more valuable in time for future empirical work. 86 F o r t h e i r s u r v e y , R o y a l L e P a g e t r a c k s t h e s u p p l y o f n e t r e n t a b l e o f f i c e s p a c e g r e a t e r t h a n 1 0 , 0 0 0 s q f t i n t h e d o w n t o w n a n d s u b u r b a n a r e a s o f m a j o r C a n a d i a n c i t i e s . F r o m t h i s d a t a b a s e t h e y r e c o r d t o t a l s u p p l y , a v e r a g e a s k i n g g r o s s o r n e t r e n t a l r a t e s , a v e r a g e a n n u a l v a c a n c y , o p e r a t i n g c o s t s , c o m p l e t i o n s a n d a b s o r p t i o n . BOMA r e c o r d s s l i g h t l y d i f f e r e n t i n f o r m a t i o n . P u r s u a n t t o t h e i n t e r e s t o f t h e i r m e m b e r s , t h e y s u r v e y d e t a i l e d o p e r a t i o n a n d m a i n t e n a n c e d a t a . T h i s p r o v i d e s a f a i r l y a c c u r a t e r e c o r d o f o p e r a t i n g c o s t s i n e a c h c i t y b r o k e n o u t b y d i f f e r e n t b u i l d i n g c l a s s i f i c a t i o n . A s a d a t a s o u r c e f o r V a n c o u v e r , I h a v e u s e d M e t r o t r e n d s , a p u b l i c a t i o n p r e p a r e d e a c h y e a r b y t h e R e a l E s t a t e B o a r d o f V a n c o u v e r . T h e d a t a p r o v i d e d i s m o r e c o m p r e h e n s i v e t h a n t h e R o y a l L e P a g e d a t a a n d s h o u l d y i e l d b e t t e r r e s u l t s . S u p p l e m e n t a r y e c o n o m i c a n d d e m o g r a p h i c i n f o r m a t i o n h a s b e e n o b t a i n e d f r o m S t a t i s t i c s C a n a d a a n d t h e p l a n n i n g d e p a r t m e n t s o f e a c h m e t r o p o l i t a n a r e a . F o r T o r o n t o , t h e t i m e s e r i e s s p a n s 1 9 6 8 t o 1 9 8 7 . F o r V a n c o u v e r t h e t i m e s e r i e s s p a n s 1 9 7 1 t o 1 9 8 7 . F o r M o n t r e a l , E d m o n t o n a n d C a l g a r y t h e t i m e s e r i e s s p a n s 1 9 7 5 t o 1 9 8 7 . T h e a g g r e g a t e d a t a b a s e h a s a p p r o x i m a t e l y 7 0 p o i n t s . 87 The following provides a description of each variable and the transformations necessary to prepare the data for the empirical analysis: Rent: Gross rental data has been used to maintain consistency i n the analysis. Gross rents require the landlord to c o l l e c t for both the rental of space and for operating costs. The rents from Royal LePage are the average annual nominal f u l l f l o o r asking rates for the top ten downtown core buildings. The rents from Metrotrends are weighted average nominal asking rates for a l l o f f i c e buildings in the downtown core b u i l t since 1960. Real rent rates are found by adjusting the nominal rate by the CPI. The rental data was transformed by taking the natural log of each rental rate and then differencing to create the %change i n rents in each year. Vacancy: Vacancies are the average annual percentages of vacant existing space and space to be completed for occupancy in that year. In the case of Calgary, Edmonton and Montreal the figures include a l l o f f i c e space in the c i t y . For Toronto and Vancouver the figures are exclusive to the downtown core area. 88 Operating: The figures include average annual variable Costs and fixed operating costs for downtown o f f i c e buildings between 50,000 and 600,000 square feet. Real operating costs are found by adjusting the nominal figures by the CPI. The data was transformed by taking the natural log of each operating cost value and then di f f e r e n c i n g to create the %change in operating costs i n each year. I n f l a t i o n : I have used 3 sources as proxies for i n f l a t i o n Proxy expectations; the average 3 month T b i l l y i e l d , the average 10 year Government of Canada bond y i e l d , and a moving average of the Consumer Price Index estimated with an ARIMA (0,1,1) model. A l l of t h i s data has been compiled from S t a t i s t i c s Canada sources. 2 O f f i c e : As a proxy for demand expectations I have used Demand o f f i c e employment data compiled for each metropolitan area in the Labour Force Survey 2The nomenclature used in the empirical model for the 3 i n f l a t i o n proxies i s as follows, TBILL: nominal 3 month Treasury b i l l rate BOND: nominal 10 year Government Bond rate FITCPI: moving average of the CPI rate RTBILL: real 3 month Treasury b i l l rate 89 conducted by S t a t i s t i c s Canada. Of f i c e employment was assumed to be the t o t a l employment in the Professional Services, Public Administration and Finance, Insurance and Real Estate sectors. The data was transformed by taking the natural log of each employment figure and then di f f e r e n c i n g to create the %change i n employment i n each year. 3 Interest: The average 3 month T B i l l rate and the average 10 year Government of Canada Bond rate have been used as variables for the interest rate. The r e a l rate of interest has been calculated by subtracting the i n f l a t i o n rate i n each year. 4.3 Empirical Results To provide a preliminary inspection of the data, the % change i n real and nominal rents have been plotted against corresponding vacancy l e v e l s in Figures 4.1 through 4.7. Both cross sectional data and each individual c i t y have been plotted for analysis. 3An ARIMA (0,1,1) estimate was conducted using the employment data for each c i t y to t r y and generate a moving average expectational variable. Unfortunately the time series was too small to y i e l d meaningful re s u l t s for the empirical model being tested. Instead, the % change i n employment each year was used as the proxy for expected o f f i c e space demand growth. 90 Looking f i r s t at the pooled cross sectional data there are some d e f i n i t e patterns which provide evidence for the propositions about the o f f i c e market. Figure 4.1 shows the nominal rent changes while Figure 4.2 shows the real rent changes for the cross sectional data set. At lower vacancy le v e l s there i s a marked increase in dispersion showing evidence of price asymmetry. The normal vacancy l e v e l appears to be i n the range of 7% to 10%. In addition, a l l the rental changes below t h i s region are generally p o s i t i v e i n d i c a t i n g that landlords increase rents at low vacancy l e v e l s to choke of the demand and preserve some inventory of space for buffering future demand shocks. Above the 10% vacancy l e v e l there i s a f a i r l y t i g h t dispersion of rental changes. This may corroborate the existence of price r i g i d i t y at high vacancy l e v e l s . However, tenant inducements are most l i k e l y clouding the true behaviour. Any nominal price changes that do occur appear to be p o s i t i v e which indicates an attempt to keep pace with the i n f l a t i o n a r y environment of the 1970's and 1980's. An inspection of re a l price changes show a greater tendency for negative price movements at high vacancy l e v e l s . Either landlords were not able to f u l l y pass through i n f l a t i o n a r y r i s e s or long term market conditions and expectations changed enough to force rents to f a l l . The plots for Montreal are shown in Figure 4.3. The p r i c e behaviour i s a b i t curious. Nominal rent changes are FIGURE 4.1 % NOMINAL RENT CHANGE VS % VACANCY C r o s s Sect ional City Data 3 0 2 0 10 - 1 0 - 3 0 • a • rP • a • • • B • • • • • • • D B o • • a P • • • • • -• D • S P • _ • ' • I I ^ I I I 1 1 1 1 1 i i i i i i r S 12 16 2 0 Vacancy Rate Source: Royal LePage Market Survey and the Real Estate Board of Greater Vancouver 92 FIGURE 4.2 % REAL RENT CHANGE VS % VACANCY 3 0 C r o s s Sect ional City Data • 2 0 H • • • 10 • • 'a • • • • • o • a - 1 0 H B • • p • a • • -s--20 • - 3 0 -40 4 " i 1 r 12 1 6 2 0 I 24 Vacancy Rate S o u r c e : R o y a l LePage Market Survey and the R e a l E s t a t e Board o f G r e a t e r Vancouver c c a: z V c o 93 FIGURE 4.3 Nominal and R e a l Rent Change v s % V a c a n c y : MONTREAL 20 18 1 6 1 4 1 2 10 8 6 4 2 0 - 2 - 4 - 6 1 1 10 9 8 7 6 5 4 3 2 1 O -1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 P • —i r~ 1 3 I 1 1 -1— 13 1 5 17 Vacancy Rate - a n i i i r 5 7 9 I 1 1 1—~~1 1—1 11 13 15 17 S o u r c e : Vacancy Rate Roya l LePage Market Survey l a r g e a n d p o s i t i v e f o r v a c a n c y l e v e l s b e l o w 1 2 % a n d p r i m a r i l y l a r g e a n d n e g a t i v e a b o v e 1 2 % . T h e r e a l p l o t s h o w s t h a t n o m i n a l p r i c e c h a n g e s a t b e s t o n l y k e p t r e a l r e n t l e v e l s i n p a c e w i t h i n f l a t i o n e v e n a t l o w v a c a n c y l e v e l s . R e a l r e n t c h a n g e s a b o v e a 1 2 % v a c a n c y l e v e l a c t u a l l y d r o p p e d . P o l i t i c a l u n r e s t i n Q u e b e c a n d t h e c o r p o r a t e e x o d u s d u r i n g t h e l a t e 1 9 7 0 ' s may h a v e l o w e r e d d e m a n d e x p e c t a t i o n s a n d f o r c e d r e n t s t o d i p . L a n d l o r d s f a c e d w i t h a s h r i n k i n g m a r k e t may h a v e b e e n l e s s w i l l i n g t o h o l d v a c a n c i e s a n d r e f r a i n e d f r o m s h a r p p r i c e i n c r e a s e s f e a r i n g f u r t h e r r e d u c t i o n s i n d e m a n d . T h e p l o t s f o r T o r o n t o a r e s h o w n i n F i g u r e 4.4. B o t h t h e n o m i n a l a n d r e a l p l o t s h o w t h e e x p e c t e d p r i c e a s y m m e t r y a t l o w v a c a n c y l e v e l s a n d p r i c e r i g i d i t y a t h i g h l e v e l s . T h e n o r m a l v a c a n c y w o u l d a p p e a r t o b e a r o u n d 3% t o 4%. T o r o n t o h a s a f a i r l y d i v e r s i f i e d e c o n o m i c b a s e w h i c h r e d u c e s t h e u n c e r t a i n t y o f d e m a n d . I t i s r e a s o n a b l e t o e x p e c t a l o w e r n o r m a l v a c a n c y r a t e . * T h e r e a r e t w o o u t l i e r s i n t h e T o r o n t o d a t a . T h e f i r s t o c c u r s i n 1 9 7 4 w h e n r e a l r e n t s j u m p e d u p b y 2 8 % a t a f a i r l y h i g h v a c a n c y l e v e l o f 8%. T h e r e s p o n s e may h a v e b e e n a j e r k r e a c t i o n t o a s u d d e n d e c r e a s e i n v a c a n c y a f t e r 4 y e a r s o f a i n c r e a s e i n t h e v a c a n c y r a t e . T h e r e c o r d a b s o r p t i o n r a t e i n 1 9 7 3 c a u s e d t h e s u d d e n d r o p i n v a c a n c i e s . T h e s e c o n d o u t l i e r "•See J . D . S h i l l i n g e t a l ( 1 9 8 7 ) FIGURE 4 . 4 % Nominal and R e a l Rent Change v s % V a c a n c y : TORONTO Vocancv Rate Vacancy Rate Roya l LePage Market Survey 96 occurred in 1983. Real rents dropped by 33% at a vacancy of 10%. As I mentioned in the previous chapter, the rental data for Toronto aft e r 1983 was corrected for tenant inducements. This may have caused the abrupt drop not normally shown by uncorrected rental data. The plots for Edmonton are shown in Figure 4.5. Both the nominal and r e a l plot show price asymmetry below a normal vacancy l e v e l of 9% to 13%. The higher normal rate i s i n d i c a t i v e of a c i t y with resource based economy. The lack of price r i g i d i t y at high vacancy l e v e l s i s probably due to the substantial change i n market conditions and demand expectations following the 1981 recession. The r e a l plot shows a nice hyperbolic curve. The one o u t l i e r for Edmonton i s the 6% increase i n r e a l rents i n the face of a 19% vacancy rate that occurred i n 1983. The response i s most l i k e l y due to the sudden surge i n absorption that occurred that year. I t i s also possible that a portion of the space that came on stream that year was preleased at pre recession rates. The preleased rates would be r e f l e c t e d i n the average rate. The plots for Calgary shown in Figure 4.6 are somewhat inconclusive. There i s some price dispersion below a 10% vacancy l e v e l , however, the majority of the r e a l rent V C C D jC o c D a: c o z 4) c c c tl or 97 FIGURE 4 .5 % Nominal and R e a l Rent Change v s % V a c a n c y : EDMONTON S o u r c e : Vacancy Rate Roya l LePage Market Survey 0> c o o c 4) ir c I o 4) c 0 o c 98 FIGURE 4 . 6 % Nominal and R e a l Rent Change v s % V a c a n c y : CALGARY Vacancy Rate S o u r c e : Vacancy Rate R o y a l LePage Market Survey 99 c h a n g e s a r e c l o s e t o z e r o e v e n a t l o w v a c a n c y l e v e l s . T h i s i s a c u r i o u s r e s u l t g i v e n t h e b o o m e x p e r i e n c e d i n t h e C a l g a r y o f f i c e m a r k e t i n t h e l a t e 7 0 ' s a n d e a r l y 8 0 ' s . T h e e x p l a n a t i o n may b e t h a t t h e r e w e r e t w o p r i c e a d j u s t m e n t r e g i m e s o p e r a t i n g i n t h e p e r i o d . P r i o r t o t h e boom, v a c a n c y l e v e l s w e r e c o n s i s t e n t l y l o w i n C a l g a r y , l e s s t h a n 5 % . 5 T h i s w o u l d i n d i c a t e a n o r m a l v a c a n c y l e v e l i n t h i s r a n g e a n d we w o u l d n o t e x p e c t t o s e e a n y s u b s t a n t i a l r e a l r e n t c h a n g e s u n t i l d e m a n d e x p e c t a t i o n s c h a n g e d . T h i s w o u l d e x p l a i n t h e l o w p r i c e r e s p o n s e d u r i n g t h a t p e r i o d . A f t e r 1 9 8 0 , l a n d l o r d s a p p e a r t o h a v e r e a c t e d s t r o n g l y t o t h e b o o m t i m e e n v i r o n m e n t w h i c h s e t o f f a new r e g i m e . T h e r e i s o n e o u t l i e r p o i n t i n t h e C a l g a r y d a t a w h i c h r e q u i r e s s o me e x p l a n a t i o n . I n 1 9 8 6 , r e a l r a t e s r o s e d e s p i t e t h e f a c t t h a t t h e o v e r a l l v a c a n c y i n c r e a s e d t o 2 0 % . T h i s d i s c r e p a n c y m o s t l i k e l y r e s u l t e d f r o m d r a m a t i c f l u c t u a t i o n s i n o i l p r i c e s t h a t o c c u r r e d t h r o u g h 1 9 8 5 a n d e a r l y i n t o 1 9 8 6 . O i l p r i c e s w e r e r i s i n g s t e a d i l y t h r o u g h 1 9 8 5 t o t h e h i g h e s t l e v e l s i n c e 1 9 8 1 , $ 3 8 . 4 1 ( C d n ) p e r b a r r e l . C o n f i d e n c e w a s i n c r e a s i n g i n t h e p e t r o l e u m i n d u s t r y a n d i t s e e m e d t o s p a r k a s u r g e o f a b s o r p t i o n i n t h e e a r l y p o r t i o n o f 1 9 8 6 . I n F e b r u a r y 1 9 8 6 , S a u d i A r a b i a a n n o u n c e d i t s d i s p l e a s u r e w i t h s o me o f t h e OPEC c o u n t r i e s who w e r e n o t a b i d i n g b y t h e i r q u o t a s . T h e y 5 L a r k e n R e a l E s t a t e R e v i e w ( 1 9 8 5 ) s h o w s t h a t v a c a n c y l e v e l s w e r e h i s t o r i c a l l y l o w i n C a l g a r y p r i o r t o 1 9 8 1 . 100 subsequently flooded the market and drove down prices to $17.40 (Cdn) a b a r r e l . Business confidence was immediately l o s t again and vacancy levels rose again through the rest of 1986. This was exacerbated by a s i g n i f i c a n t amount of tenant downsizing i n that year. The sudden twist in the market may explain the curious r e s u l t . The plots for Vancouver are shown in Figure 4.7. Asymmetric price response i s evident, however, there are peculiar dips in the change i n rents at low vacancy l e v e l s . As mentioned i n the c i t y analysis, Vancouver landlords seem reluctant to speculate and drop rea l rents the instant they begin to move upwards. The behaviour seems to indicate a very low normal vacancy l e v e l of 4% to 5%, very s i m i l a r to Toronto. This i s uncharacteristic of a c i t y which i s resource dependent. One possible explanation may be the lack of large corporate o f f i c e s in the c i t y who are r e l a t i v e l y r e s i s t a n t to economic swings. A large proportion of o f f i c e space i s occupied by small l e g a l , accounting and f i n a n c i a l tenants who are very susceptible to the whims of the economy and the l e v e l of o f f i c e rents. Table 4.1 shows the ordinary least squares regression equations estimated with the pooled cross sectional time series data. In equation 1 the CPI moving average, FITCPI i s used to proxy i n f l a t i o n expectations and the T B i l l rate, 101 FIGURE 4 . 7 % Nominal and Real Rent Change vs % Vacancy:VANCOUVER Vacancy Rate 30 20 15 10 5 H -io -\ r n 1 1 1 r~ 2 4 6 . ~i 1 1 1 1 1 1 1 1 1 1 r~ 8 10 12 14 16 18 20 Vacancy Rate Real E s t a t e Board o f Gr e a t e r Vancouver TABLE 4.1 Price Adjustment Model for the Canadian Office Market 1968 -1987 DEPENDENT VARIABLE CONSTANT TS1LL BOND flTCPl TORONTO EDMONTON CALGARY VANCOUVER 1NVAC dLnEMP dLnOP RTBILL dLnROP 1. dLn(Nom Rent) -0.13 0.01 1.18 0.04 0.03 0.02 0.02 0.13 0.03 0.16 R-2 0.24 -2.1 1.0 2.1 0.8 0.7 0.4 0.5 1.9 0.1 1.0 SSE 0.11 * * * F • 3.22 2. dLnCNom Rem) -0.09 0.01 0.04 0.03 0.02 0.02 0.16 -0.01 0.25 R*2 i 0.19 -1.6 1.9 0.B 0.6 0.4 0.5 2.3 -0.0 1.5 SSE as 0.11 • * F * 2.86 J. dlnCNom Rent) -0.10 0.00 1.38 0.03 0.04 0.02 0.02 0.16 0.04 0.17 R-2 * 0.23 -1.3 0.2 2.5 0.7 0.8 0.5 0.4 2.4 0.1 1.0 SSE 0.11 * * F « 3.05 4. dLn(Nom Rent) -0.08 0.01 0.04 0.04 0.02 0.02 0.20 0.02 0.27 R*2 * 0.15 -0.9 1.0 0.8 0.7 0.5 0.4 3.0 0.1 1.6 SSE 0.11 * F 2.38 5. dLn(Nom Rent) -0.13 0.01 1.18 0.04 0.03 0.02 0.02 0.13 0.16 R"2 - 0.26 -7.1 1.0 2.2 0.8 0.7 0.5 0.6 2.0 1.0 SSE 0.11 * * * F 3.69 Diagnostic Checks: p = .01 for f = 3.69 Skewness = -.15 Kurtosis » .53 6. dLnCReal Rent) -0.10 0.81 0.03 0.04 0.03 0.02 0.13 -0.10 -0.00 0.09 R-2 0.07 -1.7 1.6 0.7 0.9 0.6 0.5 2.2 -0.3 -0.4 0.6 SSE 0.10 * F 1.54 7. dln(Real Rent) -0.11 0.87 0.03 0.04 0.03 0.02 0.13 0.09 RA2 s 0.10 -2.3 1.9 0.8 0.8 0.6 0.5 2.2 0.6 SSE 0.10 * * * F 2.02 Diagnostic Checks: p = .06 for f « 2 .02 Skewness > -.04 Kurtosis = .60 notes: 1. t s t a t i s t i c s are shown betow each c o e f f i c i e n t . A * indicates significance. 2. See next page for variable definitions TA8LE 4.1 (continued) Price Adjustment Model for the Canadian Office Market 1968 -1987 DEPENDENT VARIABLE CONSTANT TBILL FITCPI TORONTO EDMONTON CALGARY VANCOUVER INVAC VAC LOGVAC dLnEMP dLnOP RTBILL dlnROP MONTDUHT CALOUMY 8. dLnlNom Rent) -0.10 0.00 1.29 0.02 0.02 0.02 0.00 0.16 0.07 0.18 -0.03 -0.05 R*2 » 0.22 -1.4 0.6 2.2 0.2 0.3 0.3 0.0 2.0 0.2 1.0 -0.4 -0.7 SSE = 0.11 * * F • 2.61 9. dLnCReat Rent) -0.06 0.81 -0.01 0.01 0.03 - 0.02 0.17 - 0.07 - 0.01 0.11 -0.06 - 0.08 R A2 » 0.07 -0.8 1.6 -0.1 0.2 0.4 -0.3 2.5 -0.2 -0.8 0.7 -0.8 -1.2 SSE = 0.10 * F - 1.42 10. dLnCNom Rent) 0.09 0.01 0.30 -0.00 0.05 0.08 0.00 -0.01 -0.16 0.08 -0.05 -0.14 R"2 = 0.34 0.9 1.6 0.5 -0.0 0.8 1.1 0.1 -3.6 -0.5 0.5 -0.7 -1.9 SSE = 0.10 • * F = 3.74 11. dLn(Real Rent) 0.10 0.23 -0.01 0.05 0.08 -0.01 -0.01 -0.21 0.00 0.04 -0.06 -0.15 R"2 * 0.14 1.2 0.4 -0.2 0.7 1.2 -0.1 -3.4 -0.7 0.5 0.3 -0.9 -2.1 SSE ' 0.10 J_J * F * 1.94 O CJ 0.08 -0.08 0.15 -0.07 -0.12 R-2 * 0.30 -3.2 -0.2 0.9 -1.0 -1.6 SSE • 0.10 * F = 3.44 12. dLnlNom Rent) 0.15 0.00 0.71 -0.01 0.03 0.04 -0.02 1.3 0.8 1.2 -0.1 0.5 0.6 -0.3 13. dLn(Real Rent) 0.17 0.35 -0.02 0.02 0.05 -0.03 -0.08 -0.18 -0.00 0.01 -0.09 -0.13 R*2 * 0.14 1 .6 0.7 -0.3 0.4 0.7 -0.5 -3.3 -0.6 -0.4 0.6 -1.2 -1.9 SSE = 0.10 * * F = 1.94 Notes: 1. t s t a t i s t i c s are shown below each c o e f f i c i e n t . A * indicates significance. 2. Variable d e f i n i t i o n s : dLn(Nom Rent): the Xchange in nominal rents INVAC: the inverse of the vacancy rate dLnCReal Rent): the Xchange In real rents VAC: the vacancy rate TBILL: the nominal 3 month Treasury B i l l rate LOGVAC: the l o g a r i t h m of the vacancy rate BOND: the nominal 10 year Government of Canada Bond rate dLnEMP: the Xchange in o f f i c e employment FITCPI: a moving average of the Consumer price index dLnOP: the Xchange in nominal operating costs TORONTO: a dummy variable for Toronto RTBILL the real 3 month Treasury B i l l rate EDMONTON: a dummy variable for Edmonton dLnROP: the Xchange in real operating costs CALGARY: a dummy variable for Calgary MONYDUMY: a dummy variable for 1976 - 1982 in Montreal VANCOUVER: a dummy variable for Vancouver CALDUMY: a dummy variable for 1976 - 1980 i n Calgary 104 TB ILL i s used as the i n t e r e s t r a t e v a r i a b l e . The c o e f f i c i e n t on the vacancy v a r i a b l e , INVAC shows the expected p o s i t i v e s i g n and i s s i g n i f i c a n t . T h i s s u p p o r t s the p r o p o s i t i o n t h a t t h e r e i s asymmetr ic r e n t a l p r i c e response i n the o f f i c e market and p r o v i d e s f u r t h e r e v i d e n c e t h a t t h e r e i s some optimum o r normal vacancy l e v e l t o which l a n d l o r d s r e s p o n d . The i n f l a t i o n e x p e c t a t i o n v a r i a b l e , F ITCPI has the c o r r e c t s i g n and i s a l s o s i g n i f i c a n t . The c o e f f i c i e n t i s l a r g e r than 1 which i n d i c a t e s t h a t l a n d l o r d s a r e a b l e t o pass r e n t changes o f f t o t e n a n t s which exceed the expected i n f l a t i o n f o r the coming y e a r . T h i s i s the same p e c u l i a r r e s u l t found by Rosen (1985). The e x p l a n a t i o n may be i n the l o n g term na ture o f the l e a s e s and the at tempt t o p r o v i d e an i n f l a t i o n hedge f o r the l a n d l o r d th rough the f u l l l i f e o f the r e n t a l c o n t r a c t . The v a r i a b l e f o r o p e r a t i n g c o s t changes , d lnOP and the i n t e r e s t r a t e v a r i a b l e , TB ILL show the c o r r e c t s i g n , however n e i t h e r a re s i g n i f i c a n t . T h i s s u g g e s t s t h a t i n the s h o r t t e rm, o p e r a t i n g c o s t s do not s u b s t a n t i a l l y a f f e c t the c o s t o f h o l d i n g i n v e n t o r y . T h e r e f o r e , l a n d l o r d s a re l i k e l y t o use vacancy r a t h e r than p r i c e ad justment t o b u f f e r demand s h o c k s . The d i s t u r b i n g r e s u l t i s the i n s i g n i f i c a n c e of the v a r i a b l e used t o proxy growth e x p e c t a t i o n s i n the o f f i c e market , d lnEMP. A l t h o u g h i t has the expec ted s i g n , i t has v e r y l i t t l e e x p l a n a t o r y power i n t h i s r e n t a l p r i c e ad justment model . T h i s i s most l i k e l y a c a s e o f model m i s s p e c i f i c a t i o n . Growth e x p e c t a t i o n and u n c e r t a i n t y are fundamental components of p r i c e ad justment models w i t h 105 i n v e n t o r y . 6 The 4 c a t e g o r i c a l dummy v a r i a b l e s used f o r each c i t y a re a l l i n s i g n i f i c a n t i n d i c a t i n g a l a c k o f s u b s t a n t i a l d i f f e r e n c e between T o r o n t o , Edmonton, C a l g a r y and Vancouver . The c o n s t a n t i n the e q u a t i o n p a r t i a l l y a c c o u n t s f o r any d i f f e r e n c e s i n l o c a l f a c t o r s i n M o n t r e a l . T h i s v a l u e i s s i g n i f i c a n t . T h i s may r e f l e c t the un ique p o l i t i c a l envi ronment and the c o r p o r a t e s h i f t t h a t o c c u r r e d i n t h a t c i t y d u r i n g the a n a l y s i s p e r i o d . F u r t h e r re f inement o f the model s p e c i f i c a t i o n s h o u l d b r i n g l o c a l f a c t o r s i n each c i t y more t o b e a r . The a d j u s t e d R 2 o f the e q u a t i o n .24 i n d i c a t e s a low degree o f e x p l a n a t o r y power . 7 E q u a t i o n s 2 t o 4 e s t i m a t e the model u s i n g d i f f e r e n t c o m b i n a t i o n s o f i n f l a t i o n e x p e c t a t i o n and i n t e r e s t r a t e p r o x i e s . No s u b s t a n t i a l improvement i s o b s e r v e d . To p r o v i d e a b i t o f f u r t h e r r e f i n e m e n t t o the model the i n s i g n i f i c a n t o f f i c e demand v a r i a b l e , dlnEMP was swept out i n e q u a t i o n 5. The e f f e c t on the o t h e r v a r i a b l e s was not s u b s t a n t i a l . A d i a g n o s t i c s check was done on t h i s e q u a t i o n . The F s t a t i s t i c o f 3.69 shows the model i s s i g n i f i c a n t a t the 1% l e v e l . The normal p r o b a b i l i t y p l o t o f the r e s i d u a l s shows a 6No c u r r e n t l i t e r a t u r e has shown how t o c o r r e c t l y s p e c i f y the growth e x p e c t a t i o n v a r i a b l e i n the p r i c e ad justment model . 7 K . T . Rosen (1984) had an R2 o f .55 f o r San F r a n c i s c o and J . Hekman (1985) had an R2 o f .37 f o r h i s c r o s s s e c t i o n a l da ta s e t . 106 s l i g h t l e f t skewness and some posit i v e kurtosis. Neither i s too serious. The c o r r e l a t i o n matrix for the c o e f f i c i e n t s indicates l i t t l e c o l l i n e a r i t y other than for the c i t y dummy variables. Equations 6 and 7 test the price adjustment model using variables s p e c i f i e d i n real terms. The intent here i s to eliminate any c o l l i n e a r i t y that may exis t between variables moving with i n f l a t i o n . The only marked improvement occurs i n the significance of the vacancy variable INVAC. The real i n t e r e s t variable RTBILL drops out of the model as i t loses both the proper sign and i t s signi f i c a n c e . The o f f i c e demand variable, dLnEMP i s again i n s i g n i f i c a n t . The i n f l a t i o n proxy, FITCPI i s s i g n i f i c a n t to a lesser degree and the c o e f f i c i e n t i s now between .8 and . 9 . This shows that landlords capture i n excess of 80% of the i n f l a t i o n a r y r i s e s each year. The re a l operating cost variable has the correct sign but i s even more i n s i g n i f i c a n t . The c i t y dummy variables are a l l i n s i g n i f i c a n t . Overall the sign i f i c a n c e of the model has decreased. The explanatory power has decreased to an R2 between .07 to .1 and the F s t a t i s t i c of 2.02 i s only s i g n i f i c a n t at the 6% l e v e l . Some further adjustments were made to the model to test and expand the empirical r e s u l t s obtained. 107 T h e a n a l y s i s o f t h e d a t a f o r M o n t r e a l a n d C a l g a r y i n d i c a t e s e v e n t s t h a t p r o d u c e d l o w p r i c e r e s p o n s e a t v e r y l o w v a c a n c y l e v e l s . T o a c c o u n t f o r t h i s b e h a v i o u r t w o dummy v a r i a b l e s w e r e a d d e d t o t h e m o d e l . MONTDUMY, a c c o u n t s f o r t h e p e r i o d b e t w e e n 1 9 7 6 a n d 1 9 8 2 i n M o n t r e a l a n d CALDUMY, a c c o u n t s f o r t h e p e r i o d 1 9 7 6 a n d 1 9 8 0 i n C a l g a r y . T h e r e s u l t s a r e s h o w n i n e q u a t i o n s 8 a n d 9. B o t h v a r i a b l e s ' p r o v i d e t h e c o r r e c t s i g n i n b o t h t h e n o m i n a l a n d i n f l a t i o n a d j u s t e d e q u a t i o n s , h o w e v e r , t h e s i g n i f i c a n c e i s q u i t e l o w . I t s e e m s t h e o b s e r v e d d e v i a t i o n s a r e n o t s t r o n g e n o u g h t o a c c o u n t f o r a n y s i g n i f i c a n t v a r i a t i o n i n t h e m o d e l . P r i c e a s y m m e t r y i s o n e o f t h e c e n t r a l t h e o r e t i c a l p r o p o s i t i o n s . T h e s i g n i f i c a n c e o f t h e v a c a n c y t e r m s p e c i f i e d i n n o n l i n e a r t e r m s s e e m s t o s u p p o r t t h i s b e h a v i o u r . H o w e v e r , i n o r d e r t o t e s t t h e r o b u s t n e s s o f t h i s p r o p o s i t i o n , a n o t h e r r e g r e s s i o n w a s p e r f o r m e d u s i n g a l i n e a r s p e c i f i c a t i o n o f t h e v a c a n c y v a r i a b l e , V A C . T h e r e s u l t s a r e s h o w n i n e q u a t i o n s 10 a n d 1 1 . T h e r e s u l t s s e e m t o c o n t r a d i c t t h e a r g u m e n t s r a i s e d i n t h i s t h e s i s . T h e l i n e a r v a c a n c y v a r i a b l e , V A C p r o v i d e s t h e c o r r e c t n e g a t i v e s i g n a n d i s m o r e s i g n i f i c a n t t h a n t h e n o n l i n e a r v a r i a b l e , I N V A C . T h e e x p l a n a t o r y p o w e r o f t h e m o d e l a l s o i m p r o v e d w i t h a n R 2 o f . 3 4 i n t h e n o m i n a l m o d e l , (.14 i n t h e i n f l a t i o n a d j u s t e d m o d e l ) . T h e i n f l a t i o n p r o x y , F I T C P I a l s o d r o p s i n v a l u e a n d s i g n i f i c a n c e . T h e i n t e r e s t v a r i a b l e , T B I L L s e e m s t o i m p r o v e b u t s t i l l r e m a i n s i n s i g n i f i c a n t . I t may 108 be capturing some of the i n f l a t i o n e f f e c t l o s t by the proxy, FITCPI. Both the employment growth proxy, dlnEMP and the operating cost variable, dlnOP remain i n s i g n i f i c a n t . The two additional dummy variables, MONTDUMY and CALDUMY improve su b s t a n t i a l l y . CALDUMY becomes s i g n i f i c a n t i n the i n f l a t i o n adjusted model. Overall, the results provide an in t e r e s t i n g rebuttal to those found for the proposed model. The v i s u a l inspection of the pooled cross sectional time series data c l e a r l y shows some form of asymmetric price behaviour. To further support t h i s proposition, an alternate non l i n e a r s p e c i f i c a t i o n of the vacancy variable, LOGVAC was used. The re s u l t s are provided i n equations 12 and 13. The vacancy variable has the correct negative sign and i s equally s i g n i f i c a n t to the l i n e a r term i n the previous s p e c i f i c a t i o n . The i n f l a t i o n proxy, FITCPI i s larger and more s i g n i f i c a n t than i n equations 10 and 11. However, i t s t i l l does not carry the same weight as i t does i n the proposed model and does not indicate that landlords overcapitalize i n f l a t i o n in rent changes. A l l the other variables generally perform i n a si m i l a r fashion as those in the previous equations. Both MONTDUMY and CALDUMY show some improvement i n equations 12 and 13 . In summary, the empirical analysis seems to show the following r e s u l t s : 109 1. V a c a n c i e s a r e i m p o r t a n t i n t h e s h o r t r u n p r i c e a d j u s t m e n t p r o c e s s . 2. T h e r e i s e v i d e n c e o f p r i c e a s y m m e t r y a s shown by t h e s i g n i f i c a n c e o f t h e v a c a n c y v a r i a b l e s p e c i f i e d i n n o n l i n e a r t e r m s . The e v i d e n c e i s c l e a r f r o m t h e v i s u a l i n s p e c t i o n , h o w e v e r , t h e e m p i r i c a l a n a l y s i s d o e s n o t p r o d u c e c o n c l u s i v e r e s u l t s . B o t h l i n e a r a nd n o n l i n e a r s p e c i f i c a t i o n s o f t h e v a c a n c y v a r i a b l e p r o v i d e s i m i l a r r e s u l t s . 3. I n f l a t i o n e x p e c t a t i o n s seem t o be i m p o r t a n t i n d e t e r m i n i n g t h e p r i c e a d j u s t m e n t m e c h a n i s m . 4. T o t a l o p e r a t i n g c o s t s and i n t e r e s t r a t e s do n o t a p p e a r t o be s i g n i f i c a n t d e t e r m i n a n t s i n t h e p r i c e a d j u s t m e n t m e c h a n i s m . T h i s l e a d s t o t h e c o n c l u s i o n t h a t n e i t h e r i s a s i g n i f i c a n t f a c t o r i n t h e c o s t o f h o l d i n g i n v e n t o r y i n t h e s h o r t r u n . T h i s p r o v i d e s t h e o r e t i c a l s u p p o r t f o r o b s e r v i n g v a c a n c y a d j u s t m e n t r a t h e r t h a n p r i c e a d j u s t m e n t when l a n d l o r d s a r e f a c e d w i t h n e g a t i v e demand s h o c k s . 5. E x p e c t e d o f f i c e demand i s n o t s i g n i f i c a n t i n t h i s s p e c i f i c a t i o n o f t h i s m o d e l . F u t u r e w o r k n e e d s t o be 110 done t o pr o p e r l y s p e c i f y t h i s v a r i a b l e i n the model. I t i s p l a u s i b l e t h a t expected supply needs t o be in t e g r a t e d i n t o the model to o f f s e t the expected demand. 6. In Canada, the i n d i v i d u a l nature of each c i t y o f f i c e market does not appear t o be s i g n i f i c a n t i n determining the p r i c e adjustment mechanism. As the model i s f u r t h e r r e f i n e d , l o c a t i o n a l f a c t o r s should become more important. 5.0 CONCLUSIONS In the coming y e a r s o f f i c e b u i l d i n g s w i l l c o n t i n u e t o have a s i g n i f i c a n t impact on the l a r g e c i t i e s i n Canada. The r a p i d growth o f s e r v i c e o r i e n t e d employment w i l l c o n t i n u a l l y f e e d the demand f o r o f f i c e s p a c e . Deve lopers and c i t y p l a n n e r s w i l l have t o hone t h e i r s k i l l s i n o r d e r t o a n t i c i p a t e t h i s demand and p r o v i d e a b u i l t form which s a t i s f i e s both the needs and c o n s t r a i n t s o f the urban env i ronment . The r e n t a l p r i c e ad jus tment mechanism i s an i n t e g r a l component o f the model f o r a n t i c i p a t i n g the f u t u r e requ i rements f o r o f f i c e s p a c e . A t t h i s p o i n t v e r y l i t t l e academic work has been done i n t h i s a r e a . T h i s has been due p r i m a r i l y t o a l a c k o f adequate t e s t a b l e d a t a . T h i s s h o u l d change over the coming y e a r s . The c u r r e n t growth o f the o f f i c e market combined w i th improved d a t a s o u r c e s s h o u l d s t i m u l a t e f u t u r e academic s tudy and shed some b a d l y needed l i g h t on a c h a l l e n g i n g a r e a . The c u r r e n t s c h o o l o f thought on r e n t a l p r i c e ad jus tment models i s t h a t t h e r e i s a s t r o n g r e l a t i o n s h i p between r e n t s and v a c a n c i e s . Much o f t h i s work has been t e s t e d i n the h o u s i n g market . There a re f e a t u r e s o f the o f f i c e market which p r o v i d e a s t r o n g r a t i o n a l f o r a o b s e r v i n g s i m i l a r b e h a v i o u r . A rev iew o f the r e l e v a n t l i t e r a t u r e l e a d s t o c e r t a i n p r o p o s i t i o n s about the r e n t a l p r i c e mechanism i n the o f f i c e market . In the s h o r t run o f f i c e s u p p l y i s f i x e d c r e a t i n g the requ i rement f o r i n v e n t o r y o r vacancy l e v e l s . We s h o u l d observe asymmetr ic p r i c e movements. Large p r i c e i n c r e a s e s s h o u l d be observed i n response t o p o s i t i v e demand shocks t o chock o f f demand. N e g a t i v e demand shocks s h o u l d r e s u l t i n downward p r i c e r i g i d i t y as l a n d l o r d p a r t i c i p a t e i n s p e c u l a t i v e b e h a v i o u r . Rents may e v e n t u a l l y f a l l i f e x p e c t a t i o n s change. A non l i n e a r s p e c i f i c a t i o n i s r e q u i r e d f o r the vacancy v a r i a b l e i n the p r i c e adjustment model L a n d l o r d s w i l l l i k e l y at tempt t o pass i n f l a t i o n a r y i n c r e a s e s th rough t o the t e n a n t . O p e r a t i n g c o s t s and i n t e r e s t r a t e s w i l l be impor tan t i n the p r i c e adjustment mechanism i f they have a s i g n i f i c a n t impact on the c o s t o f h o l d i n g i n v e n t o r y . There e x i s t s an optimum o r normal vacancy r a t e t o which l a n d l o r d s w i l l respond and at tempt t o m a i n t a i n . The normal vacancy r a t e i s de termined through demand e x p e c t a t i o n s , u n c e r t a i n t y , and the c o s t o f h o l d i n g i n v e n t o r y . 113 A p r i c e a d j u s t m e n t m o d e l w a s d e v e l o p e d f r o m t h e s e p r o p o s i t i o n s a n d t e s t e d u s i n g d a t a f r o m t h e C a n a d i a n o f f i c e m a r k e t . T h e d a t a s o u r c e w a s t h e R o y a l L e P a g e M a r k e t S u r v e y . F i v e c i t i e s w e r e c h o s e n t o p r o v i d e a n a d e q u a t e c r o s s s e c t i o n o f t h e C a n a d i a n m a r k e t ; M o n t r e a l , T o r o n t o , E d m o n t o n , C a l g a r y , a n d V a n c o u v e r . T h e r e a r e c e r t a i n l i m i t a t i o n s t o t h e d a t a s e t w h i c h t h e a u t h o r r e c o g n i z e s . T h e s e i n c l u d e e x c e s s i v e a g g r e g a t i o n , i n c o n s i s t e n t s u r v e y m e t h o d o l o g y a n d f a i l u r e t o c o n t r o l f o r m a r k e t i m p e r f e c t i o n s s u c h a s t e n a n t i n d u c e m e n t s . N o t w i t h s t a n d i n g t h e s e l i m i t a t i o n s , t h e R o y a l L e P a g e M a r k e t S u r v e y i s t h e m o s t c o m p r e h e n s i v e s o u r c e a t t h i s t i m e . A v i s u a l i n s p e c t i o n o f t h e p o o l e d c r o s s s e c t i o n a l t i m e s e r i e s d a t a c o n f i r m s m a n y o f t h e p r o p o s i t i o n s . P r i c e a s y m m e t r y s e e m s t o b e e v i d e n t . R e n t c h a n g e s a r e m o s t d i s p e r s e d a t l o w v a c a n c i e s w h i l e t h e d i s p e r s i o n i s t i g h t e r a t h i g h e r v a c a n c y l e v e l s . R e n t d i s p e r s i o n b e g i n s t o i n c r e a s e a g a i n a s v a c a n c y m o v e s t o e x t r e m e l y h i g h l e v e l s . Demand e x p e c t a t i o n s p r o b a b l y c h a n g e s i g n i f i c a n t l y a t h i g h v a c a n c y l e v e l s c a u s i n g p r i c e s p e c u l a t i o n t o c e a s e a n d r e n t s t o d r o p . A n o r m a l v a c a n c y f o r t h e c r o s s s e c t i o n a l d a t a d u r i n g t h e a n a l y s i s p e r i o d s e e m s t o b e i n t h e o r d e r o f 7% t o 1 0 % . E a c h c i t y s e e m s t o e x h i b i t u n i q u e b e h a v i o u r t h r o u g h t h e a n a l y s i s p e r i o d . M o n t r e a l w a s p l a g u e d w i t h p o l i t i c a l u n r e s t a n d a c o r p o r a t e e x o d u s . T h i s s e e m e d t o r a t t l e i n v e s t o r c o n f i d e n c e and lowered growth e x p e c t a t i o n s . T h i s p r e v e n t e d r e a l r e n t s from i n c r e a s i n g even at ex t remely low vacancy l e v e l s . Toron to e x h i b i t e d more c o n s i s t e n t b e h a v i o u r . T h i s i s l a r g e l y due t o i t s s t a b l e growth and d i v e r s i f i e d c o r p o r a t e s t r e n g t h . Edmonton had w i l d f l u c t u a t i o n s i n vacancy l e v e l s due t o t h e boom and b u s t e f f e c t o f the pe t ro leum i n d u s t r y . Rents r o s e i n low vacancy p e r i o d s , however, l i t t l e downward p r i c e r i g i d i t y was e v i d e n t due t o the tremendous jump i n the vacancy l e v e l . Growth e x p e c t a t i o n s o b v i o u s l y changed s u b s t a n t i a l l y a f t e r the f a l l i n the market . C a l g a r y e x h i b i t s c u r i o u s b e h a v i o u r . There appears t o be two p r i c e ad justment reg imes i n t h e d a t a s e t . The f i r s t i s a c t i v e through the s t e a d y growth p e r i o d p r i o r t o 1979. The o t h e r o c c u r s d u r i n g the boom and b u s t c y c l e from 1980 th rough 1987. As a r e s u l t , the combined a f f e c t o f the two regimes o b s c u r e s any u n i f o r m p r i c e ad jus tment mechanism. Vancouver i s r e a s o n a b l y c o n s i s t e n t w i t h the t h e o r y , however t h e r e appears t o be p e c u l i a r b e h a v i o u r on the p a r t o f l a n d l o r d s who lower r e a l r e n t s a t the s l i g h t e s t i n c r e a s e i n the vacancy r a t e . T h i s o c c u r s even a t low vacancy l e v e l s which l e a d s t o the c o n c l u s i o n t h a t Vancouver has a v e r y low normal vacancy r a t e . No p r i c e s p e c u l a t i o n seems t o o c c u r . The r e s u l t may be e x p l a i n e d by the uneasy p o l i t i c a l and l a b o u r s i t u a t i o n i n B . C . and the s e n s i t i v i t y o f the l o c a l market t o demand f l u c t u a t i o n s . O v e r a l l , the v i s u a l e x a m i n a t i o n o f the d a t a f o r each c i t y c l e a r l y p o i n t s t o the impor tance o f growth e x p e c t a t i o n s i n the p r i c e adjustment mechanism. 115 A r e g r e s s i o n w a s p e r f o r m e d o n t h e p o o l e d c r o s s s e c t i o n a l t i m e s e r i e s d a t a s e t . T h e r e s u l t s s e e m t o g e n e r a l l y c o n c u r w i t h t h e r e s u l t s f o u n d i n t h e U.S.. V a c a n c i e s a r e a n i m p o r t a n t v a r i a b l e i n t h e p r i c e a d j u s t m e n t m e c h a n i s m . H o w e v e r , t h e e x t e n s i o n i n t h i s t h e s i s w a s t h e s p e c i f i c a t i o n o f t h e v a c a n c y v a r i a b l e i n n o n l i n e a r t e r m s . T h e i n t e n t w a s t o i l l u s t r a t e t h e e x i s t e n c e o f p r i c e a s y m m e t r y i n t h e o f f i c e m a r k e t m o d e l . U n f o r t u n a t e l y , t h e m o d e l i s n o t c o n c l u s i v e i n i t s s u p p o r t f o r t h i s p r o p o s i t i o n . B o t h l i n e a r a n d n o n l i n e a r s p e c i f i c a t i o n s a r e s i g n i f i c a n t . I n f l a t i o n e x p e c t a t i o n s a p p e a r t o h a v e s o m e s i g n i f i c a n t i n t h e m o d e l . L a n d l o r d s a t t e m p t t o p a s s o f f i n f l a t i o n a r y i n c r e a s e s t o t e n a n t s . O p e r a t i n g c o s t s a n d i n t e r e s t r a t e s d i d n o t p r o v e t o b e s i g n i f i c a n t i n t h e m o d e l . T h i s a r g u e s t h a t n e i t h e r o f t h e s e t w o v a r i a b l e s a r e i m p o r t a n t t o t h e c o s t o f h o l d i n g i n v e n t o r y i n t h e s h o r t r u n . T h i s l e n d s t h e o r e t i c a l s u p p o r t f o r v a c a n c y a d j u s t m e n t r a t h e r t h a n p r i c e a d j u s t m e n t a s a r e s p o n s e t o s h o r t r u n n e g a t i v e d e m a n d s h o c k s . T h e m o s t d i s t u r b i n g r e s u l t o f t h e r e g r e s s i o n w a s t h e i n s i g n i f i c a n c e o f t h e p r o x y f o r d e m a n d o r g r o w t h e x p e c t a t i o n s i n t h e o f f i c e m a r k e t . G i v e n t h e a n a l y s i s o f t h e d a t a a n d t h e r e l e v a n t e v e n t s i n e a c h c i t y , t h e r e i s s u b s t a n t i a l r a t i o n a l e f o r t h e i n c l u s i o n o f t h i s v a r i a b l e . I t w o u l d a p p e a r t h a t t h e v a r i a b l e i s m i s s p e c i f i e d i n t h i s m o d e l . A s a s u g g e s t i o n f o r f u t u r e r e s e a r c h , t h e r e a r e t w o f u n d a m e n t a l c o n c e r n s w h i c h s e e m t o f a l l o u t o f t h i s t h e s i s . 116 F i r s t , t h e d a t a h a s t o b e i m p r o v e d s u b s t a n t i a l l y b e f o r e a n y c o n c l u s i v e r e s u l t s c a n b e f o u n d . U n i f o r m c o l l e c t i o n m e t h o d o l o g y n e e d s t o b e e m p l o y e d a n d a t t e m p t s s h o u l d b e made t o d i s a g g r e g a t e t h e d a t a b y c i t y a n d e a c h s u b m a r k e t i n o r d e r t o c a p t u r e t h e t r u e p r i c e a d j u s t m e n t m e c h a n i s m . I n a d d i t i o n , t e n a n t i n d u c e m e n t s a r e p r e v a l e n t i n c u r r e n t o f f i c e m a r k e t s . T h i s d i s t o r t s t h e r e n t d a t a a t h i g h v a c a n c y l e v e l s a n d p r e v e n t s a n a c c u r a t e a s s e s s m e n t o f s p e c u l a t i o n b e h a v i o u r a n d d o w n w a r d p r i c e r i g i d i t y . Some m e t h o d f o r c o n t r o l l i n g t h i s b e h a v i o u r n e e d s t o b e e m p l o y e d . T h e s e c o n d c o n c e r n i s t h e s p e c i f i c a t i o n o f t h e p r o x y v a r i a b l e f o r g r o w t h o r d e m a n d e x p e c t a t i o n s i n t h e p r i c e a d j u s t m e n t m o d e l . T h i s s e e m s t o b e a f u n d a m e n t a l c o m p o n e n t a n d m o d e l s w i l l c o n t i n u e t o h a v e l o w e x p l a n a t o r y a n d p r e d i c t i v e c a p a b i l i t y u n t i l t h i s v a r i a b l e i s p r o p e r l y i n t e g r a t e d . BIBLIOGRAPHY 118 B I B L I O G R A P H Y A l c h i a n , A. a n d A l l e n , W.R. E x c h a n g e a n d P r o d u c t i o n . B e l m o n t : W a d s w o r t h , 1 9 8 2 . A l c h i a n , A. " I n f o r m a t i o n C o s t s , P r i c i n g a n d R e s o u r c e U n e m p l o y m e n t " , i n M i c r o e c o n o m i c F o u n d a t i o n s o f  E m p l o y m e n t a n d I n f l a t i o n T h e o r y , p p . 27 - 5 2 . E d i t e d b y E. P h e l p s . New Y o r k : W.W. N o r t o n & C o m p a n y , 197 0. A m i h u d , Y. a n d M e n d e l s o n , H. " M o n o p o l y u n d e r U n c e r t a i n t y : T h e E n i g m a o f P r i c e R i g i d i t y . " M a r c h 1 9 8 0 , ( M i m e o g r a p h e d ) . B l a n k , D.M. a n d W i n n i c k , L. " T h e S t r u c t u r e o f t h e H o u s i n g M a r k e t " , Q u a r t e r l y J o u r n a l o f E c o n o m i c s 6 7 , 1 9 5 3 , p p . 1 8 1 - 2 0 3 . B l i n d e r , A . S . " I n v e n t o r i e s a n d S t i c k y P r i c e s : M o r e o n t h e M i c r o f o u n d a t i o n s o f M a c r o e c o n o m i c s " , A m e r i c a n E c o n o m i c  R e v i e w 7 2 , 1 9 8 2 , p p . 334 - 3 4 8 . B r i t i s h C o l u m b i a C e n t r a l C r e d i t U n i o n " E c o n o m i c A n a l y s i s o f B r i t i s h C o l u m b i a " , 8 F e b r u a r y 1 9 8 8 . B u i l d i n g O w n e r s a n d M a n a g e r s A s s o c i a t i o n I n t e r n a t i o n a l , D o w n t o w n a n d S u b u r b a n O f f i c e B u i l d i n g E x p e r i e n c e E x c h a n g e  R e p o r t . A n n u a l . C a p o z z a , D.R. "New E v i d e n c e o n R e n t s a n d V a c a n c i e s " , W o r k i n g P a p e r , V a n c o u v e r : U n i v e r s i t y o f B r i t i s h C o l u m b i a , D e p a r t m e n t o f U r b a n L a n d E c o n o m i c s , 1 9 8 0 . , a n d S c h w a n n , G. " P r i c e a n d Q u a n t i t y A d j u s t m e n t i n t h e H o u s i n g M a r k e t : A R e v i e w o f R e c e n t D e v e l o p m e n t s i n I n v e n t o r y T h e o r y a n d t h e T h e o r y o f S e a r c h " , W o r k i n g P a p e r #27, V a n c o u v e r : U n i v e r s i t y o f B r i t i s h C o l u m b i a , D e p a r t m e n t o f U r b a n L a n d E c o n o m i c s , 1 9 8 6 . C i t y o f C a l g a r y P l a n n i n g D e p a r t m e n t I n f o P a k 1 9 8 5 , " B u i l d i n g P e r m i t s S t a t i s t i c a l S u m m a r i e s 1 9 7 9 - 1 9 8 4 " i n I n f o P a k 1 9 8 5 C i t y o f T o r o n t o P l a n n i n g a n d D e v e l o p m e n t D e p a r t m e n t " O f f i c e M o n i t o r ' 8 5 " , J u n e 1 9 8 5 . , " 1 9 8 6 Q u i n q u e n n i a l R e v i e w " , D e c e m b e r 1 9 8 6 . , " D o w n t o w n E m p l o y m e n t S t u d y " , O c t o b e r 1 9 8 7 . 119 C i t y o f V a n c o u v e r P l a n n i n g D e p a r t m e n t " D o w n t o w n O f f i c e S p a c e " , Q u a r t e r l y R e v i e w , 1 9 8 4 . C o d e , W.R. " T h e S t r e n g t h o f t h e C e n t r e : D o w n t o w n O f f i c e s a n d M e t r o p o l i t a n D e c e n t r a l i z a t i o n P o l i c y i n T o r o n t o " , E n v i r o n m e n t a n d P l a n n i n g A 1 5 , O c t o b e r 1 9 8 3 , p p . 1 3 6 1 -1 3 8 0 . De L e e u w , F. a n d E k a n e m , N.F. " T h e S u p p l y o f R e n t a l H o u s i n g " , A m e r i c a n E c o n o m i c R e v i e w 6 1 , 1 9 7 1 , p p . 8 0 6 - 8 1 7 . E g e r , A . F . a n d S m i t h , J . G . " C o n s t r u c t i o n F o r e c a s t i n g : t h e D e l p h i A p p r o a c h . A S u r v e y o f C a n a d i a n O f f i c e C o n s t r u c t i o n f o r 1 9 8 6 " , L a n d D e v e l o p m e n t S t u d i e s 4, 1 9 8 7 , p p . 3 - 1 6 . E u b a n k , A.A. a n d S i r m a n s , C . F . " T h e P r i c e A d j u s t m e n t M e c h a n i s m f o r R e n t a l H o u s i n g i n t h e U n i t e d S t a t e s " , Q u a r t e r l y  J o u r n a l o f E c o n o m i c s 9 3 , 1 9 7 9 , p p . 1 6 3 - 1 8 3 . F a i r , R.C. " D i s e q u i l i b r i u m i n H o u s i n g M o d e l s " , J o u r n a l o f  F i n a n c e 2 7 , M a y 1 9 7 2 , p p . 2 0 7 - 2 2 1 . F a m a , E . " S h o r t T e r m I n t e r e s t R a t e s a s P r e d i c t o r s o f I n f l a t i o n " , A m e r i c a n E c o n o m i c R e v i e w 1 9 7 5 . G a d , G., H.K., " T o r o n t o ' s C e n t r a l O f f i c e C o m p l e x : G r o w t h , S t r u c t u r e , a n d L i n k a g e s " P h . D . t h e s i s , T o r o n t o : U n i v e r s i t y o f T o r o n t o , D e p a r t m e n t o f G e o g r a p h y , 1 9 7 6 . , a n d H o l d s w o r t h , D. " B u i l d i n g f o r C i t y , R e g i o n , a n d N a t i o n : O f f i c e D e v e l o p m e n t i n T o r o n t o 1 8 3 4 - 1 9 8 4 " , i n F o r g i n g a C o n s e n s u s . H i s t o r i c a l E s s a y s o n T o r o n t o , p p . 2 7 2 - 3 1 9 . E d i t e d b y V . L . R u s s e l l . T o r o n t o : U n i v e r s i t y o f T o r o n t o P r e s s , 1 9 8 4 . , " O f f i c e L o c a t i o n D y n a m i c s i n T o r o n t o : S u b u r b a n i z a t i o n a n d C e n t r a l D i s t r i c t S p e c i a l i z a t i o n " , U r b a n G e o g r a p h y , 6, 1 9 8 5 , p p . 3 3 1 - 3 5 1 . G o l d s t e i n , P. " E a s t e r n D e v e l o p e r s I n v a d e D e p r e s s e d W e s t e r n M a r k e t " , T h e G l o b e a n d M a i l 12 J u n e 1 9 8 5 , s e c . B l . G o r d o n , D. a n d H y n e s , A. "On t h e T h e o r y o f P r i c e D y n a m i c s " i n M i c r o e c o n o m i c F o u n d a t i o n s o f E m p l o y m e n t a n d I n f l a t i o n  T h e o r y . E d i t e d b y E. P h e l p s . New Y o r k : W.W. N o r t o n & C o m p a n y , 1 9 6 2 . G r e a t e r V a n c o u v e r R e g i o n a l D i s t r i c t . D i m e n s i o n s o f t h e G r e a t e r  V a n c o u v e r E c o n o m y 1 9 8 6 - 1 9 9 6 , D e p a r t m e n t o f D e v e l o p m e n t S e r v i c e s , J u l y 1 9 8 6 . 1 2 0 , T h e L i v e a b l e R e g i o n 1 9 7 6 - 1 9 8 6 , D e p a r t m e n t o f D e v e l o p m e n t S e r v i c e s , 1 9 7 5 . H a y e s , C. a n d J e n i s h , D. " O i l P a t c h S u p p l i e r s W o e s " , A l b e r t a  R e p o r t 8 A u g u s t 1 9 8 3 , p p . 1 1 . H a y e s , T.C. " B u i l d i n g Boom i n L o s A n g e l e s " , New Y o r k T i m e s 1 M a y 1 9 8 5 , s e c . B l . H e k m a n , J . " R e n t a l P r i c e A d j u s t m e n t a n d I n v e s t m e n t i n t h e O f f i c e M a r k e t " , A R E U E A J o u r n a l 1 3 , S p r i n g 1 9 8 5 , p p . 32 -47 H o o p e r , D., S i m m o n s , J.W., a n d B o u r n e , L . S . " T h e C h a n g i n g E c o n o m i c B a s i s o f C a n a d i a n U r b a n G r o w t h 1 9 7 1 - 1 9 8 1 " , R e s e a r c h R e p o r t # 1 3 9 , T o r o n t o : U n i v e r s i t y o f T o r o n t o , C e n t r e f o r U r b a n a n d C o m m u n i t y S t u d i e s , 1 9 8 3 . K e l l y , H. " F o r e c a s t i n g O f f i c e S p a c e Demand i n U r b a n A r e a s " , R e a l E s t a t e R e v i e w 1 3 , F a l l 1 9 8 3 , p p . 87 - 9 5 . K e r r , D. " T h e E m e r g e n c e o f t h e I n d u s t r i a l H e a r t l a n d c . 1 7 5 0 -1 9 5 0 " i n H e a r t l a n d a n d H i n t e r l a n d . A G e o g r a p h y o f C a n a d a , p p . 6 5 - 9 9 . E d i t e d b y L.D. M c C a n n . S c a r b o r o u g h O n t a r i o : P r e n t i c e H a l l C a n a d a , 1 9 8 2 . L a r k e n R e a l E s t a t e L t d . " L a r k e n O f f i c e S p a c e R e v i e w 1 9 8 5 " J u n e 1 9 8 5 . L e y , D. " D o w n t o w n i n t h e S u b u r b s ? A C o m p a r a t i v e S t u d y o f Two V a n c o u v e r H e a d O f f i c e s " , C a n a d i a n G e o g r a p h e r 2 9 , 1 9 8 5 , p p . 3 0 - 4 3 . M a c c i n i , L . J . " A n A g g r e g a t e D y n a m i c M o d e l o f S h o r t R u n P r i c e a n d O u t p u t B e h a v i o u r " , Q u a r t e r l y J o u r n a l o f E c o n o m i c s 9 0 , 1 9 7 6 , p p . 1 7 7 - 1 9 6 . M a c c i n i , L . J . " R e t u r n t o N o r m a l E x p e c t a t i o n s a n d I n v e s t m e n t D e m a n d F u n c t i o n s " , J o u r n a l o f M a c r o E c o n o m i c s 3, 1 9 8 1 , p p . 3 1 7 - 3 3 4 . M i l l s , E . S . P r i c e , O u t p u t a n d I n v e n t o r y P o l i c y C h a p t e r 4, New Y o r k : W i l e y a n d S o n s , 1 9 6 2 . " M o n t r e a l B e g i n s t o F i g h t t o R e g a i n S t a t u s a s C e n t r e f o r H e a d O f f i c e s " , V a n c o u v e r S u n 12 M a r c h 1 9 8 3 . R e a g a n , P.B. " I n v e n t o r i e s a n d A s y m m e t r i e s i n P r i c e A d j u s t m e n t " R e a l E s t a t e S t u d i e s 4 9 , 1 9 8 2 , p p . 137 - 1 4 2 . 1 2 1 , a n d W e i t z m a n , M.L. " A s y m m e t r i e s i n P r i c e a n d Q u a n t i t y A d j u s t m e n t s b y t h e C o m p e t i t i v e I n d u s t r y " J o u r n a l o f  E c o n o m i c T h e o r y 2 7 , 1 9 8 2 , p p . 4 1 0 - 4 2 0 . R e a l E s t a t e B o a r d o f G r e a t e r V a n c o u v e r " R e a l E s t a t e T r e n d s i n M e t r o p o l i t a n V a n c o u v e r : M e t r o t r e n d s " , A n n u a l . R o s e n , K.T. " T o w a r d a M o d e l o f t h e O f f i c e B u i l d i n g S e c t o r " , A R E U E A J o u r n a l 1 2 , F a l l 1 9 8 4 , p p . 2 6 1 - 2 6 9 . , a n d S m i t h , L . B . " T h e P r i c e A d j u s t m e n t P r o c e s s f o r R e n t a l H o u s i n g a n d t h e N a t u r a l V a c a n c y R a t e " , A m e r i c a n  E c o n o m i c R e v i e w 7 3 , 1 9 8 3 , p p . 7 7 9 - 7 8 6 . R o y a l L e P a g e L t d . " R o y a l L e P a g e M a r k e t S u r v e y " , A n n u a l . R y d e l l , C P . " S h o r t R u n R e s p o n s e o f H o u s i n g M a r k e t s t o Demand S h i f t s " R a n d D r a f t R e p o r t R - 2 4 8 3 - HUD, 1 9 7 9 . S e m p l e , R.K. a n d G r e e n , M.B. " I n t e r u r b a n C o r p o r a t e H e a d q u a r t e r s L o c a t i o n i n C a n a d a " , C a h i e r s d e G e o g r a p h i e  d u Q u e b e c 2 7 , 1 9 8 3 , p p . 3 8 9 - 4 0 6 . , a n d S m i t h , W.R. " M e t r o p o l i t a n D o m i n a n c e a n d F o r e i g n O w n e r s h i p i n t h e C a n a d i a n U r b a n S y s t e m " , U r b a n G e o g r a p h y 3, 1 9 8 1 , p p . 2 5 8 - 2 7 9 . S h e n k e l , W. " N e t L e a s e s : A C r i t i c a l R e v i e w " , J o u r n a l o f  P r o p e r t y M a n a g e m e n t 2 7 , 1 9 8 1 , p p . 1 4 6 - 1 5 2 . S h i l l i n g , J . D . , S i r m a n s , C . F . , a n d C o r g e l , J . B . " P r i c e A d j u s t m e n t P r o c e s s f o r R e n t a l O f f i c e S p a c e " , J o u r n a l o f  U r b a n E c o n o m i c s 2 2 , 1 9 8 7 , p p . 90 - 1 0 0 . S m i t h , L . B . "A N o t e o n t h e P r i c e A d j u s t m e n t M e c h a n i s m f o r R e n t a l H o u s i n g " , A m e r i c a n E c o n o m i c R e v i e w 6 4 , J u n e 1 9 7 4 , p p . 4 7 8 - 4 8 1 . S t a t i s t i c s C a n a d a " T h e L a b o u r F o r c e " , C a t . 7 1 - 0 0 1 , M o n t h l y . , " C a n a d i a n S t a t i s t i c a l R e v i e w " , C a t . 1 1 - 0 0 3 E , M o n t h l y . , " C o n s u m e r P r i c e I n d e x " , C a t . 6 2 - 0 0 1 , Q u a r t e r l y . V a n c o u v e r P l a n n i n g D e p a r t m e n t " C o r e p l a n O f f i c e S p a c e I n d e x S t u d y " , 1 9 8 1 b . W h i t e h e a d , J . C . " D e c i s i o n M a k i n g i n t h e P r o p e r t y D e v e l o p m e n t I n d u s t r y D u r i n g a B u s i n e s s C y c l e " P h.D t h e s i s , V a n c o u v e r : U n i v e r s i t y o f B r i t i s h C o l u m b i a , D e p a r t m e n t o f G e o g r a p h y , 1 9 8 7 . 122 Z a b a s , A. " R e a l E s t a t e I n v e s t m e n t ' H o t ' " , C a n a d i a n B u i l d i n g F e b r u a r y 1988. 

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