Determinants of rent
Written by E. Dickens
In looking at the determinants of commercial rental values in London , which is one of the world’s largest global financial centre and the capital city of one of the world’s largest economy , there will undoubtedly be factors that are inherently unique . One such factor is the fact that London is incomparable to any other city in the world in terms of historic accomplishments. Another is the global financial status of London within Europe. This essay intends to discuss the determinants of London’s commercial property rental values and seek to provide some explanation of London’s unusual rental changes from an investor perspective.
The theoretical look at determinants of rent for the purpose of investment unravels the usual factors, even for metropolitan London, as well as gives consideration to rent determinant models used in forecasting rental values. One obvious factor is the effect of the interaction of demand and supply and their elasticity on rental rates of London. Another is the effect of economic activity and the cyclic nature of economic activity in a global financial centre on rental prices. The relationship between rent values and the distance of the property from the commercial business district also bares some significance in rent determination. The use of rent determination models to forecast future rent value and plan new development which affects the market supply must also be superficially explored to understand the behaviour of London rental values.
The level of supply and demand and the elasticity of supply and demand will have some implication on the commercial rental value. If there is low demand for commercial property and property supply is in surplus the rental values will decrease in the long run or remain stable in the short term (Fraser, 1993). A compilation of research data from DTZ (Martin Davis, 2012)and Drivers Jonas Delotte shows that the supply of newly marketed space in central London over a seven year period leading up to 2012, shows that between 2007 and 2009 there is a gradual increase in the supply of properties from 1.5 million square feet in 2007 to 5 million in 2009.
Over the same two year period, the demand for commercial properties fell resulting in lower rental prices, as shown in table 2, from £65 per sq ft. to £45 per sq. ft. Fraser (1993) further adds that rent will rise sharply on an increase in demand but will tend to level off rather than fall when there is an increase in new property unless in the case of a recession . Kohlert (2010), in considering the office rental market, suggested that supply is inelastic in the short run and purports that an inelastic supply could be worsened by inefficiencies in regulations and slow developmental process. Fraser(1993) highlighted that small commercial space in prime high street locations are more inelastic than locations outside prime high street areas pointing to a difficulty in adding new spaces in these locations. Office and industrial properties outside prime areas are however relatively elastic in the long term, according to Fraser(1993), limited by planning constraints, vertical construction and the ease with which land can be transferred from one use to another. Leishman, (2003)in explaining the inelasticity in demand, claimed that commercial real estate occupiers do not respond to demand for space instantly when there is an increase in profit but wait for a sustained upturn in profits before expanding to a larger space. Leishman (2003) also added that investors or the property development industry, especially after a recession, also wait until rental demand and rates reach profitable developmental levels before investing in or starting new builds. This further causes both demand and supply of commercial spaces to be more inelastic in the short run. Therefore inelasticity in supply keeps rental values higher than expected even at the start of a recession.