Predicting turning points in the rent cycle using the Natural Vacancy Rate ? An applied study of the Dublin office market

Abstract

All property markets have a natural vacancy rate (NVR). Theory suggests that when the actual vacancy rate exceeds this NVR the market will be unbalanced. Then, rents will fall to restore equilibrium. Conversely, when vacancies are below the NVR, rents will rise. By establishing a `tipping point? between positive and negative rental growth, the NVR is a useful tool for analysing market cycles. Standard econometric practice is to model the NVR as a constant. However, this paper findsthat there was a large structural shift in the natural vacancy rate for Dublin office space in the late 1990s. Allowing for this, two discrete NVRs are estimated for Dublin. For the 1978-1998 period, the NVR is calculated at 5.2%. This is broadly in line with rule-of-thumb estimates used by industry practitioners. However, the estimated NVR for the 1999-2009 period is 15.0 % - more than twice the 7% rate that is normally assumed. One interpretation is that Dublin?s office market is set to recover sooner than expected. Currently, the actual vacancy rate is just over 23%. Rents will only stop falling when this figure has been reduced into line with the NVR. For a given rate of net absorption, this will be achieved more quickly if the NVR is 15% than if it were 7%.