Disentangling the Short and Long-Run Effects of Occupied Stock in the Rental Adjustment Process

In the current stand of literature on the rental adjustment process starting with Hendershott et al. (Real Estate Economics, 30, 165-183, 2002a, Journal of Real Estate Finance and Economics, 24, 59-87, 2002b) it has become practice to treat the compound variable "occupied stock" as a supply variable. In this study we show that this variable deserves a more critical investigation and that the general view of a supply variable may be misleading. Using panel data covering 30 urban areas for 17 years, we investigate the rental adjustment process in the German office market. The application of recently developed cointegration techniques for non-stationary panel data in conjunction with the corresponding error correction model (ECM) enables us to overcome the data limitations, particularly existent for most European real estate markets. Hence, our primary motivation is (a) to demonstrate how "occupied stock" should be interpreted correctly and (b) to provide useful insights into the long-term relationships and short-run dynamics of real office prime rents. The empirical evidence suggests that a one percent rise in office employment increases real rents on average by 1.64% through higher demand for office space. On the other hand, a one percent increase in the supply of office space decreases real rents in the long run by 2.25%. The results from the error correction model show that deviations from the long-run equilibrium lead to an adjustment process which restores equilibrium within approximately 3 years.