Estimating the Rental Adjustment Process

Rental adjustment equations have been estimated for a quarter century. In the U.S., models have used the deviation of the actual vacancy rate from the natural rate as the main explanatory variable, while in the UK, drivers of the demand for space have dominated the estimation. The recent papers of Hendershott (1996) and Hendershott, Lizieri and Matysiak (HLM, 1999) fall into the former category. We re-estimate these equations using alternative formulations but can do little to improve them overall. However, we identify econometric concerns with the specifications. We then derive a model incorporating both supply and demand factors within an Error Correction framework, and show how the U.S. and UK traditions are special cases of this more general formulation. We next estimate this equation using data from the City of London office market. Our initial specification of this more generalized model is greatly superior to the vacancy rate model. Finally, we estimate a two-equation variant with a separate vacancy rate equation; this model also performs much better than that of HLM. Importantly, our model passes standard modern econometric requirements for unit roots and co-integration. We find little evidence of special or temporal variation in natural vacancy rates.