Drivers of Commercial Demand in Property Markets

Drivers of total commercial demand

Over short periods of time property demand curve is fairly inelastic. In the short-run, property is likely to be the “fixed factor” in which case demand is perfectly inelastic. Even if property is not the fixed factor, it is difficult to substitute other factors for property such that:

• businesses work on fixed target output: property ratios
• current space is set for the remainder of the lease
• it takes time to find and lease new space
• firms expect large rental rises / falls to be reversed with the cycle

In the long-run, the elasticity of total property demand is expected to be higher than in the short-run. As an example, you can compare the space usage in Tokyo vs Chicago offices, UK vs USA superstores. This is mainly because:

• change in rental prices will encourage substitution of factors for property
• high property price will encourage of property saving work practices, technology

Conclude: for multiple reasons, short run elasticity of demand is low

Drivers of local commercial demand

Property location is considered to be the fixed factor in the short-run. Therefore, local demand is inelastic. The long-run occupiers may change location which gives rise to the concept of local elasticity of demand. Based on this, we can explain the elasticity of substitution between locations, such as, West End, City offices, Frankfurt offices, as well as, in-town versus out-of-town shopping. As you may recall from your basic modules in real estate economics, the more price elastic, the more easily one location can be substituted for another. Particularly:

• between identical buildings on the same street extremely elastic
• between different locations elasticity of substitution depends on the similarity in location characteristics (labour pool, productivity, accessibility) and relocation costs

Besides, price changes in other substitute locations will shift the demand curve and hence we can use the elasticity of substitution to define market areas by referring to the concept of cross elasticity:

• low cross elasticity: locations maintain different rent levels, are separate markets
• high cross elasticity: rental levels well equalise in time, are the same market

Summary

• Varieties of property demand: consumption, factor, investment
• Demand for commercial rented space as a factor of production
• Consumed up to marginal revenue product = rental price
• Short-run overall commercial demand is primarily a derived demand
  • Shifts in or out dependent on firms’ output with fixed output: space ratios
  • With limited price elasticity due to sticky leases, low substitution for other factors
• Long-run overall commercial demand more price elastic
  • due to more factor substation, choice of technology
• Short run local commercial demand also inelastic
• Long run local commercial demand with varying elasticity
  • depending on how close substitutes offered by other locations