1|Date 19-06-2013

Market failure

Market failure in the Amsterdam office investment market

Henk J. Brouwer

|Date 19-06-2013 2

The problem (1)› Market failure is a situation when free markets

fail to allocate scarce resources efficiently› This is the case in the Amsterdam office

market: › High long-term office vacancy rates› In many suburban areas 25% or even more› Construction of new offices continues

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The problem (2) › Money is invested in new offices, while existing

offices do not yield expected returns› Clearly waste of capital › Hypothesis: market failure related to lack of

efficiency in the office investment market› We will try to substantiate this hypothesis

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The problem (3)› KPMG (47,000 m2)

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Efficiency (1)› Market failure is a fact, inefficient investment

market most probable explanation› Efficiency of markets refers to how rapidly

information is reflected in prices› Real estate is a long-term investment, so

analysis of the future is important

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Efficiency (2)› Rational investors will use their knowledge of

the property market, the wider economy and the best available theories of how the two function and interrelate (Ball et al, 1998)

› Actual market situation should result in adjustment of common expectations

› This is not readily visible in investment market› So, investment market is not fully efficient

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Recent history (1)› Strong employment growth in Amsterdam

region in 1995-2009› During ‘Golden Years’ (1996-2001) more new

employment was created than in the preceding twenty years

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Recent history (2)› Office construction boom from 1998-2002› In 1999/2000 construction of more than 1m m2

of new offices started › Overall, in five years (1998-2002) a third added

to the office stock

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Recent history (3)› In 1999, actual availability of office space close

to zero › In 2001, it was believed that high demand for

offices was structural› Risk of insufficient capacity for office

construction› Rezoning from mixed use to office park› Planning studies for underused land announced

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Recent history (4)› Today, overall vacancy 20%› In many suburban areas over 25%› Structural vacancy is persistent, in spite of

removals and transformation› However, vacancy concentrated in older offices

(i.e. offices that have been used before)

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Vacancy 1999-2013

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

0

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

NewOld

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Vacancy (2)› Following the end of the ‘Golden Years’ and

completion of offices started in 1999/2000, vacancy soared

› In 2004-2006 complete divergence of markets of newly built and older offices

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Vacancy (3)› Supply of new offices triggered demand› Net take-up much lower than gross demand:

from 2000 to 2010, net take-up of offices was only 15% of gross demand

› Demand for new offices results in vacancy of older properties

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The consequences (1)› Partition of the market into primary and

secondary segments› Primary market fully marketable› Secondary market often difficult to let on

conventional terms› Offices can move to secondary segment after

only five to ten years

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The consequences (2)› Major adjustment of reasonable expectations

necessary› In 1999/2000/2001: strong demand for offices,

low vacancy rate, shortages more probable than oversupply

› Recently: many offices will be in primary market for 5-10 years and then move to secondary market with lower rents and higher vacancy rates

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The consequences (3)

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

0102030405060708090

Rent difference

Rent difference

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The consequences (4)› The space market is efficient, as the market

segmentation is being reflected in rents› Pronounced adjustment in rental difference

between new and older offices from 2004 to 2008

› Difference not yet sufficient to create equivalence

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Expectations› Trends, as analysed before, can continue:

strong preferences for new buildings, high supply elasticity

› Are reasonable expectations, based on current trends, included in investment yields?

› Difficult to know exactly› We have no more than a summary of the trends

on the investment market (figures from JLL)

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Office yields 1998-2012

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

0%

1%

2%

3%

4%

5%

6%

7%

8%

AmsterdamMunichStockholm

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Analysis of yields (1)› When should adjustment of expectations have

taken place?› It is more than simple information› Understanding of market processes necessary› Market participants have to appreciate

underlying process, resulting in market segmentation

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Analysis of yields (2)› Split of market as shown by diverging vacancy

rates and prices takes place between 2004 and 2008

› Yields record low in 2006 and 2007 in line with comparable cities

› Yields in Amsterdam start to remain higher as from 2008

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Analysis of yields (3)› Yield difference with Munich and Stockholm

lowest in 2006/2007: 45 bps› Rising to 75 bps in 2010 and even 115 bps in

2012› Tentative conclusion: investment markets

adjust to changed conditions, but with several years delay

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Explanation (1)› German investors major buyers on Dutch office

market› They were the first to spot opportunities in

Amsterdam after 1994 › Since 1995, they account for 35% of office

investments in The Netherlands› Estimated market share in Amsterdam area

50%

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Explanation (2)› German funds invest on behalf of multitude of

small private investors› Ultimate investor lacks insight in markets› Funds feel pressure to invest› Geltner, Miller et al (2007): duress can result in

market inefficiency

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Explanation (3)› Alternative analysis in recent report by CBRE:

high vacancy rates in peripheral submarkets are common in other cities as well

› However, this argument fails to consider that in Amsterdam peripheral areas with high supply elasticity account for 75% of the market

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Explanation (4)› Vacancy rates

Region CBD Highest submarket

Munich 2.1% 16%

Stockholm 4.6% 12.8%

Brussels 6.9% 28.6%

Amsterdam 7.2% 28.6%

Hamburg 8.1% 16.4%

Frankfurt 11.9% 35.8%

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Conclusion › Market failure is a fact: waste of capital in office

market› Lack of efficiency in office investment market is

plausible› More research into market processes is

important› Other points of interest: location patterns and

supply elasticity