An analysis and evaluation of the effects of lease terms on effective commercial rents in Frankfurt, Germany Gero Grunenberg, John Moohan and Paul Royston Nottingham Trent University UK

Aims and Objectives Investigating the effects of variations in lease terms on effective rents by means of the characteristics theory of value Testing for the explanatory and predictive power of the most parsimonious regression equation Outlining a pluralist methodological approach to market analysis 2

Methodological Options (1/2) Limitations of traditional valuation methods require more advanced methods accounting for characteristics determining market value Hedonic price studies are based on the positivist neo-classical economic research paradigm relying on deductive reasoning A distinguishing feature of hedonic price studies is the assumption that all property interests are different 3

Methodological Options (2/2) Neo-classical economics research paradigm is frequently criticised for its underlying assumptions and limitations However, the hegemony of neo-classical economics in research remains intact The need for a methodological evaluation is anticipated and a subsequent methodological development is taking place 4

Literature Review Review of a variety of methodological options –Cross-sectional –Time series –Combined time series/cross-sectional –Behavioural Behavioural studies raise questions about the validity of normative approaches Application of a cross-sectional hedonic price methodology to the analysis of the determinants of commercial office rents 5

Principles of Hedonic Price Determination Estimation of implicit (hedonic) price and demand functions for the individual characteristics of composite goods R (z) = f(z1,z2,z3,... zn) Provides a basis for differentiated goods whose quantitative and qualitative characteristics do not have observable market prices A neo-classical model using multiple regression analysis to identify and quantify the (statistically) significant characteristics determining values Hedonic studies show variations in magnitude and significance of price determining characteristics 6

General Hypotheses a.Effective rent per office unit is determined primarily by the physical characteristics of the office units, spatial orientation and lease details. b.The effective rent per metre squared of each office unit is determined primarily by their physical characteristics, spatial orientation and lease details. 7

Description of Regression Variables (Extract) 8

Application of Hedonic Model Hypotheses were tested by applying multiple regression analysis Performance of stepwise multiple regression assuming a linear functional form to derive the most parsimonious explanation of the chosen independent variable Explanatory power of model tested by adjusted coefficient of determination Predictive power of model tested by re-calibration of most parsimonious model 9

Most Parsimonious Model effective rent per office unit 10

Evaluation of Results (1/2) Comparable level of explanation to previous cross- sectional studies using a linear functional form with an adj. R 2 of Relatively low number of significant independent variables - a reflection of collinearity and high number and proportion of dummy variables? Variables at best approximations of qualitative data Lease details not statistically significant in any of the models calibrated. This runs contrary to some other studies (Brennan et al., 1984; Cannaday and Kang, 1984; Mills, 1992) 11

Evaluation of Results (2/2) Predictive power of model was weak – no clear systematic pattern of either under- or overestimation High explanatory power and poor predictive power is a paradox and requires further investigation Hence, multiple regression analysis can only assist but not replace expert valuer Hedonic model developed only a truism of the valuation process observed in behavioural studies? 12

Evaluation of Methodology and Research Method Hedonic regression models are neo-classical approaches heavily dependent on the underlying assumptions (abstraction from reality) Factors that cannot be measured statistically are deemed insignificant Problem of biased coefficients and biased sample selection Quantitative hedonic models are less likely to identify the qualitative influences on office rents that may be identified in behavioural studies This suggests the possibility of a pluralist research 13

Development of a Pluralist Methodology (1/2) Fundamentally the exploitation of synergies in research methodology by ameliorating the disadvantages of single methodological approaches whilst harnessing the advantages of individual approaches Proposal to undertake a three-stage approach to the analysis and evaluation of effective rents by means of a revised hedonic model: 14

Development of a Pluralist Methodology (2/2) Stage 1: with a panel (A) of fully qualified surveyors identification of general approach to valuation and choice of determining variables Stage2: determination of a revised hedonic price model Stage 3: validation of the revised hedonic model by testing its findings with the original panel (A) and a new panel (B) In this way we propose a combined approach to the development of a quantitative and qualitative explanation of effective commercial rents 15

Merits of a Pluralist Approach Enhanced data set through the inclusion of panel suggested variables and macro-economic factors Pooling of time-series and cross-sectional data allows to include more information and undertake more profound investigations Market will be tested for evidence of disequilibrium and sub-markets Testing alternative functional forms to achieve best fit of model to data 16

Conclusions Lease terms were not significant determinants at the 95% level of significance Paradox of strong explanatory power and weak predictive power requires further investigations Effective office rents likely to be determined by a combination of quantitative and qualitative factors -> combining hedonic model (quantitative explanation) and behavioural approach (qualitative explanation) Pluralist approach is considered worth exploring to secure greater meaning, precision and accuracy in local commercial property market analysis 17