4 Quadrant Model Investors have different reasons for investing in the property market.

For example some want to invest in properties that they can redevelop, or actively manage, others prefer a property that is already let that requires little management. Hence, particular property characteristics need to satisfy the investors requirements. Primarily the relationship between office space and investment must be established. The property market is a set of three closely interdependent markets: 1. The occupier market, which is the demand and supply of space for occupation by firms and households governed by rental price. 2. The investment market or otherwise asset market through which the ownership and management of the stock is financed by landlords, and governed by asset valuations and investment returns. 3. The development market, through which changes in the volume of stock available to both occupiers and landlords are brought about by new construction. It is governed by the relationship betw een asset values and construction costs. A graphical representation of the property market we have just described has been developed by DePasquale and Wheaton, and consists of four quadrants see figure 3.2. The four quadrants depict four binary relationships that together complete the linkages between the space and asset markets. The four quadrant graph is most useful for examining the effect on the long-run equilibrium simultaneously both within and between the space and asset markets (Geltner D. & Miller N.G. (2001:28)). Draw diagram In The occupier market, the axes depict the determination of rent and the stock of space available in the market for occupation, and are linked by simple demand. At the existing supply of space in the market (O), the point at which that line intersects the demand function will tell us the current equilibrium rent (R), given that amount of space in the market (Geltner D. & Miller N.G. (2001:28)). The higher the rent, the lower the demand for space and the more space available, the lower the rent. The demand curve is dependant on economic growth and prevailing technological and technical changes. For example, an economic growth will result in an increase in total demand, and hence shifting the demand curve up and out. The northwest quadrant represents the investment market, were the curve of the line is the investment yield or capitalisation rate. It is the ratio between rents, which are determined in the occupier market, and the value which landlords are willing to hold building. A building with say a rent at 100/m and yield of 10%, the capital value will be 1,000. With a given investment yield, the higher the rent, the higher the value of the building. The investment yield, which produces the rate of return, will be set dependant on the following: Covenants Trading costs Current rate of return on risk-free assets

y y y

y y

Any premium to take account for risk involved in holding property compared to government bonds Rental growth expectations over holding period

Therefore the required yield by investors to hold property can be expressed as: Yield= Risk Free rate + Property Premium Expected Rental Growth The two bottom quadrants depict the long-run effect of the real estate development industry, by showing the impact of construction on the total stock of built space in the market (Geltner D. & Miller N.G. (2001:29)). The more buildings will be supplied when the capital value of buildings (determined by rent and yield) increases. However, increased construction increases development costs through increased competition for land, materials and labour. The more construction there is, the larger will be the change in the stock of space. The line in the southeast quadrant indicates the volume of new development-required in-order to maintain stock space at current levels. This is calculated by the ratio of existing stock over useful life of building. Placing all the quadrants together we get an insight on how the commercial property market (and generally the property market) works. For example, referring to the diagram, the current stock space is O. With stock O and given the demand curve for space from occupiers current rents are R per m. At the prevailing investment yield Y, owners are willing to hold buildings at rents R per m at a capital value C per m. Subsequently, developers will build N m of new space at C per m and if N is the exact quantity of space required to maintain stock at its current size volume of stock will not change. The quadrant graph can be used to map out the processes of change through the three markets. The red dotted lines in the quadrant graph show the effects increased demand has on the other markets. Following the red dotted line anticlockwise, it is seen that increased demand, increases rents to R and at prevailing yields increases capital value of buildings to C. Increased tenant demand for space, increases rent and in turn increase returns for investors. Therefore it seems that investors are influenced by tenant demand, as the former seek high returns (capital values). The quadrant graph illustrates smooth adjustments to change in the property market were in reality everything changes at once. For example, an increase in demand will increase rents, but it may also lead to a fall in yields as investors future rent growth expectations increase. The property market characterised by fluctuating demand, lumpy investments and long production times means that demand and supply are in fact in disequilibrium every year, with successive rises or falls in price as producers search for the right level. This phenomenon goes by the name cobweb theory. The IPD research report April 1988 describes property cycles as the recurrent but irregular pattern of property returns. We know the cyclical behaviour of business cycles with their peaks (Booms) and troughs (Recessions) and the property cycles are similar in their pattern. The property cycle for a country is effectively the pattern of the history of property in that country. The IPD, and prev iously economic historian Peter Scott, use an all property index of returns and this index is averaged from the
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property returns of property from all types and from all regions of the country. The total percentage return, which is made up of rental return and capital growth, is, as with the economy, open to fluctuation over time and this is what creates the property cycle. The factors that affect the property cycle are obviously economic much like other assets. International shocks would affect property returns as well as domestic interest rate rises. It has been found that the underlying patterns of property cycles tend to be a period of upswing of 2-7 years and then a period of downswing of 2-9 years. See the below graph for an example of the troughs and peaks of the UK property cycle. Note a peak between 1986 and 1988, and a trough in the early 90s. These cycles allow us to predict property returns with some accuracy in the future and especially the directly forthcoming years. In this case we can compare the property cycles of different nations to study their similarity and whether they have become more similar over time.