Which Factors Drive Rental Depreciation Rates for Office and Industrial Properties?

Abstract

The life cycle of individual commercial and industrial buildings has a major impact on the form and functioning of towns and cities and is an important consideration for building owners and occupiers. During this life cycle, buildings may experience physical deterioration and obsolescence, the latter driven by changes in technology or user requirements. If new cohorts of buildings are constructed in response to such changes, the functionality and value of the existing stock will decline in relative terms. This decline in value is termed economic depreciation and the rate of such decline may be influenced by factors such as the design and quality of existing buildings, the amount and timing of expenditure on such buildings, and wider market and economic conditions. Many previous studies have measured depreciation and assessed its pattern with respect to age, producing depreciation rates that inform the inputs used by building owners in cash flow modelling exercises. This study goes beyond measurement of depreciation and seeks to explain why individual assets experience different depreciation rates. It does this by applying panel regression techniques to a dataset of rental depreciation rates for 375 UK office and industrial buildings observed over the period 1994 to 2009. Results suggest that rental depreciation rates reduce as a building gets older, while a composite measure of age and quality provides more explanation of depreciation than age alone. Furthermore, variables representing the state of the economy and local real estate market are significant in explaining how rental depreciation rates change over time.

Keywords: Rental Depreciation, Office market, Industrial market, Panel data

JEL Classification: R33, C33