The dynamics of office markets : the case of Seoul

Abstract

This study examines the dynamics of rent and vacancy rate adjustment in the Seoul office market under information asymmetry conditions. There are two sources of information asymmetry: structure information asymmetry and tenant information asymmetry. The former arises from the landlord having more information about the quality of the building structure than the tenant, and the latter stems from the landlord knowing less about the quality of the tenant than the tenant himself/herself. This study conjectures that both types of information asymmetry would lead to slower rental adjustment and/or faster vacancy rate "adjustment" under external shocks. Following Chau and Wong (2015), structure information asymmetry can be measured by the value of the structure as a percentage of the property. Assuming that construction costs (value of the structure) are similar in different locations in Seoul, land leverage (i.e. average rent) is a good indicator of structure information asymmetry. A higher land leverage implies lower information asymmetry. The office rental market in South Korea is characterized by a special form of contractual arrangement – the Chonsei rental contract. Under the Chonsei contract, the tenant pays a large lump sum “deposit,” known as Chonsei, in lieu of monthly rental payment. The Chonsei is to be returned to the tenant upon expiry of the rental contract. This study makes use of this contractual arrangement to rank the tenant information asymmetry in different industries. Based on the major types of tenants in Seoul office market, this study finds finance companies with higher information asymmetry are riskier and are thus required to pay higher rent for the same Chonsei. Therefore, the Chonsei conversion rate is higher for tenants with higher information asymmetry (riskier tenants), other things being equal. In contrast, manufacturing companies with lower information asymmetry are more credible and landlords ask them to pay lower rent for the same Chonsei, as a result, the Chonsei conversion rate is lower for tenants with lower information asymmetry (more credible tenants), other things being equal. Incidentally, we also find that the Chonsei conversion rate increases with adjusted market capitalization rate and expected future appreciation of office price but decreases with market interest rate. Empirical evidence from this study suggests that the coefficient of rent adjustment is similar for different degrees of structure and tenant information asymmetry in the Seoul office market. However, both types of information asymmetry have a significant impact on the vacancy rate adjustment because higher structure or tenant information asymmetry result in much higher coefficients of vacancy rate adjustments. On the other hand, low tenant information asymmetry leads to a higher coefficient of rent adjustment, compared to low structure information asymmetry, therefore the impact of tenant information asymmetry on the speed of rent adjustment is stronger than that of structure information asymmetry. However, low tenant information asymmetry indicates a very similar vacancy rate adjustment compared to low structure information asymmetry, hence the impact of tenant information asymmetry on the speed of vacancy rate adjustment is similar to that of structure information asymmetry. The contributions of this study are fivefold. First, we have conducted the first study on the impact of tenant information asymmetry on the rent and vacancy rate adjustment process in the Seoul office market. Second, this is the first research that has developed an innovative method of ranking (measuring) tenant information asymmetry based on the special Chonsei rental arrangement in the Seoul office market. Third, this study has contributed to the body of knowledge on the determinants of the Chonsei conversion rate, which has received much attention from many researchers and practitioners. Fourth, there have been very few empirical studies on the Seoul office market due to lack of reliable data. This study has built a Seoul office market database from various sources for empirical analysis. This database can be updated for future analysis of the Seoul office market. Fifth, the results of the study not only shed light on the long debated research question of the determinants of the speed of the rent and vacancy rate adjustment process but should also be useful for practitioners and policy makers.