How Apartment Rents and Vacancies can Rise (or Fall) Simultaneously

We at the Lusk Center put out the Casden Forecast for apartment economics in Southern California every spring. When we put out our San Diego numbers last week, we presented a result that confused people–we expect both rents and vacancies to rise in the next year.

The reason this can (and often does) happen is that real estate markets operate with lags, and feature “natural” rates of vacancy. The “natural” rate is the rate at which real rents stay constant–if vacancies fall below the natural rate, real rents rise; if they rise above, rents fall. Stuart Gabriel and Frank Nothaft did a nice paper on this some time ago.

Consider a tinker toy model of rents that is characterized by two equations (the ts in parentheses are subscripts for time):

Vac(t) = Vac(t-1)+(Rent(t-1)-1)*.05


Rent(t) = Rent(t-1)-(Vac(t-1)-.05)*Rent(t-1)

So when rents fall below $1, absorption picks up, otherwise it falls; the natural vacancy rate (the rate at which real rents rise or fall) is 5 percent. This produces the following picture of rents and vacancies:

As one can see, this simple model shows periods where rents and vacancies rise and fall together.

Of course, this is all in real terms. When there is inflation, nominal rents can rise even when the vacancy rate is above the natural rate, because rising nominal rents are masking real falling rents.

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About Richard K. Green 103 Articles

Affiliation: University of Southern California

Richard K. Green, Ph.D., is the Director of the USC Lusk Center for Real Estate. He holds the Lusk Chair in Real Estate and is Professor in the School of Policy, Planning, and Development and the Marshall School of Business at the University of Southern California.

Prior to joining the USC faculty, Dr. Green spent four years as the Oliver T. Carr, Jr., Chair of Real Estate Finance at The George Washington University School of Business. He was Director of the Center for Washington Area Studies and the Center for Real Estate and Urban Studies at that institution. Dr. Green also taught real estate finance and economics courses for 12 years at the University of Wisconsin-Madison, where he was Wangard Faculty Scholar and Chair of Real Estate and Urban Land Economics. He also has been principal economist and director of financial strategy and policy analysis at Freddie Mac.

His research addresses housing markets, housing policy, tax policy, transportation, mortgage finance and urban growth. He is a member of two academic journal editorial boards, and a reviewer for several others.

His work is published in a number of journals including the American Economic Review, Journal of Economic Perspectives, Journal of Real Estate Finance and Economics, Journal of Urban Economics, Land Economics, Regional Science and Urban Economics, Real Estate Economics, Housing Policy Debate, Journal of Housing Economics, and Urban Studies.

His book with Stephen Malpezzi, A Primer on U.S. Housing Markets and Housing Policy, is used at universities throughout the country. His work has been cited or he has been quoted in the New York Times, The Wall Street Journal, The Washington Post, the Christian Science Monitor, the Los Angeles Times, Newsweek and the Economist, as well as other outlets.

Dr. Green earned his Ph.D. and M.S. in economics from the University of Wisconsin-Madison. He earned his A.B. in economics from Harvard University.

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