Is There Value in Vacancy?

Vacancy refers to an investment property ' s unrealized income potential. Yet, is it always the case that vacancy is a drag on value ? In this article, the authors examine whether and to what extent the vacancy of commercial real estate is related to its valuation and investment performance. The testable implications are discussed for either a growth or a risk effect in the data, along with an empirical analysis covering over 12,000 individual properties, spanning three decades. The evidence is consistent with theory supporting the optionality of vacant space. Specifically, the authors find that high-vacancy properties are associated with lower capitalization rates. The negative relationship can be explained by the net operating income (NOI) growth channel (i.e., an expectation for high NOI growth from the potential occupancy of vacant space), which dominates the risk channel (i.e., a higher perceived risk in the property valuation). They also find evidence that the investment performance of high-vacancy properties is inferior to the performance of low-vacancy properties, on average. Overall, these results suggest that vacant space has option value; although, on average, the option is overvalued.