Demand with spatial substitution in commercial real estate markets

Despite the recent trend of relocating branches of UK services industry to remote locations urban theory has yet to enlist a theory of industrial rents that formally takes the properties of substitution between locations into account. This study elaborates on the Fujita, Krugman and Venables model in order to develop theoretical foundations for a pricing theory of contemporary commercial real estate markets, with a focus on offices and services industry which can also extend to include industrial space. It questions some of the central assumptions and methodological clichÈs used in the existing theory and proceeds to propose a neo-classical model that explains location pricing and allocation. A central assumption in this work is that contemporary industry is increasingly dominated by trans-national services and manufacturing firms, which are rather price taking within states. This implies that the attention could be shifted from modelling general equilibrium for an economy to partial equilibrium, since locations across the borders compete in industrial space markets. Commercial property markets are assumed to be imperfect substitutes in firmsí decision to locate, which on their own turn provide access to labour of differentiated quality. The combined quality of labour and tenancy space provided at different urban centres may vary, due to agglomeration economies and possibly other exogenous factors. Another new angle in this approach is that distance between property centres, which involves accounting for transport costs, reduced importance in services industry. Instead firms are price takers of the combined cost of location, that is labour and property costs, as a competitive open market price of the location. For this flexibility in properties of substitution this work employs Dizit-Stiglitz theory and CES production function. Finally, a simplified form of the model is calculated for the purposes of empirical tests, which is tested in an econometric exercise that considers central and suburban London office locations.