Bid rent theory office sector

Bid rent theory office sector

1. B ID R ENT T HEORY STUDY OF BID RENT CURVES FOR OFFICE SECTOR Presented By: Mahak 021 Abhishek 022 Sudeep 024 Sakshi 025 Varun 026

2. Contents: SL. NO. CONTENT 1 INTRODUCTION TO BID RENT THEORY: 2 STUDY OF TRAVEL DISTANCES IN TERMS OF INFORMATION EXCHANGE: 3 OFFICE BID RENT CURVES WITH FACTOR SUBSTITUTION 4 PRODUCTION ISOQUANT FOR ONE HECTARE OF OFFICE SPACE 5 FACTOR SUBSTITUTION: CONVEX BID-RENT CURVE 6 OFFICE BID-RENT CURVE WITH A FIXED LOT SIZE 7 CASE STUDY: LOS ANGELES AND ATLANTA 8 REFERENCES

3. INTRODUCTION TO BID RENT THEORY: It can be seen that commerce (in particular large department stores/chain stores) is willing to pay the greatest rent to be located in the CBD. The CBD is very valuable for them because it is traditionally the most accessible location for a large population. As you move from the CBD, commerce is unwilling to pay as much for a site. In fact, what they are willing to pay declines rapidly. Industry is, however, willing to pay to be on the outskirts of the CBD. There is more land available for their factories, but they still have many of the benefits of the CBD, such as a market place and good communications. As you move further out, so the land is less attractive to industry and the householder is able to purchase land. The further you go from the CBD, the cheaper the land.

4. Location Travel dist. West Travel dist. East Total travel dist. 6=1+2+3 6=1+2+3 12X2=24 1 10=1+2+3+4 3=1+2 13X2=26 2 15=1+2+3+4+5 1 16X2=32 3 21=1+2+3+4+5+6 21X2=42 Each office firm interacts with all the other office firms in the CBD to exchange information. The total travel distance for information exchange is minimized at the centre of the CBD and grows at an increasing rate as the distance to the centre increases. Travel distance for firms in a CBD STUDY OF TRAVEL DISTANCES IN TERMS OF INFORMATION EXCHANGE: Source: Urban Land Economics. (Part 2- Land rent and land use patterns)

5. Assumptions: Each office firm uses a standard office building on same amount of land. Office building at all locations are of same height. Office firms near the center of the city occupy tall buildings on small lots. Two Parameters For Deciding The Height Of The Building:- TALL MEDIUM HIGH Land (Hectares) 0.04 0.25 1.0 Building Height (Floors) 25 4 1 Capital Cost ($) 250 100 50 Graph representing Lot Size, Building Height and Capital Cost. Table representing Lot Size, Building Height and Capital Cost. OFFICE BID RENT CURVES WITH FACTOR SUBSTITUTION Source: Urban Land Economics. (Part 2- Land rent and land use patterns) The office space can be:- A tall building on a small lot A short building on a big lot . Inference:- A taller building requires more capital cost because it requires extra reinforcement to support its more concentrated weight.

6. Graph shows the Production isoquant for an office building with one hectare of office space. It shows different combinations of inputs that produce a fixed amount of output. It shows the building options for the office firm. Point t represents the input combination for the tall building Point m represents the input combinations for the medium building. Point s represents the input combinations for the short building. PRODUCTION ISOQUANT FOR ONE HECTARE OF OFFICE SPACE Graph representing Production Isoquant for one hectare of Office Space Source: Urban Land Economics. (Part 2- Land rent and land use patterns) For Tall buildings , the Capital cost is highest and the Lot size is smallest. For Medium buildings , the Capital cost lowers down . For Short buildings , the Capital cost is lowest and the Lot size is biggest.

7. TALL MEDIUM SHORT Land (Hectares) 0.04 0.25 1.0 Capital ($) 250 100 50 Building Cost (Rent = $40) Land Cost 1.6 10 40 Total Cost 251.6 110 90 Building Cost (Rent =$200) Land Cost 8 50 200 Total Cost 258 150 250 Building Cost (Rent =$1600) Land Cost 64 400 1600 Total Cost 314 500 1650 The building cost depends upon:- The prices of land The price of capital Table represents Lot Sizes and Cost as per Rent FACTOR SUBSTITUTION: CHOOSING A BUILDING HEIGHT The firm’s objective is to minimize the cost of the building, equal to the sum of land and capital cost. Low Rent ($40) Medium Rent ($200) High Rent ($1600) Total cost is minimized with a short building ($90). Total cost is minimized with a medium building ($150). Total cost is minimized with a tall building ($314). On an expensive land , a firm saves $186 , by building a tall building at a cost of $314 rather than a medium building at a cost of $500. Source: Urban Land Economics. (Part 2- Land rent and land use patterns) On a cheap land , a firm saves $20 , by building a short building at accost of $90 rather than a medium building at a cost of $110.

8. FACTOR SUBSTITUTION: CONVEX BID-RENT CURVE As land is more expensive closer to the center, so it will be rational to occupy a taller building. A move closer to the center increases the bid rent for land because: 1. Travel cost decreases 2. Factor substitution cuts the cost of an office building The curve shows implications of factor substitution for office bid-rent curve. Factor substitution increases the slope of the bid rent curve. Distance (blocks) Building Height (Floors) Total Revenue Capital Cost of Building Other Non-land Cost Travel Cost Total Rent Paid Production Site (Hectares) Bid Rent per Hectare 1 25 $500 $250 $150 $36 $64 0.04 $1,600 5 4 $500 $100 $150 $200 $50 0.25 $200 Graph representing the office bid-rent curve with factor substitution Factor substitution transforms a concave bid-rent curve into a convex curve, meaning that as we approach the city center, the price of land rises at an increasing rate. The rapidly increasing price of land in turn encourages more factor substitution, resulting in tall office buildings close to city centers. Suppose an office firm starts at a site five blocks from the center and then moves farther from the center. If the firm were to use a four-story building at the more distant location, the bid for land would decrease by an amount equal to the increase in travel cost. But given the lower price of land at a more distant location, a shorter building will be efficient, and the cost savings from factor substitution partly offset the effect of higher travel costs. Because of factor substitution, the bid rent decreases by an amount less than the increase in travel cost. Source: Urban Land Economics. (Part 2- Land rent and land use patterns)

9. The figure of the bid-rent curve is negatively sloped and concave. The slope is negative because travel cost increases with the distance to the center. The curve is concave because as we move away from the center, travel cost increases at an increasing rate, so rent decreases at an increasing rate. The bid-rent curve of office firms is negatively sloped because as we move away from the center, the cost of travel for information exchange increases. The curve is concave because travel cost increases at an increasing rate. $ 1,000 8 56 400 200 1 5 4 Land bid rent a e d Capital ($) Land: Lot size (htr.) OFFICE BID-RENT CURVE WITH A FIXED LOT SIZE This is explained by the formula, which says rent per hectare is the amount of total revenue minus capital cost minus other production cost mines travel cost, whole divided by lot size. Rent per = total revenue – capital cost – other production cost – travel cost Hectare Lot size (quantity of Land) For example : if an office is in a building of four floors on ¼ hectare of land, produces $500 worth per day, for which they need capital of $100 and other costs of $150. Then the rent per hectare is $1000. And if travel cost is added as $36. Rent per hectare= $500 - $100 - $150 = $1,000 0.25 Rent per hectare= $500 - $100 - $150 - $36 = $856 0.25 Source: Urban Land Economics. (Part 2- Land rent and land use patterns)

10. CASE STUDY: LOS ANGELES AND ATLANTA A NUMBER OF CASE STUDIES SHOWS THAT THE SPATIAL VARIATION IN OFFICE RENT , DEFINED AS ANNUAL RENT PER SQUARE METER OF OFFICE SPACE Negatively Curved Slope Tells Us That The Price Will Decrease As We Move Toward Downtown Higher Rent Is Due To Large employment s ub-centres, The Higher The Density The Larger The Effect On Office Rent Airports And Freeways Also Help For Having Higher Office Rents Los Angeles Atlanta Source: Urban Land Economics. (Part 2- Land rent and land use patterns)

11. RENT ON OFFICE SPACE: LOS ANGELES AND ATLANTA CURVE IS RELATIVELY FLAT, SMALL NEGATIVE SLOPE IT VARIES AS SHOWN IN MAP Office rent is higher for office close to highway interchanges The number of nearby professional workers and workers for industries that provide service also lead to higher rent for sites Between 1990 & 1996, the southern slope became flatter (a small negative number ), while the northern slope became steeper(a large positive number ) Source: Urban Land Economics. (Part 2- Land rent and land use patterns)

12. Urban Land Economics. (Part 2- Land rent and land use patterns) REFERENCES

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