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Commercial Office Space: Tests of a Real Options Model with Competitive Interactions

We test a real options model with competitive interactions using an extensive commercial real estate data base. The competitive nature of the local real estate market as proxied by the market's Herfindahl ratio is found to have a significant effect on building starts: larger values of the Herfindahl ratio, consistent with less competition, are associated with fewer building starts. In particular, a one standard deviation increase in this ratio leads to a 25.9% decrease in the number of new building starts. Other variables suggested by the real options model, such as the volatility of local lease rates, are also found to be important.