Presentation of Christian Merkl Economics 7800

Prof. Goodman

Reference: “Deals for Small Spaces Add Up to Big Business”,

New York Times, October 8

October 10, 2000© Christian Merkl 2000

The situation at the brokerage market for office space in New York.

Are the brokers only interested in big deals?

On the one hand,

- prestige

- the possibility of recognition by professional groups

- and a handsome commission

deals that account for huge amounts of office space at a time are the ones that bring

On the other hand,

- Big deals are rare

And small deals have advantages as well:

- when smaller companies look for space, getting an assignment is less competitive

- risk diversification: it is safer to have many small tenants than a few large ones

- many small deals lead to a healthy income, too

- small transactions are often the beginning of a new relationship

Anyway, tenants that are looking for small amounts of office space have complained that they have trouble attracting the attention of the brokers.

Why?

Let us summarize the situation at the New York brokerage market in a graph.

But first some assumptions:

- We assume that we have many broker. As a consequence, none of them can set a price

- In the article, it is mentioned that the commission for the dealers can be approximated by calculating 24 percent of the first year’s rent.

Thus: Com = 0.24 * r * s

Where com is the commission, r is the rent per square feet and s is the surface of office space in square feet.

Further assumptions

- The rent per square feet is equal for all offices, but not constant (changes over time).

Costs (C) for the broker

- there are fixed costs (f) for every transaction

- the costs increase proportionally with the number of square feets (n)

Consequently: C = f + n * s

Costs and

commission per deal

Square feet

Com = 0.24 * r * s

C = f + n* s

N

f

All office space that is smaller than N square feet is not interesting for dealers.

But there are two new developments that make small space more attractive:

- the rising rents in New York

- and the Internet

What happens in the graph if the rent (r) increases

Costs and

commission per deal

Square feet

Com = 0.24 * r * s

C = f + n * s

N

f

N’

Solution

Since the rent per square feet increases, smaller office spaces get more interesting for the dealers. The break even point decreases from N to N’.

But what about space that is smaller than N’?

Companies that rent very small amounts of office space might get help from the Internet.

Costs and

commission per deal

Square feet

Com = 0.24 * r * s

C = f + n * s

f

N’

f’

What effect might the Internet have?

C’ = f’ = n’ * s

Solution for very small transactions

For very small transactions, many steps in the supply chain of the brokers could be done electronically. As a consequence, the fixed costs as well as the proportional costs would decrease, and the break even point of niche Internet brokers would be at very small amounts of office space.

Tenants looking for bigger amounts of office space would probably not be interested in this kind of service. “Most efforts to close transactions over the Internet have been focused on smaller deals (…) because larger ones are too complicated to be reduced to a commodity.”