i. Further to my recent post, and using zohosheet.com, I've set up a simplified model showing how the optimal height of a skyscraper is very sensitive to real interest rates (scroll down to v.).
ii. Even more noticeable is that the residual buying/selling price of the site is hyper-sensitive to interest rate changes, so reducing the real interest rate from 3% to 2% does not increase the residual buying/selling price by half (as you'd expect), it more than doubles it. The residual rental value fluctuates far less - reducing the real interest rates from 3% to 2% only increases the rental value by half.
iii. The point being, if the developer gambles on real interest rates staying at 1% for the foreseeable future and leverages up to the hilt to complete the project, and then real interest rates go back to normal (2%), he loses a quarter of the value of the original project and has built seven floors too many (misallocation of capital).
iv. UPDATE: Two people asked about negative interest rates (i.e. where nominal interest rates are below inflation), which gives us a ridiculous number of storeys/floors, so I have now amended the spreadsheet to include the building's useful economic life. Fifty years seems like a fair estimate, which gives us a minimum return on investment of 2% (even with zero real interest rates). So the spreadsheet can now handle negative interest rates of down to -1.5% or so.
To avoid bickering over actual build costs and rents, I've used 19th century prices: build costs per floor $1,000 (increasing by 5% for each sucessive floor) and rental income of $100 for the ground floor (net rents fall by 1% for each successive floor). This gives an optimal height of twenty storeys above ground level and a rental value of the site of $831.
v. You can tweak all these to your heart's content by entering your own values in the input area (click 'Click to edit' first). The output area is all formulas so if I've set it up right, you can't edit those:
Of Course They Did
12 hours ago
4 comments:
I tried making a graph of floors against interest rates after setting different interest rates:
3% 20
2% 27
1% 39
0.5% 50
0% 200
-1% 200
Do your formulas work properly with negative real interest rates? I think they should!
Modern economists seem to express surprise that Andrew Lawrence's 1999 "Skyscraper Index" seems to predict economic downturns. But Henry George's magnum opus of 1879 about economic downturns mentions "towering buildings, of granite, marble, iron, and plate glass, finished in the most expensive style, replete with every convenience" and "blocks of tall tenement-houses surrounded by vacant lots", a full decade before the first batch of real skyscrapers came into use. As usual, economists are struggling to relearn what was understood a century and more ago.
AW, amen to all that. All HG did was recognise patterns and explain them, these patterns have repeated to this day. Elsewhere in the book he says, regarding this Malthusian bollocks: "No doubt one day the USA will have a population of hundreds of millions and we'll be a lot richer than we are now."
I'll email you the spreadsheet and you can muck about to your heart's content.
Cooo. You want to try it with negative real interest rates...
L, with negative real interest rates, you could get infinity storeys as the optimum outcome, so to keep the whole thing a bit realistic, it's capped at 200.
Post a Comment