Charles Ward

Forward Pricing and the Housing Market: the Pre-Sales Housing System in Taiwan

Summary In countries that have experienced rapid economic development the need to establish more efficient markets in which private property can be constructed has induced some innovative solutions. One such solution is the phenomenon of a pre‐sales market that can be observed in Taiwan, Korea and more recently in China. Developers sell their property before building is started to acquire financing for the development companies. This paper discusses the process and, by recognizing the analogy between the pre‐sales market and forward markets, analyses the implications for developers.

Intrinsic and Rational Speculative Bubbles in the US Housing Market: 1960–2011

This paper examines the dynamics of the residential property market in the United States between 1960 and 2011. Given the cyclicality and apparent overvaluation of the market over this period, we determine whether deviations of real estate prices from their fundamentals were caused by the existence of two genres of bubbles: intrinsic bubbles and rational speculative bubbles. We find evidence of an intrinsic bubble in the market pre-2000, implying that overreaction to changes in rents contributed to the overvaluation of real estate prices. However, using a regime-switching model, we find evidence of periodically collapsing rational bubbles in the post-2000 market.

Back from Beyond the Bid-Ask Spread: Estimating Liquidity in International Markets

Research on the topic of liquidity has greatly benefited from the improved availability of data. Researchers have addressed questions regarding the factors that influence bid-ask spreads and the relationship between spreads and risk, return and liquidity. Intra-day data have been used to measure the effective spread and researchers have been able to refine the concepts of liquidity to include the price impact of transactions on a trade-by-trade analysis. The growth in the creation of tax-transparent securities has greatly enhanced the visibility of securitized real estate, and has naturally led to the question of whether the increased visibility of real estate has caused market liquidity to change. Although the growth in the public market for securitized real estate has occurred in international markets, it has not been accompanied by universal publication of transaction data. Therefore this paper develops an aggregate daily data-based test for liquidity and applies the test to US data in order to check for consistency with the results of prior intra-day analysis. If the two approaches produce similar results, we can apply the same technique to markets in which less detailed data are available and offer conclusions on the liquidity of a wider set of markets.

The valuation of upwards‐ only rent reviews: an option pricing model

The upwards‐only rent review is a characteristic feature of the institutional property lease in the UK. It has been subject to increased attention by investors and regulators in the 1990s with various proposals which sought to make upwards‐only rent reviews illegal. Applies an arbitrage method based on market pricing which enables consistent valuations of different investment opportunities to be compared in a rigorous yet consistent approach. In this way the value of the upwards‐only option can be assessed. Uses the arbitrage approach to value the difference between a lease in which the rents are reviewed upwards‐only and that in which rents can be reviewed upwards or downwards. Starts by applying the arbitrage approach to a simple lease in which rent may take only two values. This simple approach is well established in the finance literature when analysing options, and the valuation of the upwards‐only lease may be seen as a multi‐option contract.

Pricing upwards‐only rent review clauses

Complicated leasing terms make both the valuation of lease contracts and the calculation of effective rent levels difficult. These complications are compounded by the existence of option‐like features in many contracts. For example, retail leases in the USA generally have overage rent clauses that allow the landlord additional rent if sales exceed a breakpoint, but set a minimum rent level under any sales conditions. Similarly, upward‐only rent review clauses are common in the UK and Australia (as well as other commonwealth countries). Here the rent is fixed at the commencement of the contract, with the option to review the rental figure in line with market conditions at pre‐determined intervals (normally every five years). If rents in the market have increased over the interim period, the rent of the subject property will be adjusted upwards accordingly and this higher level becomes the minimum possible future rent. However, if market rents have either remained static or decreased, the landlords would choose not to operate the rent review clause and the existing rent will continue. The US overage contract can be valued using a binomial approach. The upward‐only adjusting leases cannot because the value of the option is “path‐dependent”. Here, Monte Carlo valuation methods must be used. In this paper we describe both approaches. We show the relationship between the rents on these contracts relative to those without overage or with up and downward adjustment. The key determinants in establishing this relationship are the expected drift and the volatility of either sales (in the case of overage) or market rents (in the case of upward‐only leases).

Commercial real estate and equity market bubbles: are they contagious to REITs?

This paper uses a regime-switching approach to determine whether prices in the US stock, direct real estate and indirect real estate markets are driven by the presence of speculative bubbles. The results show significant evidence of the existence of periodically partially collapsing speculative bubbles in all three markets. A multivariate bubble model is then developed and implemented to evaluate whether the stock and real estate bubbles spill over into REITs. The underlying stock market bubble is found to be a stronger influence on the securitised real estate market bubble than that of the property market. Furthermore, the findings suggest a transmission of speculative bubbles from the direct real estate to the stock market, although this link is not present for the returns themselves.

Estimating the cost of capital

This paper introduces the ways of estimating the cost of capital. It briefly reviews the main theories of capital structure before explaining how the use of fixed‐interest debt finance might affect the cost of capital. It then considers ways of estimating the cost of equity and finally brings results together. Two final issues are considered: how the cost of capital can be used to appraise projects like the ones the firm is already undertaking; and how it can be used to consider projects that lie outside the normal range of business activities of the firm.

Contemporary UK market valuation methods for over-rented investment properties: a framework for risk adjustment

This paper develops the recent series of papers published in the Journal of Property Research on the market valuation of investment properties by contemporary approaches. In the previous papers, an arbitrage model has been developed and compared with the real value and short cut or modified DCF alternatives to the valuation of fully let and reversionary properties. This paper investigates the application of these models to over-rented properties where the existing contract rent is in excess of the current rental value. This examination reveals some interesting insights into the applications of the various models concerning the need to be explicit regarding future rental growth and concludes that models which do not reveal their rental growth assumptions can still be successfully applied to the over-rented situation. The paper examines the discount rate choice within contemporary approaches and maintains that the low-risk discount rate, based upon the risk free fixed interest rate adjusted for risks based upon covenant strength and property illiquidity, is a more appropriate input than a discount rate based upon other property risks such as cash flow change uncertainty and obsolescence (equated yields). It also highlights areas for future research to improve the information base for the discount rate choice.

Speculative Bubble Spillovers Across Regional Housing Markets

In this paper we determine whether speculative bubbles in one region in the United States can lead bubbles to form in others. We first apply a regime-switching model to determine whether speculative bubbles existed in the U.S. regional residential real estate markets. Our findings suggest that the housing markets in five of the nine census divisions investigated were characterized by speculative bubbles. We then examine the extent to which bubbles spill over between neighboring and more distant regions, finding that the transmission of speculative bubbles and nonfundamentals between regions is multidirectional and does not depend on contiguity or distance.

Evaluating investment projects: The hurdle rate

A previous paper in this journal discussed how to estimate the appropriate rate that should be used to evaluate investment projects. In this paper, the same theme is extended to discuss why projects might attract hurdle rates that are higher than the cost of capital. The answer involves discussion of the topic of real options, which may provide a rigorous explanation of how companies can value flexibility in capital budgeting. This paper discusses the gap between the hurdle rate and the cost of capital and explores possible explanations for the rational use of additional barriers before accepting capital projects.