Jeffrey D. Fisher

Value indices of commercial real estate: A comparison of index construction methods

The purpose of this paper is to shed light on the history of commercial property values over the past decade, and to compare different methods of constructing commercial property value indices and returns series. We examine three types of indices: (i) Indices that attempt to reconstructproperty market values by “unsmoothing” the appraisal-based Russell-NCREIF Index; (ii) Indices that trace average ex posttransaction prices of commercial property over time; and (iii) an index based onunlevering REIT share prices. By comparing the different historical pictures that result from the various index construction methodologies, one gains insight into the nature of commercial property price and valuation behavior. The REIT-based values lead the other indices in time but display greater short-run volatility. The transactions-based indices lag behind the other series in time, and are consistent with the idea that institutional investors attempt to hold onto properties until they can sell them for a price at least equal to the current appraised value, in effect trading off liquidity for reduced volatility.

The Walkability Premium in Commercial Real Estate Investments

This article examines the effects of walkability on property values and investment returns. Walkability is the degree to which an area within walking distance of a property encourages walking for recreational or functional purposes. We use data from the National Council of Real Estate Investment Fiduciaries and Walk Score to examine the effects of walkability on the market value and investment returns of more than 4,200 office, apartment, retail and industrial properties from 2001 to 2008 in the United States. We found that, all else being equal, the benefits of greater walkability were capitalized into higher office, retail and apartment values. We found no effect on industrial properties. On a 100‐point scale, a 10‐point increase in walkability increased values by 1–9%, depending on property type. We also found that walkability was associated with lower cap rates and higher incomes, suggesting it has been favored in both the capital asset and building space markets. Walkability had no significant effect on historical total investment returns. All walkable property types have the potential to generate returns as good as or better than less walkable properties, as long as they are priced correctly. Developers should be willing to develop more walkable properties as long as any additional cost for more walkable locations and related development expenses do not exhaust the walkability premium.

Integrating Research on Markets for Space and Capital

This article discusses the importance of recognizing that there are two distinct but interrelated real estate markets: the market for tenant space and the market for investment capital. The use decision is made in the space market whereas the investment decision is made in the capital market. The article points out that past research has tended to focus on a separate analysis of each of these two markets. That is, research historically has focused on understanding how changes in supply and demand affect equilibrium in either the space market or the capital market as if each market was autonomous. A graphical framework is illustrated that can be used to examine the effect of an exogenous shock to market equilibrium from either the market for space or the market for capital. Copyright American Real Estate and Urban Economics Association.

Pricing and Index Considerations in Commercial Real Estate Derivatives

It is important for participants in the nascent commercial real estate derivatives market to understand the fundamentals and the subtleties of the appraisal and transaction based indexes that underpin derivatives, as well as the proper pricing of derivatives taking into account the risk and return characteristics of the index. The authors review these considerations including the implications that appraisal lag in the index has for the equilibrium pricing of derivatives such as index swaps, and the use of such vehicles for hedging real estate risk. An important conclusion is that even if the underlying index does not represent the current equilibrium in the property market or if the property market itself is not in equilibrium, we can still use equilibrium analysis in the derivatives market to derive a fair price for an appraisal index based derivative including consideration of the effect of any lagging and smoothing in the index. The analysis highlights informational issues about indexes and property markets that present both danger and opportunity for the facilitation of a well-functioning property derivatives market in the United States and shows how usage of derivatives needs to consider the effect of possible lag in the index.

Current Issues in the Analysis of Commercial Real Estate

This paper identifies and discusses a number of current issues regarding our understanding of commercial real estate markets. These issues include: 1) accurate estimation of the quantity and location of our nations commercial space; 2) an understanding of the linkage between the space and capital markets for commercial real estate; 3) identification of the macroeconomic factors that affect the rate of return on commercial property and whether local market factors also affect the rate of return; 4) problems associated with measuring the return characteristics of equity investments in commercial property (including measures of the diversification benefits and inflation‐hedging abilities of this asset class); 5) a better understanding of rental markets, including good measures of changes in effective rents over time; and 6) examination of the rationale for ownership of commercial space by corporate users. This paper reviews recent research related to these questions and suggests future research that should prove to be fruitful.

Institutional Capital Flows and Return Dynamics in Private Commercial Real Estate Markets

This article examines the short- and long-run dynamics among institutional capital flows and returns in private real estate markets. At the aggregate U.S. level, we find evidence that lagged institutional flows significantly influence subsequent returns. When disaggregating by property type at the national level, we find that capital flows predict subsequent returns in the apartment and office sectors, but not in the retail and industrial markets. At the metropolitan level, we find that the flows help explain subsequent returns in a limited number of core business statistical areas (CBSAs), although these CBSAs collectively represent about 30% of institutional capital. We find no evidence that institutional returns are predictive of future capital flows at the national or CBSA level, suggesting that institutional investors are not chasing returns.

Tax Reform and the Value of Real Estate Income Property

This paper examines the effect of recent proposals for tax reform (Treasury I and Treasury II) on the tax benefits and value of real estate income property. The effect on tax benefits is measured by the effective tax rate, and the potential impact on value is measured by the capitalization rate (user cost). The analysis of Treasury I provides insight into the effect of a tax-neutral system on real estate since this proposal comes close to meeting the criteria of tax neutrality. The importance of debt in evaluating tax neutrality is also shown. The paper demonstrates that the interaction between tax law changes and the way interest rates adjust to inflation are critical to the conclusions. Copyright American Real Estate and Urban Economics Association.

Performance of Real Estate Portfolios

Actual cash flows from commercial properties over 1977–2004 underlie this simulation of the performance of real estate portfolios. The methodology relaxes implicit rebalancing and mark-to-market assumptions in time series analysis and uses the distribution of the internal rate of return to compare commercial property investment to portfolios of stocks and bonds over the same period. This approach allows consideration of the impact of the timing of capital flows on the IRR for real estate portfolios and provides insight into the benefits of diversification by property sector versus location. Cross-sectional variation in IRRs helps indicate the number of properties necessary to reduce the risk of achieving the IRR benchmark for properties in the NCREIF Property Index.

Pricing commercial mortgage‐backed securities

This paper presents the first known non‐proprietary empirical examination of the relationship between Commercial Mortgage Backed Security (CMBS) pricing. CMBS prices are examined as a function of the “moneyness” of the default option, the age of the security, the interest rate, interest rate volatility, property price volatility, amortization features and yield curve slope utilizing a proprietary data set of monthly prices on 40 CMBS securities. We find that though the senior tranche CMBS in the sample are effectively immune from default loss per se, they are not immune from early return of principal and resulting duration shift implied by increasing default probabilities. Thus, they behave very much like residential mortgage backed securities in that discount security prices are positively related to explanatory variables associated with potential shifts in duration. As a result, senior tranche CMBS prices increase with explanatoryd factors that raise the likelihood of default such as property volatility and loan to value ratio whereas CMBS prices decrease with variables that lower default probability such as amortization. These empirical results fit well with existing theoretical models of multi‐tranche CMBS pricing and models of commercial mortgage default and suggest that senior tranche CMBS may embody elements of risk that justify their seemingly rich spreads to similar duration corporate securities.

Rental Housing and the Economic Recovery Tax Act of 1981

This article presents a study of the impact of ERTA on the market for rental housing. Major changes in capital recovery periods and in the methods of depreciation available to investors in rental housing have been brought about because of ERTA. The effects of these changes are modeled, and short-run changes in demand price and rents are simulated with a baseline case deemed typical of a rental housing development. Results indicate that depending on inflation, declines in rent-to-value ratios ranging from 20% to 33% and 24% to 48% for conventional and low-income housing, respectively, may be expected. This implies some substitution of low-income rental housing, for otherwise, identical housing may occur and, because of new capital recovery provisions, properties will be bought and sold more frequently than previously.