Showing papers in "Journal of Real Estate Finance and Economics in 1995"

The persistence of real estate cycles

Abstract: This paper presents a model that attempts to explain the underlying causes of the prolonged cycles observed in real estate markets. In addition, the paper characterizes the features that make some property types more prone to such boom-and-bust behavior. The combination of demand uncertainty, adjustment costs, and construction lags leads to two phenomena that may help explain market persistence. The first phenomenon is the reluctance of owners to adjust occupancy levels, even in the face of large shifts in renter demand. The second phenomenon is the occurrence of periods of sustained overbuilding: the addition of new supply in the face of already high vacancy rates.

The valuation at origination of fixed-rate mortgages with default and prepayment

Abstract: This paper develops a model to rationally price fixed-rate mortgages, using the arbitrage principles of option pricing theory. The paper incorporates amortization, prepayment and default in valuing the mortgage. Having completely specified the model, numerical procedures value the different features of the mortgage contract under a variety of economic conditions. The necessity of having both the interest rate and the house price as explanatory variables, due to the interaction of default and prepayment, is demonstrated. The numerical solutions presented center around mortgage pricing at origination. Thus, variations in the equilibrium contract rate are examined for differing economic conditions and changes in the contract. Finally, by presenting a complete model, the paper yields insights for the existence of common institutional practices.

Real estate is not normal: A fresh look at real estate return distributions

Abstract: Investment risk models with infinite variance provide a better description of distributions of individual property returns in the Russell-NCREIF data base from 1980 to 1992 than normally distributed risk models. Real estate investment risk is heteroscedastic, but the characteristic exponent of the investment risk function is constant across time and property type. Asset diversification is far less effective at reducing the impact of nonsystematic investment risk on real estate portfolios than in the case of assets with normally distributed investment risk. Multirisk factor portfolio allocation models based on measures of investment codependence from finite-variance statistics are ineffectual in the real estate context.

A hedonic price model for private properties in Hong Kong

Abstract: A hedonic model is used to explore the effects of locational, structural, and neighborhood attributes on the price structure of private condominiums in Hong Kong. The regression results and the elasticities of housing attributes obtained from the Box-Cox analysis indicate that the valuation of a property is sensitive to changes in housing traits. Home buyers are rational and are willing (unwilling) to pay for desirable (undesirable) housing attributes and that the valuation of a property is market-driven in Hong Kong.

Explicit tests of contingent claims models of mortgage default

Abstract: This paper provides explicit and powerful tests of contingent claims approaches to modeling mortgage default. We investigate a model of “frictionless” default (i.e., one in which transactions costs, reputation costs, and moving costs play no role) and analyze its implications-the relationship between equity and default, the timing of default, its dependence upon initial conditions, and the severity of losses. Absent transactions costs and other market imperfections, economic theory makes well-defined predictions about these various outcomes. The empirical analysis is based upon two particularly rich bodies of micro data: one indicating the default and loss experience of all mortgages purchased by the Federal Home Mortgage Corporation (Freddie Mac), and a large sample of all repeat sales of single family houses whose mortgages were purchased by Freddie Mac since 1976.

Golf Courses and Residential House Prices: An Empirical Examination

Abstract: The importance of location is well known in the literature on real estate valuation. Our study extends this body of literature by being the first to examine empirically the effect on the selling price of single-family residential properties when they abut a golf course. We determine the incremental effect on the sales price of houses on the golf course by fitting a standard hedonic pricing model to a sample of 717 sales transactions drawn from a sub-urban area of a large city. We employ a matched-pair research design to hold constant the price effects of other location factors on these golf course properties. Our results indicate that a golf course location adds 7.6 percent to a property's sales price. We believe this finding is of interest to developers in their design of a golf course subdivision and to appraisers who wish to make location-specific value adjustments of golf course properties.

Parametric, semiparametric, and nonparametric estimation of characteristic values within mass assessment and hedonic pricing models

Abstract: Parametric estimators, such as OLS, attain high efficiency for well-specified models. Nonparametric estimators greatly reduce specification error but at the cost of efficiency. Semiparametric estimators compromise between these dual goals of efficiency and specification error. Semiparametric estimators can assume general forms within classes of functional forms. This paper applies OLS, the kernel nonparametric regression estimator, and the semi-parametric estimator of Powell, Stock, and Stoker (1989) to a data set, which should, based on theory and previous empirical work, yield positive coefficients. The semiparametric estimator, on average, displayed the performance most consistent with prior expectations followed by the nonparametric and parametric estimators. In addition, the paper shows how the semiparametric estimator can provide insights into the form of misspecification and suggest data transformations.

The present value model with time-varying discount rates: Implications for commercial property valuation and investment decisions

Abstract: A vector autoregressive model is developed for predicting cash flow and returns in the private (unsecuritized) commercial property markets. The model predicts both of these variables quite well during the sample period. The forecasting model is then used to develop a simple “buy/sell” rule for identifying property market value peaks aud troughs. An improved present value model, taking account of the predictability of property returns, is described and found to track historical market values much more closely than does either the appraisal-based index or the traditional present value model with constant expected returns. Analysis in this paper suggests that most of the change in commercial property market values has been due to changes in expected returns, rather than to changes in expected future operating cash flows. Key Wordsr valuation, investment, present value model, timing, cycles, discount rates The present value model underlies all of modern financial economics, and lies at the heart of commercial property valuation and real estate investment decision making. Traditionally this model is applied by forecasting property net cash flows and discounting those cash flows at a constant discount rate. In this model the discount rate is meant to represent the expected return (that is, the internal rate of return or total return) to an investment in the property, thereby reflecting the opportunity cost of capital. In practice, the discount rate used in the present value model as applied to property valuation has not changed much over time, largely because analysts have not known how to quantify changes in the market’s expected return on pr0perty.i Recently, evidence has mounted that asset value changes in the securities markets are not consistent with the constant discount rate model or the constant expected return assumption? Campbell and Mei (1993), among others, have found that changes in stock prices over time are due more to changes in the market’s required total returns (including price changes), than to changes in the market’s cash flow expectations.3 Furthermore, changes in the market’s expected return can be forecasted to some extent, as has been demonstrated by Liu and Mei (1992, 1994) in the case of REITs, small stocks, and large stocks. This implies that asset price changes are more predictable than was previously thought, and that turning points in asset price cycles may be somewhat identifiable in advance!

Implicit pricing across residential rental submarkets

Abstract: This paper examines implicit price differences of rental housing characteristics across various property types to measure whether determinants of rents are valued in the aggregate or separately The results show that hedonic price functions are not identical across property types, which suggests that ordinary least squares is not the appropriate estimation technique when modeling the implicit prices for an aggregate rental market Generalized least squares estimation of a random coefficient model removes the restriction of fixed parameters imposed by OLS and allows estimation of implicit prices for rental markets containing multiple property types

Price Spreads and Residential Housing Market Liquidity

Abstract: Most studies of housing market liquidity have measured liquidity in terms of time on the market (TOM), and have sought to explain TOM in terms of property characteristics and measures of market conditions. This paper departs from past studies of housing market liquidity by examining the spread between the listing and contract prices.

Using Goal Programming and the analytic hierarchy process in house selection

Abstract: The house selection process involves an assessment by the buyer of a series of qualitative and quantitative factors. Simple ranking or weighting selection methods utilizing these factors can lead to less than optimal decision making. This paper presents a model to aid in the house selection decision process. Specifically, this paper presents a Goal Programming (GP) model that utilizes the Analytic Hierarchy Process (AHP) to evaluate property attributes and make an optimal house selection decision. The formulation methodology for the proposed house selection modeling process is illustrated with examples based on data from a prior study.

REITs, real estate, and inflation: Lessons from the gold market

Abstract: This studyindirectly tests whether equity Real Estate Investment Trusts (REITs) proxy for real estate when examining real estate's inflation hedging ability. The hedging properties of gold, an underlying asset, are compared against those of gold stocks, a securitized form of the asset, and gold is shown to perform well as an inflation hedge, while gold stocks do not. This divergence between an asset and its securitized form suggests caution in drawing conclusions about real estate's ability to hedge inflation from equity REIT studies.

The wealth effects of real estate transactions: The case of REITs

Abstract: Recent literature analyzing corporate acquisitions and sales of real estate has shown that statistically significant gains accrue to both buyers and sellers when the transaction is announced. In this paper, we focus solely on the real property transactions of tax-qualified Real Estate Investment Trusts (REITs) to determine if REIT shareholders experience a similar pattern of positive wealth effects. We find that REITs do not experience any significant wealth effects from transaction announcements. However, we provide evidence that a significant positive wealth effect does occur upon the announcement of a sale transaction when the sale is associated with an increase in REIT dividends.

Price reversal, transaction costs, and arbitrage profits in the real estate securities market

Abstract: This paper studies the return reversals of exchange traded real estate securities using an arbitrage portfolio approach. Using the approach, we find that there exist significant return reversals in such securities. These return reversals could be exploited by arbitrage traders if trading costs can be ignored. However, the arbitrage profits disappear after deducting trading costs and taking into account the implicit cost of bid-ask spread. Thus, the real estate securities market is efficient at weekly intervals in the sense that one could not exploit the price reversals via some simple trading rules.

The Causal Relationships Between Residential Property Prices and Rentals in Hong Kong" 1982-1991

Abstract: This study examines the causal relationships between sale price changes and rental rate changes in the Hong Kong real estate market. Three different hypotheses are put forth: 1) the demands in the two markets are substitutes, 2) prices and rentals are positively correlated; and 3) prices and rentals are not correlated because of market segmentation. Using quarterly data of sale prices and rental rates for the five categories of residential property from four different districts, causal relationships are not found in 29 cases out of 40. For the other 11 cases, we find that price changes lead rental rate changes. The lag period is found to be one quarter, and this shows that the two markets are efficient: only one quarterly lag is necessary to establish causality where it exists.

An option pricing approach to the valuation of real estate contaminated with hazardous materials

Abstract: This paper uses option pricing to examine how the presence of hazardous materials affects real estate value. The property owner has two options. The first option is to remove the hazardous materials at the best time. The second option, embedded in the first one, is to redevelop the property at the best opportunity. The owner has three possible timing strategies with respect to the exercise of these two options: remove the hazardous materials first and retain the option to redevelop the property later, remove and redevelop at the same time, or do nothing. Conditions under which the presence of the hazardous materials may either expedite or postpone the decision to redevelop are also derived. If the regulatory environment does not allow the property owner to make optimal timing decisions with respect to the exercise of these options, then our results provide an indication of the cost of regulation as measured by the additional loss in property value.

A multivariate analysis of REIT performance by financial and real asset portfolio characteristics

Abstract: This paper examines the risk-adjusted performance of real estate investment trusts (REITs) from 1986 through 1990 in relation to financial and property characteristics of their portfolios. The Sharpe measure of risk-adjusted rate of return was regressed against financial ratios and property investment ratios for a sample of equity and mortgage REITs. The results show that, in general, financial ratios (gross cash flow, leverage, asset size), regional location of properties, and types of real estate investments determine the risk-adjusted performance. More specifically, location of properties in the western United States, ownership of health care properties, and investment in securitized mortgages positively affect the risk-adjusted return. The individual financial variables were not found to be statistically significant in influencing REIT returns.

The economics of land transfer and title insurance

Abstract: In the presence of uncertainty over the title of land (due to fraud or error), a legal system can protect either the current (innocent) owner, or a previous owner who claims title. The predominant system in the United States generally awards title to the latter in the event of legitimate claim. Thus, current owners frequently purchase title insurance to provide indemnification in the event of a loss. In contrast, the Torrens system awards title to the current owner, but provides for indemnification of any legitimate claimants. We evaluate these two systems and argue that if transaction costs are low, both promote efficient assignment of title (according to the Coase Theorem), but if transaction costs are high, the Torrens system is more likely to award title to the party that values it the most (namely, the current possessor).

Crisis and recovery in office markets

Abstract: From 1987 to 1993, U.S. office markets were in a depression similar in length and magnitude to that of the 1930s. Vacancy rates doubled, development nearly halted, and prices and rents fell precipitously. A disaster of this magnitude requires multiple causes. Poor tax policies in Washington were important causes, as was a pervasive tendency of developers and others to overforecast the growth of office employment. However, the difference between this and earlier postwar office recessions appears to be explained mostly by the effects of the microchip revolution, which entered a new phase starting in the mid-1980s. The paper concludes with relatively optimistic notes on the likely demand growth that will result from the new and improved services that the microchip revolution will permit.

Risk analysis and asset valution: A Monte Carlo Simulation using stochastic rents

Abstract: Introduction of the Present Value Distribution Model (PVD) offers an alternative method for the valuation of projects yielding intertemporal stochastic rents. A combination of concepts from many areas of the literature yields the given model. The base procedure relies on Monte Carlo Simulation with the application of recently established theories on stochastic rents, path dependent cash flow trajectories, and period dependent discount rates.

Hong Kong housing markets: Overview, tenure choice, and housing demand

Abstract: This paper presents an overview of housing markets and a cross-sectional analysis of housing demand in Hong Kong. Disturbances from political events have produced price upheavals in property prices; long-term inflation and low interest rates provide a strong stimulus for a sustained price surge in the housing market. Household income seems to have relatively little bearing on recent development in the market, especially when demand for housing has become more investment-oriented.

Bank Risk and Real Estate: An Asset Pricing Perspective

Abstract: While a number of papers have investigated the time-series behavior ofex post bank stock returns and real estate returns, no study has comprehensively studied the relationship betweenex ante risk premiums on both assetsand the time-varying nature of such premiums in relationship to economic and real estate market conditions. In this study, we investigate how the changing nature of bank risk taking, especially in the real estate market, has affected theex ante pricing of risk in the market for bank stocks. We find that the time variation in bank risk premiums are partly determined by interest rate and real estate market conditions. We also discover that the real estate factor has been important for banks in the 1980s.

Controlling the incentive problems in real estate leasing

Abstract: This paper develops a formal model that characterizes potential conflicts of interest between real-estate landlords and tenants. The model demonstrates a tenant's incentive to undermaintain or overuse (i.e., abuse) a leased property while highlighting the moral hazard problem as a cause of the failure of the lease irrelevance proposition. As a consequence, the lease irrelevance proposition's faiure implies that if tenant abuse incentives are left unrestricted, the market for leased real estate may cease to function. The efficacies of various lease arrangements suggested by Smith and Wakeman (1985) and other researchers in controlling the tenant abuse incentives are evaluated in this framework as a means of counteracting the inherent problems. Our analysis supports the greater use of variable lease schemes (e.g., security deposits and penalty clauses), which peg real-estate lease rates to the level of property abuse rather than more traditional fixed payment contracting arrangements.

Rapid housing privatization in reforming economies: Pay the special dividend now

Abstract: State ownership and operation of the housing stock in the previously centrally planned economies severely distorts housing markets, stifles labor mobility, and produces operating losses that exacerbate fiscal deficits. The conventional wisdom regarding structural reform is to gradually increase administered rents, thereby reducing deficits. Housing sales, where they occur, are primarily motivated to generate revenue to cover deficits in current operating budgets. We argue that the perceived benefits to a prolonged transition are illusory and the social costs are high.

The pricing of real estate investment trust initial public offerings

Abstract: This paper examines the pricing of Initial Public Offerings (IPOs) of Real Estate Investment Trusts (REITs). Unlike standard corporations, evidence suggests that REIT IPOs are correctly priced in the initial market. Significant negative initial-day return for mortgage REITs is found to be a function of using the bid price to calculate returns for those securities, which trade initially over the counter (OTC). If the bid-ask average or the ask price is used in calculating returns, any apparent overpricing disappears. Additionally, we find that once transactions costs are considered, an investor is better off purchasing a REIT on the offering.

An Analysis of Shopping Center Investment.

Abstract: During the 1980s, the oversupply of retail space has lowered rents, raised vacancies, and damaged the integrity of financial institutions as developers and other borrowers have been forced into default. This paper explores the propensity of developers to create shopping center space. The research draws on the macroeconomic investment literature to formulate a model of shopping center investment. We estimate our model using shopping center and sales data from all fifty states of the United States and the District of Columbia. Our results provide evidence about how investment in new shopping space responds to changes in retail sales, capital costs, and taxes.

Optimal development of a building site

Abstract: This paper points out that the simple convex cost curve of classical economics is relevant to the issue of optimal building size, but only if the questions of time and cost of capital are ignored. It then aims to replace the static production cost model with a multiperiod model and to find a new optimum rule similar to “marginal cost equals price” appropriate to the construction process. A further purpose of the paper is to propose a simple land valuation model, reflecting the land use potential of a site taking into account the price of floor space, the cost and pace of construction, and the cost of capital.

Overbuilding, real estate lending decisions, and the regional economic base

Abstract: The primary purpose of this paper is to evaluate the causes of overbuilding in the context of economic base theory. A second and closely related purpose is to determine if the economic base multiplier effect is stronger in the long run. Construction decisions depend on the strength of the local economy. Since basic activity is highly cyclical, if there are significant lags in the multiplier process running from basic to nonbasic sectors, then growth in non-basic employment will continue when the basic sector slows or declines. Hence, overbuilding may be, in part, a result of false signals about future growth in the local economy to builders, developers and lenders at the time a project is conceived. In addition, one of the important sources of the lags in the multiplier process is the construction sector. Potential solutions to overbuilding are discussed in an economic base context. The implications for bank regulation, bank lending and feasibility analysis are discussed.

Pricing effects in Fannie Mae agency bonds

Abstract: As a government-sponsored enterprise, Fannie Mae enjoys certain advantages over other firms. The extent of these advantages, while widely discussed, have not yet been fully quantified. This paper empirically examines the returns to Fannie Mae general obligation bonds under the assumptions of the Arbitrage Pricing Theory. The model provides an explicit method for estimating the risk premium on Fannie Mae bonds. The results indicate that liquidity and tax effects are important in explaining the returns to Fannie Mae bonds. The results also indicate that the market does not incorporate changes in the riskiness of the mortgage market into the returns on Fannie Mae bonds. The results provide support for the contention that Fannie Mae, as a government sponsored enterprise, enjoys a significant advantage over other firms in the capital market.

Headquarters, office employment, and the wave of urbanization in the New York City region

Abstract: Hierarchical theory suggests that high-density office activity, such as corporate headquarters, epitomizes the concept of agglomeration. This research tests whether office employment in a metropolitan area agglomerates around suburban nodes of specialized office and corporate headquarter activity or if office employment change shifts in response to the wave of urbanization. The location of the Fortune 500 manufacturing and service headquarters and the ratio profiles of office employment within each county are used in the test. We conclude that headquarters are not located in specialized office employment nodes. Rather, the office employment becomes specialized as the county becomes more urbanized.