A significant part of adding value to a clients efforts is to be aware of new
and emerging trends in the industry. Whether its changing cap rates or
dynamic legal and regulatory issues sure to shape the intelligent way of doing
business, REC stays on top. In an effort to stay on the cutting edge with
current issues and trends, REC devotes significant time to reviewing and
analyzing industry periodicals, research reports and white papers.
Occasionally, REC will do its own proprietary research regarding trends it sees
emerging as a result of its participation in the industry.
A Structural Model for Capitalization Rates A dynamic cap rate model is built that links the cap rate to multi-period expected returns and rental growths. The cap rate is the weighted average of all future growth-adjusted discount rates, which have substantial variations over time. The model shows that the cap rate is significantly related to both future expected return and expected rental growth.
The Secular and Cyclical Determinants of Capitalization Rates In addition to risk free Treasury rates, general corporate risk premium operating in the economy and the net amount of debt issued in the economy (scaled by GDP), or liquidity, have been determined to have significant impacts on cap rates.
Factors Influencing Capitalization Rates The results from this study indicate that differences across property types are important in evaluating cap rates. The rank order for cap rates by property type from highest to lowest was hotels and motels, industrial, commercial services, offices, commercial retail, and apartments.
Living with Terminal Capitalization Rates To understand how investors form expectations about future prices, the authors model the spread between the contemporaneously period-zero going-in and terminal capitalization rates and the spread between terminal rates assigned in period zero and going-in rates assigned in period N. Study results confirm statistical relationships between the terminal and the next holding period gioing-in capitalization rate spread and the period-zero discount rate.
Determinants of Appraisal Based Cap Rates Capitalization rates extracted from the NCREIF database (appraisal based) move exactly as stock PE ratios do, but only if appraisers form expectations about future income growth by looking myopically backward and not forward. NCREIF cap rates seem to move contrary to the mean-reverting nature of the market. Past income growth seems to be extrapolated forward. The data suggest that it is possible to generate reliable forecasts of appraisal based capitalization rates, which are conditioned on forecasts of market rents and interest rates. Other important findings include: 1) Cap rates are different across MSA's because of variations in fixed market characteristics, 2) Market specific cap rates are shaped by the behavior of the local market, and 3) Market specific cap rates also incorporate national influences including interest rates and expected general inflation.
The Functional Relationship Between Going In vs Going Out Cap Rates The selection of an appropriate going-out cap rate, in a discounted cash flow analysis, requires a careful examination of the changes in the assumed income-growth rates, changes in the assumed required rates of return, and changes in the assumed property-appreciation rates during and after the projected holding period.
A Cross Sectional Analysis of Cap Rates by MSA Using data from Real Capital Analytics for multi-family properties, the authors explore several models that combine the expected influences from housing demand growth, supply constraints, liquidity risk and the interaction of these to explaing cap rate differentials across geographic regions. The authors document substantial geographical variation across MDA's for the gap between apartment cap rates and the risk free rate, and consider several factors that could potentially cause this variation.
Exploring Capitalization Rates Differentials Across Property Types Capitalization rates across property types differ along three dimensions: in the magnitude of their fixed, time-invariant component (lease characteristics, re-leasing costs, investment size, tenant sensitivity, space convertability, inforamtion availability, locational substitutability); in the pattern of their time trends (capital market factors, demand and supply drivers); and in the persistence of these time trends (investment capital requirements, information inefficiencies). Further empirical work is required to substantiate any explanations put forth.
Office Capitalization Rates: Why do they Vary Across Metropolitan Markets? The study indicates that variations are largely determined by differences in critical office market variables that presumably shape investor income growth expectations and risk perceptions. Such variables include the vacancy rate, completions rate, absorption rate, the size of the market and the historical volatility of the metro economy. Furthermore, on average, capitalization rates do not respond very rapidly to changing market conditions.
Office Capitalization Rates: Real Estate and Capital Market Influences
The Predictability of Real Estate Capitalization Rates A mathematical approach, linking real estate capitalization rates with conditions in the broader capital markets, with suitable adjustments for lags and presumed risks. The study is based on actual property operating statistics from the NCREIF database, and differentiates based on property type.
Cap Rates and Real Estate Cycles This paper aims to fill the knowledge gap and provide readers with a sound understanding of both the conceptual underpinnings and the fundamental determinants of cap rates. The paper also examines cap rate dynamics during previous recessionary periods with the intent of gaining a better understanding of cap rate behavior during the current economic downturn and what we might expect looking forward as the current economic cycle plays out.
PREI Cap Rates and Interest Rates Based on historical evidence, if the 10-year Treasury bond yield rises to 5% over the next couple of years, the average NCREIF cap rate could move from its recent level of 6.1% to anywhere in between 5.4% and 7.6%, an admittedly broad range. At the midpoint, however, the ending cap rate would be 6.5%, a modest increase of about 40 bps.
Real Time Valuation DCF Modeling The Real-Time Valuation model uses tenant-by-tenant, credit based spreads over the Treasury yield curve as the basis for discounting current and future rental streams to present value at an appropriate risk-adjusted rate. Duration, weighted average risk, risk profiles, loss potential from defaults, and measures of discount rate and rental growth rate elasticities are additional statistics derived by the model. However, the handling of operating expenses leaves much to be desired.
Common Errors with DCF Models
3. Market Trends
4. Quarterly Reports
5. CMBS
CMBS Lending Rebooted: A Return to Basics A continued return of the CMBS market is critical to the overall real estate market recovery. The evolving CMBS 2.0 is returning so far with a different attitude toward risk, more equitable deal terms and some lender friendly deal structure elements.
Douglas Thompson, CFA shares his insights and experiences of transacting
business in the intertwined industries of real estate and banking.
