The accuracy of valuations: expectation and reality

The relationship between valuations and the subsequent sale price continues to be a matter of both theoretical and practical interest. This paper reports the analysis of over 700 property sales made during the 1974/90 period. Initial results imply an average under-valuation of 7% and a standard error of 18% across the sample. A number of techniques are applied to the data set using other variables such as the region, the type of property and the return from the market to explain the difference between the valuation and the subsequent sale price. The analysis reduces the unexplained error; the bias is fully accounted for and the standard error is reduced to 15.3%. This model finds that about 6% of valuations over-estimated the sale price by more than 20% and about 9% of the valuations under-estimated the sale prices by more than 20%. The results suggest that valuations are marginally more accurate than might be expected, both from consideration of theoretical considerations and from comparison with the equivalent valuation in equity markets.

The dynamics of asset prices and transaction activity in illiquid markets: the case of private commercial real estate

This paper investigates the relationship between capital flows, turnover and returns for the UK private real estate market. We examine a number of possible implication of capital flows and turnover on capital returns testing for evidence of a price pressure effect, ‘return chasing’ behaviour and information revelation. The main tool of analysis is a panel vector autoregressive (VAR) regression model in which institutional capital flows, turnover and returns are specified as endogenous variables in a two equation system in which we also control for macro-economic variables. Data on flows, turnover and returns are obtained for the 10 market segments covering the main UK commercial real estate sectors. Our results do not support the widely-held belief among practitioners that capital flows have a ‘price pressure’ effect. Although there is some evidence of return chasing behaviour, the short timescales involved suggest this finding may be due to delayed recording of flows relative to returns given the difficulties of market entry. We find a significant positive relationship between lagged turnover and contemporaneous capital returns, suggesting that asset turnover provides pricing information.

Are local economic development incentives promoting job growth? An empirical case study

At a time when cities are competing with one another to attract or retain jobs within a globalizing economy, city governments are providing an array of financial incentives to stimulate job growth and retain existing jobs, particularly in high cost locations. This paper provides the first systematic and comprehensive analysis of datasets on economic development incentives in New York City over the last fifteen years. The evidence on job retention and creation is mixed. Although many companies do not meet their agreed-upon job targets in absolute terms, the evidence suggests that companies receiving subsidies outperform their respective industries in terms of employment growth, that is, the grow more, or decline less. We emphasize that this finding is difficult to interpret, since firms receiving incentives may not be representative of the industry as a whole. In other words, their above-average performance may simply reflect the fact that the Economic Development Corporation (EDC) selects economically promising companies within manufacturing (or other industries) when granting incentives. At the same time, it is also possible that receiving incentives helps these companies to become stronger.

Spatial patterns of office employment in the New York region

This study analyzes the regional spatial dynamics of the New York region for a period of roughly twenty years and places the effects of the 9/11 terrorist attacks in the context of longer-term regional dynamics. The analysis reveals that office-using industries are still heavily concentrated in Manhattan despite ongoing decentralization in many of these industries over the last twenty years. Financial services tend to be highly concentrated in Manhattan whereas administrative and support services are the least concentrated of the six major office-using industry groups. Although office employment has been by and large stagnant in Manhattan for at least two decades, growth of output per worker has outpaced the CMSA as well as the national average. This productivity differential is mainly attributable to competitive advantages of office-using industries in Manhattan and not to differences in industry composition. Finally, the zip-code level analysis of the Manhattan core area yielded further evidence of the existence of significant spillover effects at the small-scale level.

Asymmetric space market adjustment in the London office market

Models of the City of London office market are extended by considering a longer time series of data, covering two cycles, and by explicit modeling of asymmetric rental response to supply and demand model. A long run structural model linking demand for office space, real rental levels and office-based employment is estimated and then rental adjustment processes are modeled using an error correction model framework. Adjustment processes are seen to be asymmetric, dependent both on the direction of the supply and demand shock and on the state of the rental market at the time of the shock. A complete system of equations is estimated: unit shocks produce oscillations but there is a return to a steady equilibrium state in the long run.

Sources of alpha and beta in property funds

This paper examines issues related to potential analytical performance systems for global property funds. These will include traditional attribution methods but will also cover the performance concepts of alpha and beta widely used in other asset classes. We look at issues including...what creates beta, and what drives alpha in real estate investment? How can it be measured and isolated? How do these concepts relate to traditional attribution systems? Can performance records and performance fees adequately distinguish between these drivers? In this paper we illustrate these issues by reference to a case study addressing the complete performance record of a single unlisted fund.

Spatial concentration in institutional industrial real estate investment in the England and Wales

In two recent papers Byrne and Lee (2006, 2007) examined the geographical concentration of institutional office and retail investment in England and Wales at two points in time; 1998 and 2003. The findings indicate that commercial office portfolios are concentrated in a very few urban areas, whereas retail holdings correlate more closely with the urban hierarchy of England and Wales and consequently are essentially ubiquitous. Research into the industrial sector is very much less developed, and this paper therefore makes a significant contribution to understanding the structure of industrial property investment in the UK. It shows that industrial investment concentration is between that of retail and office and is focussed on LAs with high levels of manual workers in areas with smaller industrial units. It also shows that during the period studied the structure of the sector changed, with greater emphasis on the distributional element, for which location is a principal consideration.

Unlisted property funds and the emerging property markets

This paper sets out to describe the changing nature of global property investment, to provide background information regarding the nature of unlisted property funds and their managers and investors, and especially the role played by unlisted property funds in facilitating cross-border investing. In particular, it focuses on the development of unlisted funds as intermediary structures carrying institutional capital from developed to developing markets. It presents the results of new research by UK research firm Property Funds Research (PFR) and the University of Reading which explores the extent to which this new vehicle has been effective in delivering capital to emerging markets. The research relates the number of funds targetting particular countries and to population and GDP per capita. It finds that there is a very strong relationship between the popularity of a country for investment through this vehicle format and these independent variables. More interesting, perhaps, is the identification of outlier countries where the amount of investment is significantly less - or greater - than that predicted by population and GDP per capita.

Data uncertainty in real estate forecasting

The rapid expansion of the TMT sector in the late 1990s and more recent growing regulatory and corporate focus on business continuity and security have raised the profile of data centres. Data centres offer a unique blend of occupational, physical and technological characteristics compared to conventional real estate assets. Limited trading and heterogeneity of data centres also causes higher levels of appraisal uncertainty. In practice, the application of conventional discounted cash flow approaches requires information about a wide range of inputs that is difficult to derive from limited market signals or estimate analytically. This paper outlines an approach that uses pricing signals from similar traded cash flows is proposed. Based upon ‘the law of one price’, the method draws upon the premise that two identical future cash flows must have the same value now. Given the difficulties of estimating exit values, an alternative is that the expected cash flows of data centre are analysed over the life cycle of the building, with corporate bond yields used to provide a proxy for the appropriate discount rates for lease income. Since liabilities are quite diverse, a number of proxies are suggested as discount and capitalisation rates including indexed-linked, fixed interest and zero-coupon bonds. Although there are rarely assets that have identical cash flows and some approximation is necessary, the level of appraiser subjectivity is dramatically reduced.

The appraisal of data centres: deconstructing the cash flow

This paper analyses the appraisal of a specialized form of real estate - data centres - that has a unique blend of locational, physical and technological characteristics that differentiate it from conventional real estate assets. Market immaturity, limited trading and a lack of pricing signals enhance levels of appraisal uncertainty and disagreement relative to conventional real estate assets. Given the problems of applying standard discounted cash flow, an approach to appraisal is proposed that uses pricing signals from traded cash flows that are similar to the cash flows generated from data centres. Based upon ‘the law of one price’, it is assumed that two assets that are expected to generate identical cash flows in the future must have the same value now. It is suggested that the expected cash flow of assets should be analysed over the life cycle of the building. Corporate bond yields are used to provide a proxy for the appropriate discount rates for lease income. Since liabilities are quite diverse, a number of proxies are suggested as discount and capitalisation rates including indexed-linked, fixed interest and zero-coupon bonds.

Firm size and competition: a comparison of the housebuilding industries in Australia, the UK and the USA

Housebuilding is frequently viewed as an industry full of small firms. However, large firms exist in many countries. Here, a comparative analysis is made of the housebuilding industries in Australia, Britain and the USA. Housebuilding output is found to be much higher in Australia and the USA than in Britain when measured on a per capita basis. At the same time, the degree of market concentration in Australia and the USA is relatively low but in Britain it is far greater, with a few firms having quite substantial market shares. Investigation of the size distribution of the top 100 or so firms ranked by output also shows that the decline in firm size from the largest downwards is more rapid in Britain than elsewhere. The exceptionalism of the British case is put down to two principal reasons. First, the close proximity of Britain’s regions enables housebuilders to diversify successfully across different markets. The gains from such diversification are best achieved by large firms, because they can gain scale benefits in any particular market segment. Second, land shortages induced by a restrictive planning system encourage firms to takeover each other as a quick and beneficial means of acquiring land. The institutional rules of planning also make it difficult for new entrants to come in at the bottom end of the size hierarchy. In this way, concentration grows and a handful of large producers emerge. These conditions do not hold in the other two countries, so their industries are less concentrated. Given the degree of rivalry between firms over land purchases and takeovers, it is difficult to envisage them behaving in a long-term collusive manner, so that competition in British housebuilding is probably not unduly compromised by the exceptional degree of firm concentration. Reforms to lower the restrictions, improve the slow responsiveness and reduce the uncertainties associated with British planning systems’ role in housing supply are likely to greatly improve the ability of new firms to enter housebuilding and all firms’ abilities to increase output in response to rising housing demand. Such reforms would also probably lower overall housebuilding firm concentration over time.

Influences on secured lending property valuations in the UK

A significant part of bank lending in the UK is secured on commercial property and valuations play an important part in this process. They are an integral part of risk management within the banking sector. It is therefore important that valuations are independent and objective and are used properly to ensure that secured lending is soundly based from the perspective of both lender and borrower. The purpose of this research is to examine objectivity and transparency in the valuation process for bank lending and to identify any influences which may undermine the process. A detailed analysis of 31 valuation negligence cases has been followed by two focus groups of lenders and valuers and also questionnaire surveys of commercial lenders and valuers. Many stakeholders exist, for example lenders, borrowers and brokers, who are able to influence the process in various ways. The strongest evidence of overt influence in the process comes from the method of valuer selection with borrowers and brokers seen to be heavily involved. There is some also some evidence of influence during the draft valuation process. A significant minority of valuers feel that inappropriate pressure is applied by borrowers and brokers yet there is no apparent part of the process that leads to this. The panel system employed by lenders is found to be a significant part of the system and merits further examination. The pressure felt by valuers needs more investigation along with the question of if and how the process could dispel such feelings. This is seen as particularly important in the context of bank regulation.

A question of value: a discussion of property pricing and definitions of value

Valuation is often said to be “an art not a science” but this relates to the techniques employed to calculate value not to the underlying concept itself. Valuation practice has documented different bases of value or definitions of value both internationally and nationally. This paper discusses these definitions and suggests that there is a common thread that ties the definitions together.

A meta analysis of real estate fund performance

This paper provides evidence regarding the risk-adjusted performance of 19 UK real estate funds in the UK, over the period 1991-2001. Using Jensen’s alpha the results are generally favourable towards the hypothesis that real estate fund managers showed superior risk-adjusted performance over this period. However, using three widely known parametric statistical procedures to jointly test for timing and selection ability the results are less conclusive. The paper then utilises the meta-analysis technique to further examine the regression results in an attempt to estimate the proportion of variation in results attributable to sampling error. The meta-analysis results reveal strong evidence, across all models, that the variation in findings is real and may not be attributed to sampling error. Thus, the meta-analysis results provide strong evidence that on average the sample of real estate funds analysed in this study delivered significant risk-adjusted performance over this period. The meta-analysis for the three timing and selection models strongly indicating that this out performance of the benchmark resulted from superior selection ability, while the evidence for the ability of real estate fund managers to time the market is at best weak. Thus, we can say that although real estate fund managers are unable to outperform a passive buy and hold strategy through timing, they are able to improve their risk-adjusted performance through selection ability.

Volatility persistence and time-varying betas in the UK real estate market

This paper investigates the degree of return volatility persistence and the time-varying behaviour of systematic risk (beta) for 31 market segments in the UK real estate market. The findings suggest that different property types exhibit differences in volatility persistence and time variability. There is also evidence that the volatility persistence of each market segment and its systematic risk are significantly positively related. Thus, the systematic risks of different property types tend to move in different directions during periods of increased market volatility. Finally, the market segments with systematic risks less than one tend to show negative time variability, while market segments with systematic risk greater than one generally show positive time variability, indicating a positive relationship between the volatility of the market and the systematic risk of individual market segments. Consequently safer and riskier market segments are affected differently by increases in market volatility.