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 nation's 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.     

The Integration of Commercial Real Estate Markets and Stock Markets

This paper tests whether commercial real estate markets (both exchange-traded and non-exchange-traded) are integrated with stock markets using multifactor asset pricing models. The results support the hypothesis that the market for exchange-traded real estate companies, including REITs, is integrated with the market for exchange-traded (non-real-estate) stocks. Moreover, the degree of integration has significantly increased during the 1990s. However, when appraisal-based returns (adjusted for smoothing) are used to construct real estate portfolio returns, the results fail to support the integration hypothesis, although this may reflect the inability of these estimated private market returns to accurately proxy for commercial real estate returns. Interestingly, the growth rate in real per capita consumption is consistently priced in both commercial real estate markets and stock markets, whereas previous studies have found mixed evidence on the role of consumption in explaining ex ante stock returns.     

How Do Firms Finance Nonprimary Market Investments? Evidence from REITs

This study explores the impact of investment characteristics, mainly investment location relative to the firm's primary market, on financing choices by real estate investment trusts (REITs). Using a large sample of commercial property acquisitions, we show that REITs are 4–8% less likely to use secured (mortgage) debt when acquiring properties in their primary markets than elsewhere. The documented evidence supports a demand‐side story for the relation between investment characteristics and financing. Moreover, the evidence is consistent with the hypothesis that REITs avoid mortgage financing in their primary markets to preserve operational flexibility in those markets.     

Handing Over the Keys: A Perspective on Mortgage Default Research

This paper is the text of the 1992 Presidential Address for the American Real Estate and Urban Economics Association. A comparative evaluation of mortgage default research finds that both the residential and commercial markets evolved from informal underwriting rules, to formalized (though unvalidated) ratios and rules of thumb, to early risk ratings based upon empirical evidence, to gener-alizable econometric models of default, to option-based pricing models. The commercial market lagged the residential market by about 10 to 20 years at first but is now only about five years behind. The survey finds that research and progress in understanding mortgage credit risk has been precipitated by a public policy need or mandate, data availability, and adequate technology. The absence of any one of these factors has hindered progress in the past. Finally, six emerging issues in default research are identified and discussed: (1) the degree of "ruth-lessness" with which default is exercised, (2) loan recourse, (3) the magnitude and timing of revenues and losses associated with default, (4) loan modification, (5) default in a portfolio context, and (6) leasehold default. Progress in these areas will enhance the efficiency of both the residential and commercial markets.     

Can biotechnology reach the poor? The adequacy of information and seed delivery

The paper examines the expectation that biotechnology can provide significant benefits for smallholder farmers. It uses evidence from current seed systems and variety choice in developing countries. In particular, it examines the adequacy of information flow and the performance of seed markets. Many of the biotechnology innovations proposed for use by smallholders feature qualities that may not be immediately obvious to farmers; implications are drawn for the potential demand for these transgenic varieties. The adequacy of seed systems is also examined, including the characteristics of local seed diffusion and the experience of commercial seed enterprises. The paper concludes that investments in public biotechnology must be accompanied by policies that encourage commercial seed system development and that empower farmers to be able to take full advantage of new technology.     

Investor Sentiment,Limits to Arbitrage and Private Market Returns

This article examines the relation between investor sentiment and returns in private markets. Relative to more liquid public markets, private investment markets exhibit significant limits to arbitrage that restrict an investor's ability to counteract mispricing. Using vector autoregressive models, we find a positive and economically significant relation between investor sentiment and subsequent private market returns. We provide further long‐horizon regression evidence suggesting that private commercial real estate markets are susceptible to prolonged periods of sentiment‐induced mispricing as the inability to short‐sell in periods of overvaluation and restricted access to credit in periods of undervaluation prevents arbitrageurs from entering the market.     

Retail Commercial Banking: An Update on a Period of Extraordinary Change

The 1990s has been an extraordinary period for theretail commercial banking industry. This industryupdate discusses some of the important developmentsand issues they have raised from the standpoint ofcompetition and antitrust policy. A massive mergermovement and removal of restrictions on interstatebanking have raised questions about barriers to entry,the influence of very large banks on the behavior ofother banks in local banking markets, the potentialfor multimarket interdependence among large banks thatmeet one another in numerous markets, and theappropriateness of local markets for analyzingcompetition. Finally, the emergence of electronicbanking and the unbundling of the pricing of serviceshave highlighted the possible importance of switchingcosts for customers in retail banking.     

On the Value of Environmental Certification in the Commercial Real Estate Market

A significant part of the global carbon externality stems from the real estate sector. Environmental certification is often hailed as an effective means to resolve the information asymmetry that may prevent markets from effectively pricing the energy performance of buildings. This study analyzes the adoption and financial outcomes of environmentally certified commercial real estate over time. We document that nearly 40% of space in the 30 largest U.S. commercial real estate markets holds some kind of environmental certification in 2014, as compared to less than 5% in 2005. Tracking the rental growth of 26,212 office buildings, we measure the performance of environmentally certified real estate over time. We document that certified office buildings, on average, have slightly higher rental, occupancy and pricing levels, but do not outperform non‐certified buildings in rental growth over the 2004–2013 period. Further performance attribution analysis indicates that local climate conditions, local energy prices and the extent of certification lead to significant heterogeneity in market pricing. On aggregate, these findings provide some evidence on the efficiency of the market in the adoption and capitalization of environmental characteristics in the commercial real estate market.     

Price Discovery in American and British Property Markets

This paper examines the securitized (public) and unsecuritized (private) commercial property markets in the United States and the United Kingdom for evidence of price discovery. Appraisal-based returns are corrected for smoothing, without presupposing the true returns to be uncorrelated or unpredictable across time. Real Estate Investment Trusts (REITs) and property company returns are corrected for leverage. We find evidence that price discovery occurs in the securitized market structure in both countries, and that this price information does not fully transmit to the unsecuritized markets for a year or more. In Britain, the unsecuritized market appears to be more closely and immediately linked to the securitized market than is the case in the U.S.     

GMM Repeat Sales Price Indices

Illiquid assets are widely spread within the economy but their indices are difficult to measure. This paper proposes a Generalized Method of Moment (GMM) repeat sales regression for estimating illiquid asset price indices. This method has estimators that are arithmetic averages of individual asset returns. This method is able to estimate custom-weighted indices, including equal- and value-weighted indices. It can incorporate hedonic variables to improve estimation accuracy, and it can work with a reweighting technique to mitigate a biased sample problem. Simulations based on artificial markets indicate that the method is more accurate than some alternatives in both efficient and sluggish markets, with and without temporal aggregation. As an application, we use this method to estimate a commercial property price index.     

Analysis of Canadian and Mexican banking strategies in the U.S.

This article reviews regulations and commercial banking structures in Mexico, Canada and the U.S., and examines the comparative operations of Canadian and Mexican bank affiliates in the U.S. vis-a-vis each other and also with U.S. commercial banks of comparable size serving the same markets. Results obtained regarding significant differences in the operations of these banks appear to be consistent with the nascent FDI theory of multinational banking. International survey results regarding bank managers' perceptions and decision criteria suggest that this variable should also be incorporated in the evolving theory.     

The food security challenge

The article first describes current market conditions and the nature of the food security challenge they present. Second, the article considers the kinds of food security measures which have been or could be taken with respect to improving LDC operations in commercial grain markets, using reserves to achieve supply and price stabilization objectives and making food aid a more effective instrument for food security.     

Economics, Competition, and Costs in the Resructuring of U.S. Electricity Markets

Many of the problems facing U.S. electricity markets stem from blatant disregard for the advice and warnings of economists who specialize in these markets. The short list of disregarded economic advice includes existing market power of some generators; transmission discrimination, lack of efficient pricing of transmission congestion; inefficient retail prices; anemic incentives to minimize costs; and lack of consumer choice and experience, occasionally coupled with high switching costs. As uncomfortable as the current state of electric power restructuring may be, going back to full regulation likely would be worse. There is reason to hope that less direct paths to increased competition will resolve some of the worst policy patches and half-reforms. These less direct paths to increased competition include expansion of the size of geographic markets, geographic expansion of transmission unbundling, reductions in obstacles to long-term supply contracting, growth of demand response programs, improvements in generator efficiency and availability, and expansion of real-time pricing and customized energy services for commercial and industrial customers. In aggregate, these constitute a promising “quiet phase” of electric power reform.     

Recoveries on Distressed Real Estate and The Relative Efficiency of Public versus Private Management

This study examines average recoveries from distressed commercial real estate assets held by FSLIC receiverships, and explores differences in the relative efficiency of public versus quasi-private and private entities in the management of these assets. It finds that properties located in markets with rising per capita income and properties that were judged to be less difficult to manage and sell provided higher recoveries, while properties with smaller writedowns prior to government takeover provided lower recoveries. The analysis also provides evidence that quasi-private management by the Federal Asset Disposition Agency provided higher mean recoveries, while private management by contractors provided lower mean recoveries than did public management by FSLIC receivership staff.     

Resource Dependency,Innovative Strategies,and Firm Performance in BOP Markets

Low‐income markets have attracted the interest of academics, politicians, and business leaders alike. In recent years, numerous companies such as Unilever, Cemex, Tetrapak, and Vodafone have provided evidence that low‐income markets offer commercial business opportunities and that private companies can realize profitable business activities while simultaneously contributing to the alleviation of poverty. However, companies are challenged by constraining conditions such as poor infrastructure, nonexistent distribution channels, illiteracy, corruption, lack of enforceable legal frameworks, and violent conflicts when entering those markets. In order to succeed, companies develop new strategies, introduce innovative business models, and develop novel capabilities. Three innovative practices are commonly named in the literature that should enable companies to operate successfully in low‐income markets: (1) integrating the local population and local entrepreneurs to cocreate products; (2) cooperating with nontraditional or fringe stakeholders; and (3) building local capacity, which means improving the market conditions of low‐income markets. This study applies a resource dependence perspective as it provides valuable explanations on the interaction between companies and their environment, how companies cope with environmental constraints, and how the environment and different strategies affect business outcomes. By integrating a resource dependence perspective, the study theoretically frames the strategic recommendations of the literature and answers the underlying research question of whether environmental conditions of low‐income markets cause the execution of innovative practices and whether such practices influence the outcome of companies operating in low‐income markets. The research hypotheses are tested in a structural equation model against data of 103 firms operating in low‐income markets. The study reveals that companies integrate local actors to cocreate products and cooperate with nontraditional and fringe stakeholders to reduce resource dependency. Local capacity building, which means improving the local environment, is only applied by companies when strong partnerships with nontraditional and fringe stakeholders are established. Finally, the study shows that partnerships with nontraditional and fringe stakeholders as well as local capacity building have a positive effect on organizational performance. Thus, when companies aim to enter low‐income markets, they should not follow the recommendation of the transaction cost theory and internalize resources, but rather cooperate with nontraditional partners and invest in the local environment. Moreover, the study shows that market entries into low‐income markets require long‐term commitments to engage in partnerships with regional authorities, local community groups, and nongovernmental organizations. Without these partnerships, it is not possible to reduce high resource dependencies and to establish successful businesses in low‐income markets. Thus, governments should create general conditions that facilitate the creation of partnerships between nontraditional actors and companies, and assist them to improve environmental conditions in these markets.     

Returns and Information Transmission Dynamics in Public and Private Real Estate Markets

This paper examines U.S. public and private commercial real estate returns at the aggregate level and by the four major property types over the 1994–2012 time period. Returns are carefully adjusted for differences between public and private markets in financial leverage, property type focus and management fees. Unconditionally, we find that passive portfolios of unlevered core real estate investment trusts (REITs) outperformed their private market benchmark by 49 basis points (annualized) over the 1994–2012 sample period. Our baseline vector autoregression results suggest that REIT returns do not embed additional commercial real‐estate‐specific information useful in predicting private market returns. These results strongly suggest that equity REIT returns react to fundamental (latent) asset pricing information more quickly than private market returns given their greater liquidity and price revelation. REITs therefore serve as a fundamental information transmission channel to private market returns when asset pricing variables are omitted.     

The changing public role in services to food and agriculture : The legal regulation of food markets in India

A framework allowing the commercial transfer of property rights is an essential prerequisite to market exchange widely considered the prerogative of the state. Here, the social history of the legal regulation of agricultural markets in central, south and northeast India is examined. Regulatory law is shown to be riven with unanticipated outcomes, working as intended only under rare conditions of competition and absence of preharvest commercial debt. Meso level institutions of collective action and micro level behaviour by firms also regulate exchange, unsystematically according to their multiple objectives. Foreign funded projects and another layer of customary procedure. In the light of this analysis, the current policy debates over agricultural market reform are discussed and an analytical framework and suggestions for reform are offered.     

Does the Theory of Irreversible Investments Help Explain Movements in Office–Commercial Construction?

Focusing on the relevance of the modern investment theory in explaining movements in office–commercial construction, we attempt to advance existing empirical work in two respects. First, building on recent theoretical advances, we offer an extended empirical model of new construction that takes into account the full opportunity cost of irreversible investments in uncertain environments. Second, using updated time series of office–commercial construction across the nation's largest markets, we empirically estimate such a model to (i) explore investment behavior during 1982–1998 and (ii) detect differences, if any, in such behavior between the pre- and post-recession years. Our empirical findings are fully consistent with the theory of irreversible investments. Such findings highlight both the relevance and the relative importance of uncertainty in underlying demand factors in shaping movements in office–commercial construction, while pointing altogether to more cautionary investment behavior during the post-recession years.     

Linking smallholder farmers to markets on extensive and intensive margins: Evidence from Nicaragua☆

Access to modern commercialization channels is key for smallholder farmers to move away from subsistence farming and overcome poverty. However, achieving that goal is challenging for smallholders given their lack of appropriate managerial practices, production technology and infrastructure. This paper examines the association between receiving trainings in two distinct entrepreneurial practices, one direct at the individual and farmer-association level and another indirect at the community level, and commercialization in non-local markets at the extensive and intensive margins. We exploit a panel dataset of bean producers in Nicaragua that participated in an NGO program implemented between 2007 and 2012. We find opposite results for the two market-linkage activities, especially on the intensive margin or volume of sales. While reciving direct training on entrepreneurial practices (EP) is positively associated with commercialization, training on municipality engagement (ME) activities is negatively associated. These correlation patterns are mainly observed among entrant farmers as opposed to those already participating in commercial markets prior to the program implementation. We also find varying results for ME activities by plot size and leadership position. Additional estimations show that training activities that are positively correlated with bean commercialization are not necessarily correlated with the commercialization of other crops, and vice versa.     

Controlling for the Impact of Variable Liquidity in Commercial Real Estate Price Indices

Liquidity in private asset markets is notoriously variable over time. Therefore, indices of changes in market value that are based on asset transaction prices will systematically reflect intertemporal differences in the ease of selling a property. We define and develop a concept of "constant-liquidity value" in the context of a model that is characterized by pro-cyclical volume of trading. We then present an econometric model that allows for estimation of both a standard transaction-based price index and a constant-liquidity index. Our application to the NCREIF database reveals that, in the case of institutional commercial real estate investment, constant-liquidity values tend to lead transaction-based and appraisal-based indices in time, and also to display greater volatility and cycle amplitude. The differences can be significant for strategic investment policy viewed from a mean-variance portfolio optimization perspective.