QFIP 113 - Secular & Cyclic Determinants of Cap. Rates

Question 1

Interpretation of Cap Rates

Answer 1

• Inverse price-to-earnings ratio
• or earnings (net operating income) to price (cost or value) ratio

Question 2

Criticism of NCREIF cap rates

Answer 2

• NCREIF cap rates are sometimes critiqued for being based on appraisal-based values instead of actual sales transactions
• Appraisal-based underestimates returns volatility due to infrequency of appraisals
• However, in the US they are the sole source of data that goes back several decades

Question 3

Models used in Real Estate Cap Rates Study in QFIP 113 reading

Answer 3

• All models are estimated using the fixed effects panel method with White’s heteroskedasticity correction for standard errors:
  
  • Allows both time series and cross-sectional variation
  • Explicitly models time-invariant differences
  • Increases the power of post-estimation tests

Question 4

Overview of The Standard Specification for Cap Rates

Answer 4

• Postulates that cap rates follow an adjustment process around equilibrium values
• The equilibrium is estimated at the same time as the adjustment and determined by two sets of influences:
  
  • Influences of the discount rate that reflect both the opportunity cost of capital and systematic market risk
  • Fundamental factors that shape investors’ income growth expectations

Question 5

Meaning of Dj Dummy Variables terms in Standard Spec Cap Rates Models

Answer 5

captures any region-specific behavior

Question 6

The two additional factors in the Extended Model Specifications for Cap Rates and their expected regression coefficient signs?

Answer 6

1. SPREADt: Economy-wide corporate bond spread
   
   • Measures degree of risk aversion in the economy
   • Expected to have a positive regression coefficient, because of compensation for increased risk
2. DEBTFLOWt: Ratio of Total Net Borrowing to GDP
   
   • Measures avaibility of debt
   • DEBTFLOW is expected to have a negative regression coefficient – easy debt can cause bubbles, increasing prices and decreasing cap rates.
   • When debt is scarce, real estate transactions become more difficult; prices may fall below assets’ fundamental value.

Question 7

Regression Results Extended Model Specifications for Cap Rates

Answer 7

• Equation (2) is more statistically significant overall than Equation (1) (i.e. it was a good idea to add the new variables).
  
  • The adjusted R-squared is larger in Eqn 2 compared to Eqn 1
• The addition of the new regressors for DEBTFLOW and SPREAD does not change the sign or significance of existing regressors.
  
  • This is a good result, and hints that the new factors are orthogonal to the original factors

Question 8

Conclusions made about structural change that considered adding structural change dummy variable to the Extended Sepc model for Cap

Rates

Answer 8

• Structural change is gradual and exogenous to the model
• Observed structural change cannot be attributed to slowly varying existing regressors in Eqn 2

Question 9

Signs of the estimated variable coefficients in Cap Rates Model 4 (structural change variable)

Answer 9

Question 10

How do Spreads and DebtFlow variables impact the RRI and RTB variables in cap rates models?

Answer 10

SPREAD AND DEBTFLOW will not change sign and significance of Real rent index (RRI) and Real T-bond (RTB) since they are orthogonal to RRI and RTB factors

Question 11

Regression Summary Table for QFIP-113

Answer 11