From the Research Desk

11/6/2012 | By Calvin Schnure

Published in the July/August 2012 issue of REIT magazine.


SOURCE: “The Long-Run Dynamics between Direct and Securitized Real Estate,” published in Journal of Real Estate Research, January-March 2011.

AUTHORS: Elias Oikarinen, Martin Hoesli and Camilo Serrano, all with European universities

SYNOPSIS: A team of economists investigated the long-run relationship between returns on listed U.S. equity REITs and direct U.S. real estate investments. They found that REIT returns lead private real estate returns but, in the long run, provide exactly the same diversification benefits.

“The contemporaneous correlation between the returns on direct and indirect real estate investments is typically found to be weak. Several factors may explain this—for example the use of appraisal-based indices is likely to bias the correlations downward—but much of the low correlation observed can probably be attributed to the sluggish adjustment of direct real estate prices to shocks in the fundamentals. Due to the higher liquidity, greater number of market participants, smaller transaction costs and the existence of a public marketplace in the securitized market, the indirect real estate market is generally more informationally efficient than the direct market.

The results show evidence of a tight long-run relationship between NCREIF and NAREIT total return indices, implying that over the very long horizon their diversification properties are similar. The findings should be of importance to long-term portfolio investors such as pension funds or other institutional investors. In particular, co-integration between NAREIT and NCREIF indices indicates that REITs and direct real estate are substitutable in the mixed-asset portfolio of a long-horizon, buy-and-hold investor. Since the two real estate indices are co-integrated with one another but not with the stock market, REITs are likely to bring equivalent long-term diversification benefits to a stock portfolio as direct real estate.

The current notable deviation from the estimated long-run relationship between the direct and securitized real estate return indices, caused by the global financial crisis, has significant implications for today’s investment strategy as securitized real estate is likely to perform better than direct real estate in the forthcoming years.”


SOURCE: How Accurate Are Commercial Real Estate Appraisals? Evidence from 25 Years of NCREIF Sales Data,” published in Journal of Portfolio Management, Special Real Estate Issue, September 2011.

AUTHORS: Susanne Cannon and Rebel Cole from
DePaul University

SYNOPSIS: Two economists analyzed how close appraised values on commercial properties approach the true market values of those properties as reflected in transaction prices. They found that appraised values both differ significantly from actual values and lag behind them.

“In this study we have analyzed the accuracy of commercial real estate appraisals using data from properties sold out of the NCREIF National Property Index during the 1984-2010 period. On average, appraisals are more than 12 percent above or below subsequent sales prices, and this result holds true for both external and internal appraisals. Even in a portfolio context where errors can cancel out each other, results are not appreciably better: appraisals are off by an average 4 percent to 5 percent of value because the under- and overvaluations are highly correlated across properties at the same points in time. In other words, errors don’t “average out.”

We also find that appraisals appear to lag the true sales prices, falling below in hot markets and remaining above in cold markets. Things are even worse when we look year by year. For external appraisals, the median absolute error is 15.2 percent for 2008 and the average is 20.6 percent. The average absolute error for external appraisals is greater than 10 percent in each year from 2002 to 2009 with the exception of 2007, when it was 9.1 percent. Moreover, the signed percentage appraisal errors are larger for levered properties relative to unlevered properties.”

Bank Credit Lines Help REITs Maintain Access to Capital

SOURCE:  “Can Bank Lines of Credit Protect REITs against a Credit Crisis?” published in Real Estate Economics, Summer 2012.

AUTHORS:  Joseph T.L Ooi, Woei-Chyuan Wong and Seow-Eng Ong (all from National University of Singapore).

SYNOPSIS:  Bank credit lines are found to have helped REITs maintain access to capital during three credit crises: the period around the LTCM failure, the market collapse and 9/11 attacks, and the early stages of the recent global financial crisis. These findings have two caveats, however. First, smaller and riskier firms may be unable to draw on committed lines of credit. Second, and more significant, the study does not analyze the extent to which REITs were able to access credit lines through the depths of the financial crisis.

“In a tight credit market, the primary concern of most real estate investment trusts (REITs) is the ability to access capital and maintain adequate liquidity. Bank lines of credit or loan commitments… have been theorized to provide insurance protection against a credit crisis. This article examines whether bank lines of credit can indeed provide some insurance for REITs and allow them to access credit during bad times.  Covering three credit crunch events, both the origination and utilization patterns of commitment loans by 275 REITs publicly traded between 1992 and 2007 are analyzed.

We find that bank lines of credit insulated REITs from credit rationing at both the broad market level as well as at the firm level. However, the insurance value is qualified in the case of smaller and risky firms which may not get to extend their credit limit or draw down on their existing credit lines in a credit crisis.”

Long Planning Lags Will Delay Rash of New CRE Development

SOURCE:  “Time-to-Plan Lags for Commercial Construction Projects,” Finance and Economics Discussion Series (FEDS), Federal Reserve Board, April 2012.

AUTHORS:  Jonathan N. Millar (Federal Reserve Board), Stephen D. Oliner (UCLA Ziman Center for Real Estate and American Enterprise Institute), and Daniel E. Sichel (Federal Reserve Board).

SYNOPSIS:  The lag between the start and completion of a construction project is relatively well known, but there has been little research into the time required to plan new developments. These Fed researchers explore project-level data on more than 250,000 commercial construction projects between 1999 and 2010. They find the planning lags are long, exceeding two years in dollar-weighted terms. These results suggest that it may be several years before new commercial development rises appreciably.

“We use a large project-level dataset to estimate the length of the planning period for commercial construction projects in the United States. We find that these time-to-plan lags are long, averaging about 17 months when we aggregate the projects without regard to size and more than 28 months when we weight the projects by their construction cost. The full distribution of time-to-plan lags is very wide, and we relate this variation to the characteristics of the project and its location. In addition, we show that time-to-plan lags lengthened by 3 to 4 months, on average, over our sample period (1999 to 2010). Regulatory factors help explain the variation in planning lags across locations, and we present anecdotal evidence that links at least some of the lengthening over time to heightened regulatory scrutiny.”

Calvin Schnure is NAREIT vice president, research & industry information.



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