From the Research Desk



11/8/2012 | By Calvin Schnure

Published in the November/December 2012 issue of REIT magazine.

SOURCE 1: “Commercial Real Estate Returns: An Anatomy of Smoothing in Asset and Index Returns” forthcoming in Real Estate Economics.

AUTHORS: Shaun A. Bond, Soosung Hwang and Gianluca Marcato (University of Cincinnati, Sungkyunkwan University and University of Reading).

SOURCE 2: “Transaction‐Based and Appraisal‐Based Capitalization Rate Determinants” published in Swiss Finance Institute, Research Paper Series N°12 – 28.

AUTHORS: Alain Chaney and Martin Hoesli (IAZI and University of Geneva, Swiss Finance Institute).

SYNOPSIS: Two separate papers look outside the United States at the determinants and extent of appraisal smoothing in valuations of commercial real estate. Bond et. al. examine individual property returns from the Investment Property Databank for U.K. commercial real estate, a dataset very similar to the NCREIF in the United States. They find smoothing in appraisals. Their estimate of the smoothing parameter, however, is smaller than that found in prior studies, possibly due to small sample bias in earlier studies, or because aggregating individual property returns can lead to high levels of persistence at the index level, or due to the impact of nonsynchronous appraisals on the estimated smoothing process.


Chaney and Hoesli study the difference between appraisal-based and transaction-based cap rates in Switzerland. Appraisers pay more attention to property characteristics, which change only slowly if at all, but less emphasis on growth expectations and the cost of capital. Investors place less emphasis on characteristics of the individual property, which are diversifiable, but take more of a portfolio perspective to valuations. These differences in focus help explain why appraisal values are smoothed.

From Bond et. al.: “Appraisers tend to review past estimates and embed that old information into their estimates, thereby dampening volatility in their price estimates… We observe small degrees of smoothing at the individual property level and yet a high level of persistence in aggregate index returns… Commonly used unsmoothing estimates at the index level overstate the extent of smoothing that takes place at the individual property level.”

From Chaney and Hoesli: “Investors are more concerned with the opportunity cost of capital than appraisers, thus linking cap rates more strongly to capital markets, while appraisers have a stronger focus on what they directly observe when they appraise a property, i.e. property characteristics. Property-specific variables hardly change over time, while capital market variables change frequently and significantly. If appraisers were indeed to overweight property-specific information at the cost of capital market information, the resulting values would be smoothed.” 




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