Do Discount Rates Predict Returns and Risk for Private Equity? Evidence from Commercial Real Estate

Abstract

This paper analyzes whether investors’ discount rates predict ex post returns and Jensen’s alpha in the private commercial real estate market. Tracking 4,430 properties in the U.S. that were worth 127 billion dollars at acquisition over the 1997 to 2014 period, I find that individual properties’ acquisition cap rates, which measure discount rates, have significant predicting power for ex post returns and Jensen’s alpha. The power is robust across property types and metro areas, is stronger in the short term, and persists when I control for sample selection, latent factors, heterogeneous factor loadings, and the pricing of non-systematic risk.