Commercial Property Market Research Articles

Defining the three Rs of commercial property market performance

Purpose – Modern property investment allocation techniques are typically based on recognised measures of return and risk. Whilst these models work well in theory under stable conditions, they can fail when stable assumptions cease to hold and extreme volatility occurs. This is evident in commercial property markets which can experience extended stable periods followed by large concentrated negative price fluctuations as a result of major unpredictable events. This extreme volatility may not be fully reflected in traditional risk calculations and can lead to ruin. The paper aims to discuss these issues. Design/methodology/approach – This research studies 28 years of quarterly Australian direct commercial property market performance data for normal distribution features and signs of extreme downside risk. For the extreme values, Power Law distribution models were examined as to provide a better probability measure of large negative price fluctuations. Findings – The results show that the normal bell curve distribution underestimated actual extreme values both by frequency and extent, being by at least 30 per cent for the outermost data point. For the statistical outliers beyond 2 SD, a Power Law distribution can overcome many of the shortcomings of the standard deviation approach and therefore better measure the probability of ruin, being extreme downside risk. Practical implications – In highlighting the challenges to measuring property market performance, analysis of extreme downside risk should be separated from traditional standard deviation risk calculations. In recognising these two different types of risk, extreme downside risk has a magnified domino effect with the tendency of bad news to come in crowds. Big price changes can lead to market crashes and financial ruin which is well beyond the standard deviation risk measure. This needs to be recognised and developed as there is evidence that extreme downside risk determinants are increasing by magnitude, frequency and impact. Originality/value – Analysis of extreme downside risk should form a key part of the property decision process and be included in the property investment manager’s toolkit. Modelling techniques for estimating measures of tail risk provide challenges and have shown to be beyond traditional risk management practices, being too narrow and constraining a definition. Measuring extreme risk and the likelihood of ruin is the first step in analysing and dealing with risk in both an asset class and portfolio context.

Property market modelling and forecasting: simple vs complex models

Purpose– The commercial property market is complex, but the literature suggests that simple models can forecast it. To confirm the claim, the purpose of this paper is to assess a set of models to forecast UK commercial property market.Design/methodology/approach– The employs five modelling techniques, including Autoregressive Integrated Moving Average (ARIMA), ARIMA with a vector of an explanatory variable(s) (ARIMAX), Simple Regression (SR), Multiple Regression, and Vector Autoregression (VAR) to model IPD UK All Property Rents Index. The Bank Rate, Construction Orders, Employment, Expenditure, FTSE AS Index, Gross Domestic Product (GDP), and Inflation are all explanatory variables selected for the research.Findings– The modelling results confirm that increased model complexity does not necessarily yield greater forecasting accuracy. The analysis shows that although the more complex VAR specification is amongst the best fitting models, its accuracy in producing out-of-sample forecasts is poorer than of some less complex specifications. The average Theil’sU-value for VAR model is around 0.65, which is higher than that of less complex SR with Expenditure (0.176) or ARIMAX (3,0,3) with GDP (0.31) as an explanatory variable models.Practical implications– The paper calls analysts to make forecasts more user-friendly, which are easy to use or understand, and for researchers to pay greater attention to the development and improvement of simpler forecasting techniques or simplification of more complex structures.Originality/value– The paper addresses the issue of complexity in modelling commercial property market. It advocates for simplicity in modelling and forecasting.

Market maturity: China commercial real estate market

Purpose– The purpose of this paper is to explore the evolutionary path to market maturity that China property market has taken over the last few decades. The focus is on the commercial real estate markets in Beijing and Shanghai. It will help international investors understand the market environment, risk and market activity process.Design/methodology/approach– In this research, the authors apply the market maturity framework and its key determinants based on previous work undertaken by Keogh and D’Arcy (1994) and Chinet al.(2006) for the analysis of Chinese commercial property market. Particular focus is on Beijing and Shanghai. The questionnaire is designed to obtain fair and objective views from international property consultancy firms active in Beijing and Shanghai markets. There are not many of these international property consultancies. The reason why this type of business was selected was to insure that the business had an understanding of China’s place in the global commercial real estate market as this market matures from its emerging market status.Findings– The findings reveal that the respondents felt the commercial property markets in Shanghai and Beijing were now moderately mature. However, issues such as poorer level of standard market information, development instability, low transparency of the legal system, high taxes and high government invention still existed in China’s commercial property market, therefore hindering its progress towards greater market maturity.Research limitations/implications– The small same size of the survey is the major limitation of the research.Practical implications– International investors and analysts can benefit from the research findings through a better understanding of the behaviour and trends in this unique market which will be reflected in their decision-making process.Originality/value– An explorative approach was used due to the lack of data to examine the perception of China’s commercial property market’s evolution and maturity. The findings can then be placed in the context of other Southeast Asian cities. The evolutionary process of China’s property market is rarely examined in previous studies of China property market due to the lack of data and transparency.

EVALUATION OF COMMERCIAL PROPERTY MARKET MATURITY: A CASE OF LITHUANIA

Property market maturity level is one of the influential factors affecting competitiveness of a country in a global arena. Local economies of Central and Eastern Europe may have reacted differently to the economic globalisation process, but property markets in these countries became very much dependent on global trends in terms of market development, evolution and adaption of practices. This article analyzes scientific observations and aspects of property market evolution, suggests a model of property market evolution and adapts the property market maturity concept, applying it in the case of the Lithuanian commercial property market. This article also presents the results of a survey among the commercial property market actors, which mainly suggests the level of property market maturity. The results indicate that although the overall market degree of maturity still needs to be improved, the elements of professional services, the actors’ activity, the investment market environment and the flow of information ranked better maturity, compared to the other elements used in the study.

Forward–futures price differences in the UK commercial property market: Arbitrage and marking-to-model explanations

In this paper the differences between forward and futures prices for the UK commercial property market are analyzed, using both time series and panel data. A first battery of tests establishes that the observed differences are statistically significant over the study period. Further analysis considers the modeling of this difference using mean-reverting models. The proposed models are then estimated with a number of alternative estimation methods and second stage statistical tests are implemented in order to decide which model and estimation method best represent the data.

Spatial Dependence in Commercial Property Prices: Micro Evidence from the Netherlands

Following a hedonic framework, this paper constructs various transaction-based commercial property price indicators for the Netherlands. Using quarterly data from the Investment Property Databank (IPD), the analysis covers a total of 10,000 listed properties over the period 2001-2011. The study contributes to the empirical literature by introducing a spatial econometric methodology into a hedonic framework, via a spatially lagged explanatory variable (spatially lagged valuations per square metre). The results provide significant evidence of the presence of spatial dependence in unit valuations in all sub-sectors of the commercial property market, namely retail, office, industrial and residential. Accordingly, high (low) priced commercial properties tend to be geographically clustered rather than randomly distributed over space. The comparison of the alternative transaction-based indices shows a systematic upward bias in the baseline transaction-based indicator that relies solely on prior appraisals. In addition, compared to the baseline indicator, the spatially augmented transaction-based price indicator appears to fluctuate less and is more robust to small sample sizes. These results are robust for alternative spatial weights matrix specifications. JEL Classification: R30, C31, C21, R12

List Price Information in the Negotiation of Commercial Real Estate Transactions: Is Silence Golden?

This study examines the use (and non-use) of list price information in the process of marketing commercial real estate. As far as we are aware, this has not been addressed in the literature. While housing market research suggests that list prices can serve as a strong anchor and/or signal, list price information is included in less than one-third of the commercial property sales and is less likely to be included as part of the sellers’ offering information for larger multi-tenant properties. Given the potentially powerful effect of list prices (first offers) on outcomes, the non-use of list price information is a puzzle. We speculate that the limited use of list prices may be due to the sellers’ interests in both maintaining their informational advantage and not truncating higher than expected offers, especially during periods of economic growth or with more complex properties. Using a two-stage selection correction model, we find that office properties which provide list price information are, on average, associated with lower price outcomes (ceteris paribus) and that these outcomes vary by price cohort and economic condition. It is important to note, however, that while these findings identify a correlation, they do not necessarily imply causation (i.e., that the use of list prices ‘cause’ transaction prices to be lower). Our results support the notion that asymmetric information and signaling (i.e., the conveyance of property and/or seller information that may affect the likelihood of sale) play a dominant role in explaining the sellers’ strategic non-use of list price information in the commercial property market.

Local Traits and Securitized Commercial Mortgage Default

We expand on the standard commercial mortgage default model and create a new model by looking beyond the usual factors of option value, insolvency, property type, region, originator type, state foreclosure laws and macroeconomic measures. The new model incorporates measures of local economic conditions, specifically MSA-level commercial property market conditions, county level unemployment, and local home price appreciation. We estimate our new model using a dataset containing the performance histories of over 30,000 CMBS loans that were originated between 1998 and 2012. We find that those local trait variables affect the default rate of CMBS loans significantly and provide improved explanatory power over the standard model. We further explore the impact of local home price measures by comparing the explanatory power of lagged and contemporaneous home price indexes, comparing the power of home price indexes at the state, county, and zip-code level, examining the interaction of home price indexes with commercial property type, looking at the impact of home price indexes over time, and at the impact of introducing local commercial land price indexes. We find that local residential house price-related measures provide a high quality and high frequency signal of local market conditions.

Supply, Demand and the Value of Green Buildings

Attention to ‘sustainability’ and energy efficiency rating schemes in the commercial property sector has increased rapidly during the past decade. In the UK, commercial properties have been certified under the BREEAM rating scheme since 1999, offering fertile ground to investigate the economic dynamics of ‘green’ certification in the commercial property market. This paper documents that, over the 2000–09 period, the expanding supply of green buildings within a given London neighbourhood had a positive impact on average rents and prices, but reduced rents and prices for environmentally certified real estate. The results suggest that there is a gentrification effect from green buildings. However, each additional “green” building decreases the marginal effect of certification in the rental and transaction markets by 2 per cent and 5 per cent respectively. In addition, controlling for lease contract features, like contract length and the rent-free period, modifies the impact of environmental certification on rental prices.

The Significance of Capital Flows into the Australian Commercial Property Markets

Capital flows to Australian commercial property have been US$67 billion over the 2007-2011 period. This places Australia as the sixth most active property market globally. Using the extensive Real Capital Analytics database, this paper examines these Australian property capital flows in a local, Asia-Pacific and global context. The dynamics of these property capital flows are also assessed by major cities, property type and investor type. Overall, Australia is found to be an important commercial property investment market at both a local, Asia-Pacific and global level, with strong investor support from both domestic and international property investors as part of their property investment strategies.

The diffusion over time and space of energy efficiency in building

Awareness of global warming and the extent of greenhouse gas emissions have focused more attention upon energy efficiency in building. Moreover, the inventory of “green” office space in the United States has increased dramatically since the introduction of rating schemes that attest to the energy efficiency or sustainability of commercial buildings. In some metropolitan areas, the supply of certified office buildings has more than doubled in the last decade, and there are a few metropolitan areas where “green” office space now accounts for more than a quarter of the total office stock. In this paper, we analyze the diffusion of buildings certified for energy efficiency across US property markets. Using a panel of 48 metropolitan areas observed over the last fifteen years, we trace the diffusion of green building practices across the country. We then model the geographic patterns and dynamics of building certification, relating industry composition, changes in economic conditions, characteristics of the local commercial property market, and the presence of human capital, to the cross-sectional variation in energy-efficient building technologies and the diffusion of those technologies over time. Understanding the determinants and the rate at which energy-efficient building practices diffuse over space and time is important for designing policies to affect resource consumption in the built environment.

Is Instrinsic Energy Efficiency Reflected in the Pricing of UK Office Leases?

The aim of this research is to investigate whether the intrinsic energy efficiency rating of an office building has a significant impact on its rental value. Using a sample of 817 office buildings with Energy Performance Certificate (EPCs), we investigate whether a pricing differential can be identified depending on the energy rating. While previous analyses of this topic have typically relied on appraisal-based and/or asking rent data, our dataset contains actual contract rents as well as information on lease terms. The results indicate a significant rental premium for energy efficient buildings. However, we find that this premium appears to be mainly driven by the youngest cohort of state-of-the-art energy efficient buildings. We also find that tenants of more energy efficient buildings tend to pay a lower service charge but this link appears to be rather weak and limited to newer buildings. Hence, we argue that the information contained in the EPC is still not fully taken into account in the UK commercial property market with the possible exception of both the highest and the lowest EPC ratings.

The risk free rate of return in UK property pricing

PurposeThe aim of this paper is to consider the appropriate benchmark risk free rate sui for pricing of property investments in the UK and, in doing so, investigate the financial characteristics and performance of the UK gilt yields. European investors have been significant players in the UK commercial property market during the last decade and in order to be competitive in bidding situations with UK‐based investors, require to be aware of the pricing criteria adopted.Design/methodology/approachThis paper analyses the stability, yield distribution and volatility of both conventional gilts and index‐linked gilts with different maturities over the period 1980‐2010. It considers the changing structure of the UK commercial property market and reports on a questionnaire survey of the UK property investment community, which focused on the rationale behind the selection of the appropriate risk free rate of return.FindingsThe analysis suggests that ten‐year index‐linked gilts have been the most stable, but that if conventional gilts are preferred, then five‐year nominal appear to be more stable than ten‐year nominal; ten‐year real yields are smoother and relatively less volatile. In the authors' survey of the UK property investment fund managers and their advisors, the majority, but by no means all of the respondents, used the ten‐year nominal gilt yield as their risk free rate of return. However, questions were raised as to whether it was appropriate to use spot or average gilt yields, particularly when rates in 2009/2010 had fallen to such low level.Originality/valueThe findings provide a better understanding of how the different maturities of gilts behave. Insight is given on the criteria adopted by investors when selecting the risk free rate.

The basis of valuations for secured commercial property lending in the UK

PurposeIn the context of the financial crash and the commercial property market downturn, the purpose of this paper is to examine the basis of valuation used in the UK commercial property lending process. Post‐crisis there is discussion of countercyclical measures, including the monitoring of asset prices; however there is no consideration of a different approach to property valuation. This paper questions this omission, given the role that valuations play in the bank regulatory process.Design/methodology/approachThe different bases of valuation available to lenders within international valuation standards are identified as market value (MV), mortgage lending value (MLV) and investment value (IV), with MV being the most used in the UK. Using the different bases in the period before the financial crisis, the UK property market is modelled at a national office, retail and industrial/warehouse sector level to determine the performance of each alternative valuation basis within the context of countercyclical pressures on lending.FindingsBoth MLV and IV would have produced lower valuations than MV, although there are some practical issues involved in adopting the different bases for the bank lending.Originality/valueThe use of a different valuation basis could provide lenders with tools for more informed and prudent lending.

Measuring the financial performance of green buildings in the UK commercial property market

PurposeGiven the centrality of data and information to the evaluation and operation of policies to reduce carbon emissions, the purpose of this paper is to investigate potential sources of data within in the UK on the commercial building stock in terms of its physical characteristics, financial performance, energy consumption and environmental performance. The research aimed to increase understanding of the potential sources of data on property attributes, financial performance and energy use or environmental performance, with a particular emphasis on evaluating their strengths and weaknesses in terms of scope, quality, availability and practicability.Design/methodology/approachThis is an explorative, qualitative study that uses semi‐structured interviews conducted with 11 different data holding organisations.FindingsWhilst public sector organisations have the potential to provide the data required for large samples, there are major barriers to obtaining and linking the different databases. Data on the three key data elements (prices, attributes and environmental performance) tend to be split between different governmental agencies. There are likely to be substantial problems (and costs) of linking the databases due, in particular, to definitional differences. There is a conflict between government's public good objective of increasing knowledge of the environmental performance of buildings and its objective of maximising revenues from the commercial exploitation of data. Since the private sector organisations that hold data are commercially motivated, the samples that they have gathered are largely client driven and, consequently, tend to be partial, particular, proprietary, private and product‐related.Originality/valueSince pricing studies are central to evaluating the effectiveness of eco‐labelling in property markets, this paper improves one's understanding of the role of information and data barriers to improving the allocative efficiency of commercial property markets.

The Diffusion of Energy Efficiency in Building

We analyze the diffusion of buildings certified for energy efficiency across US property markets. Using a panel of 48 metropolitan areas (MSAs) observed over the last 15 years, we model the geographic patterns and dynamics of building certification, relating industry composition, changes in economic conditions, characteristics of the local commercial property market, and the presence of human capital, to the cross-sectional variation in energy-efficient building technologies and the diffusion of those technologies over time. Understanding the determinants and the rate at which energy-efficient building practices diffuse is important for designing policies to affect resource consumption in the built environment.

Sustainability – The Crucial Challenge for the Valuation Profession

Valuation has a pivotal role in increasing the level of sustainability in the built environment. To date, sustainability has received limited attention in valuation practice, and as a result the relationship between sustainability and market value has not been clearly defined. As a consequence, the commercial investment community are hesitant to invest in sustainability beyond best practice management techniques. Valuers’ lack of acknowledgement of sustainability in valuation practice and its changing role in property investment in the built environment, has had a potentially detrimental impact by limiting investment in sustainability in commercial property. Consequently, this lack of acknowledgment and incorporation of sustainability in practice has the potential to cause chaos within the market in the future.It was found that valuers, per se, are inexperienced and have limited knowledge of sustainability in commercial property. Due to differences between generations of valuers, this paper examines whether ‘younger’ valuers’1 knowledge of sustainability, as a concept, measurement and any possible relationship with market value is more extensive than senior valuers. Or whether senior valuers experiences in the market are more sensitive to the change sustainability is having in the commercial property market. A key issue for the profession concerning sustainability and its effect on the market is the limited channels for knowledge development. The implications of this research are the need for increased curriculum in university education, so knowledge dissemination across the profession can be achieved. The development of knowledge of sustainability and its relationship in commercial property will progress the incorporation of sustainability in valuation practice. As a consequence, this will increase the investment in sustainability in the commercial property market.

The Impacts of Commercial Lease Structures on Landlord and Tenant Leasing Behaviours and Experiences

The commercial property market in New Zealand is characterized by two standard but distinct lease environments. In Auckland, the commercial core of the economy, net leases dominate, whereas in Wellington, the political capital, gross leases are dominant. These different lease environments have the potential to strongly influence the nature of landlord and tenant relationships in these markets. Using in-depth interviews with key industry personnel, this study examines the perceptions, behaviours, experiences and key issues confronting landlords and tenants under net and gross leases. The paper examines how different lease structures affect the behavioural and attitudinal characteristics of landlords and tenants including: landlord/tenant perceptions of a lease, the operation and maintenance procedures, landlord-tenant relationship, and ultimately, overall satisfaction.

Investment Styles and Performance in the Australian Unlisted Wholesale Property Fund Market

Unlisted wholesale property funds are an established property investment product which offers institutional investors an attractive approach for exposure to the Australian commercial property market. This research benchmarks the investmentstyles of the property funds covered by the Mercers unlisted property fund index with reference to IPD/PCA Property Investor Digest indices over the 2001-2009 period.Based primarily on tracking error analysis, this research identified a range of structured and active investment styles in the selected property funds. This appears to be linked to debt levels and to be sector specific with the relatively highly geared office property funds being the most affected by changes in property market conditions.Further research is recommended as to the impact of debt funding on investment performance measures. However, this research shows how investment evaluation techniques can be a valuable decision making tool for an astute investment into unlisted wholesale property funds.

Loss Aversion and Anchoring in Commercial Real Estate Pricing: Empirical Evidence and Price Index Implications

We consider two famous phenomena from behavioral economics: loss aversion (based on prospect theory), and anchoring, for the role they played in the pricing of commercial property in the U.S. during the 2000s decade. We find that loss aversion played a major role, approximately as big as was found by Genesove & Mayer in their 2001 study of the 1990s Boston housing market. We also find that more experienced investors, and larger more sophisticated investment institutions, exhibit at least as much loss aversion behavior as less experienced or smaller firms. We extend earlier research by examining how behavior changes in different market environments during the dramatic cycle of 2001-09, and discover that loss aversion operated most strongly during the cycle peak and turning point in 2007, and then became virtually ineffective during the extremely severe drop in the demand side of the market during the 2008-09 crash. We extend previous work by developing longitudinal price indices of the U.S. commercial property market that control for, and explicitly incorporate, the behavioral phenomena we have modeled. From an econometric methodology perspective, these price indices suggest that controlling for behavioral phenomena can be quite important for developing successful hedonic price indices. The indices also suggest that, while the behavioral phenomena are important at the individual property level, the impact of the psychological loss aversion behavior reflective of prospect theory was sufficiently attenuated at the aggregate market level such that the pricing and volume cycle in the U.S. commercial property market during 2001-09 was little affected by it. However, we document substantial strategic pricing differences between sellers facing a gain compared to sellers facing a loss, consistent with a strategy to sell winners and hold onto losers, with the extent of the pricing difference varying longitudinally across the market cycle.