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Article

The Secular and Cyclic Determinants of Capitalization Rates: The Role of Property Fundamentals, Macroeconomic Factors, and “Structural Changes”

Serguei Chervachidze, James Costello and William C Wheaton
The Journal of Portfolio Management Special Real Estate Issue 2009, 35 (5) 50-69; DOI: https://doi.org/10.3905/JPM.2009.35.5.050
Serguei Chervachidze
is a capital markets economist at CBRE Econometric Advisors and a doctoral candidate in economics at the University of Houston in Houston, TX.
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  • For correspondence: schervachidze@twr.com
James Costello
is a principal at CBRE Econometric Advisors in Boston, MA.
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  • For correspondence: jcostello@twr.com
William C Wheaton
is a principal at CBRE Econometric Advisors and a professor of economics at the Massachusetts Institute of Technology in Cambridge, MA.
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  • For correspondence: wheaton@mit.edu
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Abstract

In this article, the authors revisit many studies that have attempted to explain the determinants of real estate capitalization rates. Two new innovations are introduced. First, the authors identify two macroeconomic factors, in addition to risk-free Treasury rates, that greatly impact cap rates—the general corporate risk premium operating in the economy and the amount of debt (liquidity) available. The addition of these factors greatly adds to the ability of previous models to explain the secular fall of cap rates in the last decade and their recent rise. Second, the authors search for “structural” shifts in the cap rate using innovative tests, including a large number of macroeconomic factors. The tests identify two distinct periods that the authors label as “investor sentiment.” A period of negative sentiment was identified from 1991 to 1996 and a period of positive sentiment was identified from 2002 to 2007. Methodologically, the analysis uses a large and robust quarterly panel dataset of 30 U.S. metropolitan areas from 1980 Q1 through 2007 Q4. The authors compare the models using traditional measures of within-sample fit, as well as how the models behave in in-sample backtest forecasts.

  • © 2009 Institutional Investor, Inc.
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The Journal of Portfolio Management: 35 (5)
The Journal of Portfolio Management
Vol. 35, Issue 5
Special Real Estate Issue 2009
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The Secular and Cyclic Determinants of Capitalization Rates: The Role of Property Fundamentals, Macroeconomic Factors, and “Structural Changes”
Serguei Chervachidze, James Costello, William C Wheaton
The Journal of Portfolio Management Sep 2009, 35 (5) 50-69; DOI: 10.3905/JPM.2009.35.5.050

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The Secular and Cyclic Determinants of Capitalization Rates: The Role of Property Fundamentals, Macroeconomic Factors, and “Structural Changes”
Serguei Chervachidze, James Costello, William C Wheaton
The Journal of Portfolio Management Sep 2009, 35 (5) 50-69; DOI: 10.3905/JPM.2009.35.5.050
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  • Article
    • Abstract
    • BACKGROUND AND RELATED LITERATURE
    • DATA AND METHODOLOGY
    • THE STANDARD SPECIFICATION: MARKET FUNDAMENTALS AND TREASURY RATES
    • EXTENDED MODEL SPECIFICATIONS: ADDING RISK PREMIUM AND DEBT FLOWS
    • TESTING FOR STRUCTURAL CHANGES
    • COMPARATIVE ANALYSIS OF ALTERNATIVE SPECIFICATIONS
    • BACKTESTS AND FORECASTING PERFORMANCE OF ALTERNATIVE SPECIFICATIONS
    • CONCLUSION
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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