Some Thoughts on Real Estate Pricing

Abstract

In this article, the author examines two key aspects of commercial real estate pricing. First, the spread between interest rates and commercial real estate pricing represents the market’s consensus view on the future growth of real estate’s (unlevered) cash flow less the differential in their return premiums. Second, real estate pricing itself is examined. Real estate’s (unlevered) cash-flow yield should equal the real return requirement grossed up for inflationary effects plus the uncompensated portion of inflationary growth in future cash flows (i.e., the extent to which the expected growth of real estate’s cash flow lags the expected inflation rate). A change in interest rates resulting from a change in the expected inflation rate will not affect real estate pricing, provided the real estate markets are operating at or near equilibrium. A change in interest rates resulting from a change in the real-return requirement will directly affect real estate pricing—even when the real estate markets are operating at or near equilibrium.

TOPIC: Real estate