yale school of management introduction to real estate history and concepts
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Yale School of Management
Introduction to Real Estate
History and Concepts
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Yale School of Management
The Dynamics of Real Estate Markets
Real Estate Finance Spring 2005
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Yale School of Management
From Pro Forma to Stochastic Processes
• Pro Forma risk analysis
• Cash flows depend upon:– Scenarios– Probability assessments
• Discount rates depend upon– Systematic vs. unsystematic risk drivers
• Is there any way to incorporate all of this?
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Yale School of Management
Simulation Tools
• Value drivers:– Rents– Vacancies– Expenses
• Drivers of value drivers:– – –
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Yale School of Management
Simulation Methods
• Requires structure/model– Rent processes– Vacancy processes– Interest rates– Covariance estimates
• Model: Sivitanides, Torto, Wheaton (2003)– MSA/aggregate structural relationships
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Yale School of Management
Forward Looking?
• Rational Model: Efficient markets– Agents anticipate future conditions and trends
• Myopic model– Agents react to immediate conditions– Rational explanation?– Muth model
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Yale School of Management
Are Cycles Rational?
Time
Index Values (USD)
0.8
20
1
2
3
4
5
6
7
8
910
11.210.8
3.1
Dec1977
Jun2004
Dec1978
Dec1979
Dec1980
Dec1981
Dec1982
Dec1983
Dec1984
Dec1985
Dec1986
Dec1987
Dec1988
Dec1989
Dec1990
Dec1991
Dec1992
Dec1993
Dec1994
Dec1995
Dec1996
Dec1997
Dec1998
Dec1999
Dec2000
Dec2001
Dec2002
U.S. Inflation NCREIF Property TR U.S. LT Gvt TR
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Yale School of Management
Cobweb Model 1
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Yale School of Management
Cobweb Model 2
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Yale School of Management
STW Analysis
• Interest rates matter
• Spreads and Cap Rates not forward-looking
• No trend towards efficiency
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Yale School of Management
Rents and Vacancies
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Yale School of Management
Patterns:
• Autocorrelation
• Inter-dependence
• Mean reversion
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Yale School of Management
Cap Rates and Interest Rates
• C = NOI/P e.g. Before Tax Yield• Why Negative?• Why Positive?
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Yale School of Management
Hypotheses
• Inflation hedge.• Lower future growth.• GDP changes.• Recent trends: dropping since 2000
– 9.5 to 8.5 RCA– 8.5 – 7.5 NREI– NCREIF no change
• What about diversification?• Trends in the equity market?• Sentiment?
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Yale School of Management
Survey of Institutional Investors+/ - Assets Allocated to Real Estate over next 2-3 Years
0
10
20
30
40
50
60
70
80
I ncrease Decrease Stay the Same Uncertain Prefer not toanswer
Q5
Fre
qu
en
cy
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Yale School of Management
STW Analysis
• Cap Rates moved by interest rates
• Historical analysis remains reliable
• Other factors that could explain structure?– Strategy?– Other investments?
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Yale School of Management
Back to Simulation
• CF depends on:– Rents, vacancies
• Prices depend upon – interest rates– Growth expectations– inflation
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Yale School of Management
Simple Simulation:
• Rents follow a random walk• R(t) = R(t-1) + e(t)• E(t) is a random error• Spreadsheet simulation straightforward• Take last qtr rent, add a normal error term to
it, then move forward one cell for ten cells.• Do this 100 different times and look at
range of outcomes.
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Yale School of Management
Problems
• Random walk assumption
• Normal errors and positive rents
• Don’t know std of error
• Don’t know if random walk makes sense
• What to do?
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Yale School of Management
More Complex Recipe
• If rents autocorrelated– Estimate an autoregression:– R(t) = a + bR(t-1) + e(t) SAVE ERRORS– Take R(0) as today’s rents– R(1) = a+bR(0) + e* where * means random
draw from saved errors.– Move to the next cell
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Yale School of Management
Ultimate Recipe
• Include other variables in estimation stage
• Vector auto-regression – Allows rents to depend on past vacancies– Allows vacancies to depend on past rents– Allows them to depend on past interest rates
• Also allows simulation of extreme cases
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Yale School of Management
VAR Forecasts