What is the Duration of Swiss Residential Property? An Empirical Estimate Using Transaction Data

The appeal of the duration concept comes from its simplicity and wide-use in portfolio immunization. Various duration measures are available for fixed income securities with predefined cash flows (Macaulay duration, modified duration) or interest-rate dependent cash flows (effective duration). Real estate shares some features with fixed-income securities (relatively stable cash-flows) but it also has very distinct properties (no fixed maturity, possibility toîupgradeî the asset through investment). Furthermore Swiss residential rental real estate is particular within the real estate universe due to the existing legal restriction of the rent revising process. The paper starts with a description of the rent revision process and the interactions between the rent-controlled and the free market. An overview of the existing studies on duration of real estate indicates why the existing measure cannot be used for the Swiss case. I then proceed and try to develop an empirical measure of interest rate sensitivity for the Swiss market. The empirical model starts from the dynamic DCF framework developed by Campbell Shiller 1988. Given the statistical properties of the data, the Campbell Shiller is expanded into an autoregressive distributed lag model. Focus is placed on developing a sound econometric model with significant estimates. The main results indicate an interest rate sensitivity of -3.9% with changes taking up to 3 quarters to be incorporated in the price process. An interesting result in this study is also the existence of an autocorrelation structure in the transaction-based index. Tests of normality and auto-correlation of residuals certify that the OLS assumptions are met.