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The other (commercial) real estate boom and bust: The effects of risk premia and regulatory capital arbitrage

Author

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  • Duca, John V.
  • Ling, David C.

Abstract

In the 2000 s, U.S. commercial real estate (CRE) prices experienced a boom and bust as dramatic as the more widely analyzed swings in house prices and contributed significantly to bank failures. We model short-run and long-run movements in capitalization rates (rent-to-price-ratio) and risk premia for office building and apartments. In the mid-2000s’ boom, CRE prices were mainly driven by declines in required risk premia that stemmed from a weakening of capital requirements. In the bust, CRE price declines were initially driven by a jump in general risk premia and later by a tightening of effective capital requirements on commercial mortgage-backed securities (CMBS) from the Dodd-Frank Act. The subsequent recovery in CRE prices was induced and sustained by unusually low real Treasury yields. We conclude that macro-prudential regulation of leverage may help limit asset price booms by preventing sharp declines in risk premia.

Suggested Citation

  • Duca, John V. & Ling, David C., 2020. "The other (commercial) real estate boom and bust: The effects of risk premia and regulatory capital arbitrage," Journal of Banking & Finance, Elsevier, vol. 112(C).
    • Handle: RePEc:eee:jbfina:v:112:y:2020:i:c:s0378426618300633
    DOI: 10.1016/j.jbankfin.2018.03.006
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    Keywords

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • R33 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Nonagricultural and Nonresidential Real Estate Markets

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