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What Causes the Differential Movements of Cap Rates in the High and Low End Housing Markets?

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  • Jiancong Liang
  • Siu Kei Wong
  • Kwong Wing Chau

Abstract

The capitalization rate used in real estate literature is the ratio of net operating income to property value. This paper has investigated the capitalization rate movements in Hong Kong from 1987 to 2012. In Hong Kong, capitalization rates for residential and commercial properties were closely intertwined during 1984-1997. However, after 1997, diverging patterns were observed: commercial properties' cap rates became higher than residential properties'; cap rates for lower-end properties increased relative to higher-end properties. What are the factors that determine the cap rates in Hong Kong?What are the causes that generate such gap between different properties types' cap rates in Hong Kong? Based on the basic Gordon model, WACC and CAPM, the study seeks to explain the cap rate movements in Hong Kong by modelling it as a function of the risk-free rate, risk premium, and expected long-run rental growth. Our preliminary results show that the cost of debt, stock market performance, unemployment, CPI inflation, and price growth are significant determinants of cap rates. At the same time, the LIBOR/HIBOR ratio and price growth are significant determinants of cap rate gaps. Additionally, the cap rates would also adjust to its lagged term due to autocorrelation.

Suggested Citation

  • Jiancong Liang & Siu Kei Wong & Kwong Wing Chau, 2013. "What Causes the Differential Movements of Cap Rates in the High and Low End Housing Markets?," ERES eres2013_69, European Real Estate Society (ERES).
    • Handle: RePEc:arz:wpaper:eres2013_69
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    JEL classification:

    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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