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13-04 Expected Returns and the Expected Growth in Rents of Commercial Real Estate

  • Plazzi, Alberto
  • Torous, Walt
  • Valkanov, Rossen
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    We investigate whether the cap rate, that is, the rent-price ratio in commercial real estate incorporates information about future expected real estate returns and future growth in rents. Relying on transactions data spanning several years across fifty-three metropolitan areas in the U.S., we find that the cap rate captures fluctuations in expected returns for apartments, retail, as well as industrial properties. For offices, by contrast, the cap rate does not forecast returns even though adsditional evidence reveals that expected returns on offices are also time-varying. We link this varying success of the cap rate in forecastings commercial property returns to differences in the stochastic properties of their rental growth rates. The growth in office rents has a higher correlation with expected returns and is more volatile than for other property types. Taken together, these characteristics diminish the correlation between the cap rate and the future returns to offices.

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    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt8c68m5tk.

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    Date of creation: 27 Jul 2004
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    Handle: RePEc:cdl:anderf:qt8c68m5tk
    Contact details of provider: Postal: 110 Westwood Plaza, Los Angeles, CA. 90095
    Web page: http://www.escholarship.org/repec/anderson_fin/

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    1. William N. Goetzmann & Bradford Case & K. Geert Rouwenhorst, 1999. "Global Real Estate Markets: Cycles And Fundamentals," Yale School of Management Working Papers ysm116, Yale School of Management.
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    5. Eugene F. Fama & Kenneth R. French, 2001. "Disappearing Dividends: Changing Firm Characteristics Or Lower Propensity To Pay?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 14(1), pages 67-79.
    6. John Y. Campbell, 1985. "Stock Returns and the Term Structure," NBER Working Papers 1626, National Bureau of Economic Research, Inc.
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    8. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
    9. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
    10. Karl E. Case, 2000. "Real Estate and Macroeconomy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 119-162.
    11. Jeremy C. Stein, 1996. "Rational Capital Budgeting in an Irrational World," NBER Working Papers 5496, National Bureau of Economic Research, Inc.
    12. Malcolm Baker & Jeffrey Wurgler, 2003. "A Catering Theory of Dividends," NBER Working Papers 9542, National Bureau of Economic Research, Inc.
    13. Sydney Ludvigson & Martin Lettau, 1999. "Consumption, aggregate wealth and expected stock returns," Staff Reports 77, Federal Reserve Bank of New York.
    14. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
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