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The Journal of Real Estate Finance and Economics

Erschienen in:

21.10.2016

Inflation Illusion, Expertise and Commercial Real Estate

verfasst von: William G. Hardin III, Xiaoquan Jiang, Zhonghua Wu

Erschienen in: The Journal of Real Estate Finance and Economics | Ausgabe 3/2017

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Abstract

Data from the National Council of Real Estate Investment Fiduciaries (NCREIF) provide a unique setting to examine the inflation illusion hypothesis. NCREIF provides appraisal-based and transaction-based return series allowing comparison of market participants with specific valuation expertise to general market participants. Results using the appraisal-based indices indicate that the mispricing term is not statistically significantly related to expected inflation, which suggests that commercial valuers do not suffer from inflation illusion. Interestingly, results based on the investor oriented transaction-based indices show that the mispricing term is inversely related to expected inflation and that mispricing plays an important role in determining the long-term discount rate. These results are robust across different empirical specifications, inflation data and subsamples by property type. The comprehensive findings suggest that the inflation illusion effect in direct investment in real estate differs from securitized markets. This study further adds to the general literature regarding the impact of inflation illusion on asset markets by showing that experienced participants may not suffer from inflation illusion which suggests that 1) novice participants may be driving its appearance and 2) experience and training mitigate this bias.

Vorheriger Artikel A Relook into the Impact of Divestitures in the Presence of Agency Conflicts: Evidence from Property Subsidiary Sell-Offs in China

Nächster Artikel REITs, Growth Options and Beta

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There is a substantive real estate literature on information processing heuristics and bias that has been primarily focused on decision-making and tested using controlled experiments.

The term “valuers” is used since the appraisal-based indices use value estimates along with formal appraisals. In all cases the value estimate is made by an expert with experience who may or may not be completing a formal appraisal. This is a common term in the literature outside the US.

Besides the housing market, previous literature also focuses on REITs (see Hardin, Jiang and Wu (2012)). However, one might argue that REITs are more like stocks than direct real estate investment since the REIT market is heavily influenced by the stock market in the past decade.

NCREIF TBI (NTBI) is an index based on the properties that were included in the NCREIF appraisal-based property index (NPI) and were sold during that quarter. As NCREIF indicates, the NTBI will not replace the NPI. Instead, it is a complementary index. See more details on NCREIF website, www.NCREIF.org.

There is a substantial literature on the limits of both appraisal-based and transaction-based return indices in real estate. We focus on a behavioral bias.

Shanteau (1992) is one of the first to emphasize environment, task and feedback in the development of functional heuristics. In valuation of income producing real estate, task and protocol within a DCF framework are used to generate a value estimate. Acquisition specialists are not focused on the valuation process specifically and are tasked to acquire real estate and are incented to create acquisition targets. Within a large real estate investment management firm, professionals can and will have different objectives impacting expertise and heuristics. The basis in commercial real estate, however, remains a DCF model.

In the present context, the essential comparison is based on experience and training since the appraisal base series is created from observations by professionals experienced in valuation. Even within real estate investment management firms there will be differences in training and expertise by function.

One potential issue related to the time series variables in VAR models is non-stationarity. The Augmented Dickey Fuller test is used to examine this issue. For the return and dividend growth variables, the null hypothesis of unit root is rejected. The dividend yield variable does not pass the unit root test which is not surprising since dividend yield in real estate is highly persistent and the tests for a unit root have low power in finite samples against the alternative of a root close to but below unity (see Schwert 1987; Lo and MacKinlay 1989; Cochrane 1991). Asset price cannot deviate too much from fundamentals (e.g., dividend, earnings). Theory (see Vuolteenaho (2000, 2002)) implies that dividend yield should be stationary though both stock price and dividend series are non-stationary Indeed, Vuolteenaho (2000) states that “I’m forced to base the stationarity assumption more on economic intuition than on a clear-cut rejection of the unit root hypothesis”. Hence, following Vuolteenaho (2000, 2002), we do not take the difference of REIT dividend yield, since dividend yield theoretically shouldn’t be non-stationary. In other words, we follow the literature and assume stationarity for dividend yield based on economic theory and intuition.

A test for optimal lag based on Akaike Information Criterion (AIC) is conducted. The result shows that one lag is the optimal lag in the VAR setting.

We do not address the appraisal smoothing issue. Our focus is on a behavioral bias and we test whether expertise (being an expert) mitigates inflation illusion. For a summary of the appraisal index literature, please see Bond and Hwang (2007) and Cheng et al. (2011).

Fund managers and other real estate professionals may be influenced by portfolio allocations, liquidity needs, acquisition and disposition fees and other factors not directly tied to a valuation estimate.

The results are not surprising given that many retail properties have leases that are fixed in amount over a long time period increasing interest rate risk.

Note that this implication is based on the results from the VAR model and VAR is only a category of econometric models that examine the linear interdependency among multiple time series variables. It is possible that the real relationship between the mispricing term and expected inflation is non-linear. Our interpretation is based on VAR based estimate results.

The findings are complementary to investigations in real estate related to anchoring (see Tversky and Kahneman (1974) for a general application and Diaz (1990), Diaz (1997), Black and Diaz (1996) and Diaz and Wolverton (1998), for real estate specific applications). While we do not specifically test the anchoring hypothesis, it seems that the real estate practitioners anchor to prospective income increases over a discount rate mean reverting hypothesis. A property may appreciate, but this is due to a lower than expected future discount rate versus income/cash flow growth.

A related issue is any effect associated with regional heterogeneity in real estate markets. Brunnermeier and Julliard (2008) note that, in the residential real estate sector, the regional heterogeneity is less pronounced than it appears. In the commercial property sector, Liang (2013) measures the integration of the commercial property markets using NCREIF property transaction cap rate data. The author finds that the US commercial property markets are largely integrated and local market conditions explain little concerning transaction cap rates. Thus, it is not likely that regional heterogeneity will significantly influence the main findings. The present reported findings do include those from segmenting the market by property type, which is more common in commercial markets research.

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Titel: Inflation Illusion, Expertise and Commercial Real Estate
verfasst von: William G. Hardin III
Xiaoquan Jiang
Zhonghua Wu
Publikationsdatum: 21.10.2016
Verlag: Springer US
Erschienen in: The Journal of Real Estate Finance and Economics / Ausgabe 3/2017
Print ISSN: 0895-5638
Elektronische ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-016-9587-7

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