Refining the real estate pricing model

Crosby, N., Jackson, C. and Orr, A. (2016) Refining the real estate pricing model. Journal of Property Research, 33(4), pp. 332-358. (doi:10.1080/09599916.2016.1237539)

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Abstract

Investment theory dictates that capitalisation (cap) rates for freehold real estate should be determined by the risk-free nominal rate of return plus the risk premium (RP) less the expected growth rate, with an allowance for depreciation. However, importing the concept of the RP from the capital markets fails to guide investors through the complexities of the asset, or enable exploration of purchaser preferences and behaviour. A refined pricing model for real estate is proposed, based on a concept termed a risk scale, to distinguish between macro (market) and micro (stock) determinants of risk and growth within the RP. This pricing model is estimated for a major global investment market, using a cross-sectional inter-temporal framework, with a data-set of 497 transactions in the London office sector over 2010 Q2–2012 Q3. Average cap rates are estimated at just over 5%, with asset-specific attributes dominating yield determination, with submarket quality and tenant covenant most important; and unexpired term insignificant, surprising during the ‘flight to safety’ characterising the period. International investors bought at lower cap rates, despite the ongoing economic and financial instability of the study period. Improving understanding of pricing behaviour and market transparency is important and may be advanced through the pricing model.

Item Type:Articles
Additional Information:Output from RICS Research Trust funded project - Extending the Pricing Model.
Keywords:Property investment, office market, London, capitalization rates, risk premium.
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Orr, Dr Allison
Authors: Crosby, N., Jackson, C., and Orr, A.
Subjects:H Social Sciences > H Social Sciences (General)
College/School:College of Social Sciences > School of Social and Political Sciences > Urban Studies
Journal Name:Journal of Property Research
Journal Abbr.:JPR
Publisher:Taylor and Francis
ISSN:0959-9916
ISSN (Online):1466-4453
Published Online:20 October 2016
Copyright Holders:Copyright © 2016 Informa UK Limited, trading as Taylor & Francis Group
First Published:First published in Journal of Property Research 33(4):332-358
Publisher Policy:Reproduced in accordance with the copyright policy of the publisher

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