Commercial Real Estate Valuation: Fundamentals Versus Investor Sentiment

43 Pages Posted: 15 May 2008

See all articles by Jim Clayton

Jim Clayton

University of Connecticut School of Business; Cornerstone Real Estate Advisers

David C. Ling

University of Florida - Warrington College of Business Administration

Andy Naranjo

University of Florida - Warrington College of Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: April 2008

Abstract

This paper investigates the role of fundamentals and investor sentiment in commercial real estate valuation. In real estate markets, heterogeneous properties trade in illiquid, highly segmented and informationally inefficient local markets. Moreover, the inability to short sell private real estate restricts the ability of sophisticated traders to enter the market and eliminate mispricing. These characteristics would seem to render private real estate markets highly susceptible to sentiment-induced mispricing. Using error correction models to carefully model potential lags in the adjustment process, this paper extends previous work on cap rate dynamics by examining the extent to which fundamentals and investor sentiment help to explain the time-series variation in national-level cap rates. We find evidence that investor sentiment impacts pricing, even after controlling for changes in expected rental growth, equity risk premiums, T-bond yields, and lagged adjustments from long run equilibrium.

Keywords: Sentiment measures, limits to arbitrage, principal components, error-correction

Suggested Citation

Clayton, James F. and Ling, David Curtis and Naranjo, Andy, Commercial Real Estate Valuation: Fundamentals Versus Investor Sentiment (April 2008). Available at SSRN: https://ssrn.com/abstract=1132361 or http://dx.doi.org/10.2139/ssrn.1132361

James F. Clayton (Contact Author)

University of Connecticut School of Business ( email )

Storrs, CT

Cornerstone Real Estate Advisers ( email )

One Financial Plaza, Suite 1700
Hartford, CT 06103
United States

David Curtis Ling

University of Florida - Warrington College of Business Administration ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-9307 (Phone)
352-392-0301 (Fax)

Andy Naranjo

University of Florida - Warrington College of Business Administration ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3781 (Phone)

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