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Jim Clayton Director of Research Pension Real Estate Association. University of Connecticut Center for Real Estate and Urban Economic Studies Real Estate Capital Markets Update. October 24, 2008. Agenda …. Property valuations and the investment market
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Jim Clayton Director of Research Pension Real Estate Association University of Connecticut Center for Real Estate and Urban Economic Studies Real Estate Capital Markets Update October 24, 2008
Agenda … Property valuations and the investment market The joint determination of price and liquidity in private asset markets Commercial mortgage flows and pricing The interrelationships between financial leverage, market liquidity and property valuations Insights about private market pricing from public REIT pricing
But First … “Generally speaking, the more liquid the market, the better. But there is an important caveat – if market participants come to expect that market liquidity will always be ample, and they acquire assets with the assumption that they can liquidate their positions quickly and at fairly predictable prices, they may end up taking on more risk than has been factored into the purchase price … this could sow the seeds of a nasty correction in the event of a shock and a rapid price decline in market liquidity. That said, liquidity is the lifeblood of markets.” - From remarks by David Longworth, Deputy Governor of the Bank of Canada, in a speech to the Investment Industry Association of Canada, Toronto, 3 October 2007.
“Market liquidity is essential to allow assets to be bought and sold quickly and with low transaction costs. Liquidity allows for ready leverage but it also creates the means for crises … it is in the froth of liquidity that profits are made and demons are spawned.” A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation Richard Bookstaber, 2007 John Wiley & Sons, Hoboken NJ
Distribution of PREA Investor Member Real Estate Investment Strategies
Primer/Recap of Leverage Impact … Notes … Var[rD]=0, since the cost of debt is fixed and debt is assumed riskless in terms of default σ2 =var[.] {variance} σ = √var[.] {standard deviation} Property risk Added financial leverage risk
Thinking about Price-Liquidity adjustment and the role of Leverage in Private Markets …
Recent Asset Class Returns … Private Institutional Real Estate
The New Barometer of Financial System “Fear” …. The “TED” Spread
The New Barometer of Financial System “Fear” …. The “TED” Spread
Property Valuation Appreciation … Appraisal & Transaction-Based Indices
Transaction-Based Index Family(MIT Center for Real Estate derived from NCREIF sales)
Real Estate Transaction Activity … Search Model Framework Sellers Buyers
transaction volume determined by intersection of buyer and seller reservation price distributions • transaction volumeandprice are jointly determined; or, transaction prices are conditional on market liquidity at time of sale changes in transaction frequency…buyer value distributions shift more relative to seller distributions in response to shocks.
Commercial Property Price Changes Over the Past Year (Moody’s/REAL CPPI to Q2’08)
Wall Street … Arbitrage, slicing-dicing, risk-management, synthetic exposure, derivatives, hedge funds Alphabet soup of CRE debt-related structured finance products … CMBS CDO CDS CMBX
Fuelling the growth of CMBS & Mezz Lending …CRE Collateralized Debt Obligations (CDOs) CRE CDOs
