Do Different Price Points Exhibit Different Investment Risk and Return in Commercial Real Estate?

Abstract

Conventional real estate price indexes provide a single measure for the path of asset prices over time (controlling for the quality of the representative or average property). Properties could, however, have different price dynamics based on the price segment in which they are traded. On the demand side, investors at different price points are differentiated by the amount of capital they have at their disposal and the type and source of financing. Smaller, private investors cluster at lower price points, whereas large institutions dominate the high price points. On the supply side, properties at different price points may serve different space markets with different types of tenants and may reflect different supply elasticity and land/structure value ratios. In this article, the authors use an unconventional approach, quantile regression, to estimate price indexes for different price segments in commercial real estate. Their results show that there are indeed large differences in price dynamics for different price points. These differences are suggestive of a lack of integration in the property asset market because the authors find apparent differences in the risk–return relationship. Lower-price-point properties exhibit less risk (in the form of volatility and cycle amplitude) but have no evidence of lower total returns. Lower-price-point properties also show greater momentum and thus greater predictability. Keywords: commercial real estate; quantile regression; chained hedonic index; investment property; equilibrium asset pricing; price of risk