Commercial real estate volatility : a decomposition of historical market values

Abstract

Risk -- both its mitigation and its exploitation in pursuit of profits -- is likely the most important topic in the study of investment. Risk in private market commercial real estate, however, has been historically less well understood than other more liquid asset classes. To date, most of the research on risk in real estate investment has focused on how changes, cycles, or shocks in the underlying space or asset markets occur. This paper furthers the study of commercial real estate risk by decomposing historical asset volatility into its component space and asset market parts. We do this through the application of a variance decomposition framework on NCREIF NPI time-series data that has been de-trended of long-term secular market movements. In doing so, we are able to compare the relative contributions of space and asset market volatility to commercial real estate price volatility and, more importantly, demonstrate how the expectations of investors who sit at the intersection of those two markets may play an overlooked role in moderating or augmenting volatility.