The secular and cyclical determinants of capitalization rates: The role of credit availability, adaptive expectations, and structural changes

This dissertation aims to improve on the many studies that have attempted to explain the determinants of commercial real estate capitalization rates. It adds two major innovations to the existing literature, which explains capitalization rates as a function of Treasury rates, local market fundamentals, and risk spreads. First, it introduces the role of credit availability in affecting asset prices. A mechanism based on adaptive expectations in price formation by real estate investors is developed to demonstrate how credit availability might affect asset pricing. Second, it allows for the existence of long-term structural change in the capitalization rate relationship, which is exogenous to the factors included in the model.;This study tests these theoretical propositions by estimating a variety of empirical specifications on a large quarterly panel data set of appraisal capitalization rates for approximately 30 US metropolitan areas from 1980g1 through 2007q4. A battery of structural change tests is performed to identify the existence of long-term exogenous structural change in the capitalization series. Finally, the dissertation tests the relative performance of the various specifications by checking the ability of the various models to explain the 2000-2007 period, which was marked by a strong decline in capitalization rates across property types. This is accomplished by performing a series of in-sample dynamic forecasts for that period.;A number of key findings are identified as a result of this empirical analysis. First, results suggest the existence of myopic pricing behavior on the part of commercial real estate investors. Second, the availability of debt is shown to have a positive and statistically significant effect on asset prices and a negative effect on capitalization rates. This paper argues that both findings imply the operation of adaptive expectations in asset pricing in commercial real estate markets. Third, the study finds statistically significant evidence of slow structural change in the capitalization rate relationship throughout the sample history that is exogenous to the model of capitalization rates. Fourth, results suggest the lack of statistically significant differences in capitalization rate trends across metropolitan statistical areas.