Towards Indices of Real Estate Value and Return

IN THIS PAPER, the construction of an index of value and return for non-owner occupied industrial property is chronicled. Although real estate is an important investment vehicle (aggregate value is large in comparison to the stock market), relatively little is known of the historical holding period risk and return for equity owners of real property. In a related paper [Hoag, 1979], current empirical knowledge of real estate returns is summarized and found to be meager. Practically, there are no available indexes which attempt to measure price appreciation, cash flow or return from real estate. Actually, many observers question the existence of one national real estate market. With no easily observable market transaction prices, there is little wonder about the paucity of index numbers. Worse yet, with no information available on investment returns it is very difficult to utilize current investment management technology (the Capital Asset Pricing Model-CAPM) to estimate the risk entailed in a real estate investment. In Section ?2, a conceptual framework for estimating real estate value and return is developed and related to methods currently utilized in common stock risk/return analysis. The method of analysis expounded herein leads naturally to a consideration of a property valuation function based on a vector of fundamental microeconomic and macroeconomic variables which affect property value. With certain reasonable approximations, the valuation model leads directly to an estimate of the market rate of return on real estate, the risk and return associated with each property and the market risk. In this paper, the analysis focuses on time series properties of risk and return estimates for real estate. Coefficients of responsiveness to the fundamental valuation characteristics which are analogous to a multifactor analysis of common stock risk and return can be computed. The responsiveness coefficients are analyzed further in Hoag [1979]. This technique is specialized to one particular property classification in Section ?3: industrial real estate (consisting primarily of warehouses with some light manufacturing and distribution.) The valuation factors relevant to these properties are detailed and the sample is discussed in Section ?4. Section ?5 presents the estimated valuation function and the returns on a subsample of carefully checked observations. The estimates of the valuation function are performed