Interest Rates, Forward Commitments, and Life Insurance Company Demand for Mortgages

[Excerpt] Periodic flows of life insurance company (LIC) funds into the mortgage market result almost entirely from acceptances of forward commitment contracts negotiated months, and often years, earlier. Thus, Jaffee (1972) and others (Bisignano, 1971; Lintner, 1976; Lintner et al., 1978; Pesando, 1974; Ribble, 1973; and Smith and Sparks, 1971) have considered forward commitment behavior as the appropriate foundation for developing supply-of-mortgage-fund equations in large-scale econometric models and for analyzing the portfolio behavior of LICs and other financial institutions involved in issuing mortgage commitments

The Effect of a Rise in Interest Rates on Hotel Capitalization Rates

Capitalization rates for all commercial real estate are affected by changes in the general level of interest rates. Hotel capitalization rates should respond more quickly to interest rate changes than those of other property types because hotels do not experience the “lease friction” found in other commercial properties, with their lengthy leases. This analysis estimates the statistical connection between interest rate changes and cap rates. Holding other important factors constant, the model estimates that at current levels a 100-basis-point increase in the 10-year U.S. Treasury rate will produce a 28-basis-point uptick in hotel capitalization rates. Continuing improvement in the U.S. economy should eventually result in higher interest rates, but any improvement should also bring both compression of the hotel risk premium and stronger NOI growth, each of which place downward pressure on capitalization rates. With hotel capitalization rates currently in a range of 7.0 to 8.5 percent and an expected slow pace of interest-rate changes, the modelled outcome suggests that hotel property values will remain stable for the foreseeable future. Hotel investors should therefore have ample time to ponder disposition decisions without fear of losing gains while new investors will need to rely on the strong dividend flows currently being produced by hotels for a greater shares of total returns

How to Determine the Future Direction of Hotel Capitalization Rates

[Excerpt] For many in the hotel industry, the ratio of property-level operating income and asset market pricing - the capitalization or ‘cap’ rate – provides an important foundation for rational investing and financing decisions. During periods, such as the recent past, when both the numerator and denominator of the ratio experience different magnitudes of movement, hotel cap rate interpretations become especially difficult for all in the industry. As the markets for hotel room sales now appear headed toward more stability, hopes are rising that the wide bid/ask spreads now in the hotel asset market will narrow, leading to more normal transaction volume and returning property development to pre-2001 levels. The topic addressed in this article is the near-term direction of hotel cap rates. If the rate increases, then the pace of property transaction activity and development will be slower than if rates decline. Based on the conceptual arguments presented below, the probability of hotel cap rates declining in the short run exceeds the probability of rates increasing

Is Overbuilding Risk Declining? Evidence From Hotel Markets

“In the old days, construction statistics and other important data were closely guarded secrets. Developers can now look at competitors’ numbers and tell at a glance if an area is becoming overbuilt.” From a Wall StreetJournal article about U.S. office markets, January 23, 2004

Real Estate Capitalization Rate Interpretations through the Cycle

Both the numerator and denominator of real estate capitalization rates may experience different degrees of movement as markets evolve from one phase of the cycle to another. Capitalization rate interpretations become especially difficult surrounding these turning points. The issue takes two forms. First, periods of market transformation create confusion about what cap rate to apply. Opportunities may occur at turning points to introduce substantially different numerator estimates, which results in multiple capitalization rates for the same property and thus compromises the decision rules of modern investment theory. Second, simultaneous changes in its components (i.e., riskfree rate, risk premium and expected growth rate of income) cause capitalization rates to change, sometimes in unpredictable ways. Tracking the directional pattern of capitalization rates requires an understanding of how and why the components change. This article addresses both forms of the issue

New Beats Old Nearly Every Day: The Countervailing Effects of Renovations and Obsolescence on Hotel Prices

As is the case with other commercial real estate types, hotels begin to depreciate from the time they open, in a process largely driven by functional obsolescence. Unlike other asset types, however, hotel values hit an inflection point at which they begin to rise again. Average annual depreciation for the 3,810 chain-affiliated hotels in this sample was within the range found in other commercial types of real estate. Depreciation rates start off relatively brisk in the first few years, because hotel owners typically do not begin renovations until around year ten. When owners do begin renovation, those expenditures slow but do not stop the decline in the typical hotel’s value. Then, around year twenty-eight, the depreciation reverses for hotels that are still in business. Not only have renovations stabilized the loss in value, but other, unknown factors promote the hotel’s value­—a phenomenon that could be called a vintage effect. Such fully depreciated properties may be located in particularly favorable sites, or they may have architectural or other features that make them attractive to investors

Real Estate Private Equity: The Case of U.S. Unlisted REITs

Purpose - The purpose of this paper is to demonstrate how fixed-share prices, as a structural flaw in private equity funds targeted to small-unit investors, economically disadvantages those investors in favor of sponsors. Design/methodology/approach - The theoretical model incorporates fixed share prices with continuous investment opportunity and evaluates the wealth transfer from long-term investors to marketing affiliates and soliciting dealers in the form of fees paid on the sale of shares to follow-on investors. Findings - This result holds in the presence of high-payout dividend policy that attempts to compensate for wealth transfer. Research limitations/implications - Should share prices be marked-to-market using real estate appraisals or another method, the unlisted REIT and related offerings, such as tenant-in-common funds, will be profitable for sponsors without economically disadvantaging long-term investors. Practical implications - The findings from this research are useful to fund sponsors who design real estate investment products for small-unit investors. These products may retain the advantageous characteristics of existing products while eliminating the disadvantageous features. Originality/value - This is the first academic research on private equity capital raised from small-unit investors

Market Intervention by the Courts: The Economics of Occupational Boundary-Setting

[Excerpt] Market intervention by the courts may take many forms and may occur in a variety of contexts. Sometimes even the most obscure types of judicial decisions can exert a significant impact on the efficiency of exchange (i.e., the price-quality equilibrium) in the market. Consequently, one criterion for evaluating legal precedent is its impact, if any, on the efficiency of exchange in the market

Do Property Characteristics or Cash Flow Drive Hotel Real Estate Value? The Answer Is Yes

Analysts typically use two types of methods to value hotels: comparable sales and the present value of income (sometimes calculated as discounted cash flow). This report explores whether one model is superior to the other, and whether combining both models results in more precise hotel valuations. This evaluation addresses the issue of which property characteristics and income calculations are the most effective in explaining variation in the prices of hotels, how the descending influence of hotel property characteristics and income present value components determine the prices of hotels, and whether hedonic and income-based models produce similar estimates of hotel values. The findings show that using an approach based on comparable sales or one based on incomes results in similar value estimates. Beyond that, the analysis finds that combining both models does not result in more precise hotel valuations

Antitrust Immunity and the Economics of Occupational Licensing

[Excerpt] The proposition that the common law tends to evolve in the direction of economic efficiency has been advanced by Posner and others. This proposition implies that, over time, legal precedent which promotes efficiency of exchange in the market, and thus maximizes the wealth of market agents, will displace precedent that is incompatible with this objective. In evaluating market impact, however, it is important to note that legal precedent which is perceived to be compatible with efficient exchange when viewed from the perspective of outmoded economic theory may not be as compatible as it appears