Abstract
Option pricing theory predicts that capital improvement expenditures are positively linked with high or increasing market lease rates. Ceteris paribus, when the market lease rate is high, or when there is an expectation of higher lease rates in the future, owners are encouraged to increase investment to capture a larger profit. In contrast, when the market lease rate is low, or when there is an expectation of lower lease rates in the future, owners are encouraged to defer capital improvements, causing a skewness in the cash flows. Our empirical results generally support the notion that normal levels of capital expenditures not only maintain value but also actually may create value.
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Notes
Capital investments are assumed to be made at the beginning and returns are realized at the end of the period.
We choose a lag length of four quarters on market value and do not find improvement in our model by including more or less lags.
Properties with no observed capital expenditures (censored or uncensored) are deleted from the analysis. If a property has any missing data, all of that property’s data are also deleted form the analysis.
Southeast Florida includes Miami, Fort Lauderdale, and W. Palm Beach.
The property types hotels, land, and other (which includes entertainment, healthcare, manufactured housing, parking, self-storage, and senior living) have been excluded from the analysis.
We use a simple dating rule to determine periods of low or declining market lease rates. The dating rule used is to identify the peaks and troughs in market lease rates for each property type. Periods of low or declining market leases rates are those periods from peak to trough year-over-year net operating income growth rates.
Here leverage may include senior or junior mortgages, participating mortgages, variable-rate mortgages, step-ups, etc.
Trophy properties are unique, as having unique characteristics that allow owners to extract (at least in theory) a premium rent from prospective tenants for use of the space. Thus, weighed against other properties, market capitalization effects may vary depending on trophy property status.
The other category is a heterogeneous grou** consisting of less than 4% of all observations.
In the NCREIF dataset, internal or in-house appraisals are often performed at the end of the quarter for the first three quarter in the calendar year, with an external appraisal being performed by an independent appraiser at least once a year, typically at the end of the calendar year. Because internal or in-house appraisals are often stale, one would naturally expect a higher market capitalization associated with external appraisals.
The NCREIF index is published for four NCREIF regions: East, Midwest, South, and West. Many authors have used these four NCREIF regions to control for locations when assessing return performance. Alternatively, some authors have attempted to group MSAs into economic regions when assessing the return performance data from NCREIF. Doubtless more elaborate schema could be constructed to control for locations when using the NCREIF dataset. Our results would indicate that any such scheme would need the data as disaggregated as possible.
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Acknowledgements
The authors are grateful to the Real Estate Research Institute for funding this work. We are thank participants at the RERI Annual conference and the 2015 AREUEA-ASSA conference, an anonymous referee, and seminar participants at the University of Heidelberg for helpful comments.
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Bond, S.A., Shilling, J.D. & Wurtzebach, C.H. Commercial Real Estate Market Property Level Capital Expenditures: An Options Analysis. J Real Estate Finan Econ 59, 372–390 (2019). https://doi.org/10.1007/s11146-018-9680-1
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DOI: https://doi.org/10.1007/s11146-018-9680-1