Valuation accuracy in vacant office properties
A comparison between appraised cap rates and transaction cap rates
SANAZ MIRZAEI
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Titel research project: Valuation accuracy in vacant office properties Student: Sanaz Mirzaei [4317882] Address: Buitenhoflaan 17, 2353 MG Leiderdorp Phone: 0643418510 E-mail address: [email protected] Date proposal: July 2, 2015 MSc Laboratory: Real Estate Management First mentor: Drs. Philip Koppels Second mentor: Dr. Ir. Hilde Remøy External Examinator: Dirk Dubbeling (OTB) ii Valuation accuracy in vacant office properties
Preface
This master thesis discusses the valuation accuracy in vacant office properties in the Netherlands. It is written for the Real Estate Management graduation lab at the Department of Real Estate and Housing, within the Faculty of Architecture at the TU/Delft. It covers the final official assessment session (P5) of the total of five official assessment sessions for the graduation process started in September 2014.
The research proposal is built upon the current problem of the Dutch office market, namely oversupply and the bottlenecks of converting the obsolete office stock. Even though the transformation of surplus stock is generally accepted by various market parties ( e.g. government, investors, redevelopers, financier, academic researchers, etc.), there is no statistically significant evidence pertaining the valuation accuracy of vacant office stock. Therefore, this research aims at providing such indications with a hope to facilitate the adaptation process of the obsolete office stock and overcome the oversupply of the Dutch office market.
The result of this research can be found in the rest of this thesis. I thank the following people for their help: my first mentor Philip Koppels and second mentor Hilde Remøy for their kind support and constructive feedback, Aart Hordijk for his valuable input and lastly my mentors at the Amsterdam municipal tax office, Sander Sijm and Thijs Booij. Without their valuable input this thesis would be completely different.
Sanaz Mirzaei July 2015 Valuation accuracy in vacant office properties iii
Executive summary
INTRODUCTION The Dutch office market is experiencing fundamental changes. On one hand, the low dynamics of the office market caused by the financial and real estate crises and the changes in the behavior of office users, reduced the required office space in this market (in 2014 7% lower take-up than 2013). On the other hand, continuous overproduction and oversupply of offices caused by the accelerating expansion of this market from the 1980’s and onwards, resulted in a huge gap between demand and supply in the office market. This all off balanced the Dutch office market that much, that this market never recovered since the 2001 crisis in real estate, even before the financial crisis in 2008 started. As a result there is a relatively high average national vacancy rate of 15.7% which equals 7.8 million square meter of the total office stock.
Adaptive re-use strategies as one of the possible strategies for dealing with vacant offices can be seen (partly) as a solution to balance the oversupply of the office market. Adaptive re-use strategies consist of either renovation, within use adaptation of obsolete office buildings, or conversion to new use.
PROBLEM STATEMENT Even though the adaptive re-use strategies are mentioned as a possible solution to balance the oversupply of the Dutch office market and decrease the current structural vacancy, they are often obstructed by a lack of financial feasibilities. Many parties (e.g. investors, redevelopers, etc.) believe that valuations of vacant offices are too high in comparison to their actual market value. Previous research has indicated that difficulty and uncertainty in estimating the value of vacant properties has a negative influence on the valuation accuracy. Since a vacant property generates no rental income and may have a relatively low promise for future tenancy, assumptions in appraising this property are more uncertain and therefore prone to some degree of inaccuracy in valuation.
Besides limiting the adaptive re-use strategies, other consequences of inaccuracy in valuation are its negative influence on: the solvency rate and judgment about the financial position of property owners, on property cash flow after tax due to the inaccuracy in estimated assessed value, and lastly, on recording a lower volatility in appraisal indices compared to the real estate value (transaction price) which results in not recording the true volatility of the Dutch office market.
Therefore, studying the accuracy of appraised market value in comparison to the actual market value (transaction price) of vacant offices is of importance of the Dutch real estate market, Dutch financial institutions as well as the Dutch society.
RESEARCH GOAL This thesis focuses on this specific problem by determining the cap rate components as one of the important input variables for determining the property value. This is to understand the differences and similarities in pricing processes of two main market players, namely appraisers and investors to enhance accuracy and consistency in office property valuation in the Netherlands. Subsequently, it aims to increase awareness about valuation accuracy for vacant office properties among various market players (e.g. investors, appraisers, developers, etc.) by studying whether any variation in accuracy depends upon the variation in vacancy rate. Therefore, the main research questions of this study are: iv Valuation accuracy in vacant office properties
1. To what extent do appraised cap rates correspond with transaction cap rates?
2. Can the differences between appraised cap rates and transaction cap ratesbe explained (partly) by structural vacancy risk?
Whereas the main research hypothesis to be tested are as follows:
Hypothesis 1 The appraised cap rates of Dutch offices during the rising market are lower (appraised value is higher) than the transaction cap rates (prices), to a larger extent than the declining market (after financial crisis).
Hypothesis 2 Appraisers put more weight on easily observable elements in determining office cap rates whereas investors are more concerned with macro-economic variations over time.
Hypothesis 3 The differences between appraised cap rates and transaction cap rates of an office property have a positive correlation to its vacancy risks.
Theoretical framework Literature on cap rate determinants show a trend from the dominancy of macroeconomic and time-series variations in cap rates, to the development of those where micro-level and property- specific factors become more prominent in explaining the driving forces of cap rates. Due to an increase of the investors’ awareness and interest in the quality and characteristics of properties within investment funds, and also the development of ‘Big Data’ and availability of large volumes of information (structured and/or unstructured) regarding property characteristics, this thesis introduces a new dynamic and applicable model specification to determine cap rates as follows:
Where; = + ∗ − + 1 − ∗ + + + − = risk free rate, = Loan-to-value ratio, = rate of return on debt, ⁄ = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes, = a constant expected rate of growth in the NOI.
This model decompounds the risk premium component achieved on investing in the office market, to location, the property-itself and the user (office-user) attributes. Furthermore, it develops these (1) components by categorizing them into background context, location, property, and office-users determinants= of cap rates in a new cap rate regression model specification: Where; V = property value, NOI = Net Operating Income in the first year, Ro= overall capitalization rate (%).
(2)
Where;= = expected required rate of return (discount rate %).
(3) Where;= = expected required rate of return (discount rate %), = expected rate of growth in the NOI.
(4)
=− (5) Where; == ∗ + 1− ∗ = overall cost of capital, = Loan-to-value ratio,
= cost of debt, ⁄ = cost of equity.
(6)
Where;= + (̅ −) = expected return on property, = risk free rate, = expected market return, = equity beta ( ). ̅ (,)⁄
Where; = premium from participation in real estate,
= premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes.
= + ∗ − + 1 − ∗ + → = + ∗ − + 1 − ∗ + + + = + + +
(16)
= – → = + ∗ − + 1 − ∗ + + + − = + ∗ − + 1 − ∗ + + + (17)
Where; = risk free rate, = Loan-to-value ratio, = rate of return on debt, ⁄ = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes, = a constant expected rate of growth in the NOI. Valuation accuracy in vacant office properties v
(18)
Where; =+ ∑ + ∑ +∑ + ∑ + = constant or intercept term, = the coefficient of variables indicating context, location, property and office users factors, α = the error term. The backgroundε context, addresses the overall conditions/circumstances at the time that (19) investments 1take place. It consists of variables related to the macro-economic conditions, capital marketWhere; expectations,= office market trends, and sale conditions. This category focuses on elements that mostly= Appraised change cap over rate (%), time (time-series). The second category, location, considers the property = net income multiplier. location at both macro- and micro-level and examines both cross-sectional and time-series changes of cap rates. The third category addresses variables pertaining the property itself (property-specific (20) characteristics) while the last category focuses on elements that are associated with the office-users = (tenants).Where; Figure i shows the interrelation among these four categories. = overall capitalizationcontext rate (%), = property value (gross transaction price), = Net Operating Income in the first year.
context
location
property office-users
Figure i, interrelation among four categories of background context, location, property, and lastly office-users.
Empirical research Data The data for this research is gathered by combining two databases from the Amsterdam Municipal Tax office (in Dutch Gemeentebelastingen Amsterdam), and the TU/Delft property database. In addition to these databases, a complimentary database is created from different sources including: the Central Bureau of Statistics in the Netherlands, De Nederlandsche Bank, and a couple of real estate agencies such as Jones Lang LaSalle, Cushman & Wakefield, and DTZ Zadelhoff. The final database consists of 124 office transactions in Amsterdam from 2004 till 2011.
Hypothesis 1 | Valuation accuracy appraised versus transaction cap rates To test this hypothesis, the appraised cap rates and transaction cap rates are compared per year before and after the financial crisis. The transaction cap rates are calculated ex-post, whereas the appraised cap rates are present ex-ante in the Amsterdam Municipal Tax office database. In order to measure the differences between appraised cap rates and transaction cap rates, a total variance vi Valuation accuracy in vacant office properties test is used. To gauge the accuracy, both average absolute differences and average directional differences between transaction and appraised cap rates are measured. The absolute differences is an appropriate indicator to see how different, on average, the typical transaction cap rate is from the appraised cap rate. Whereas, the directional differences provides an indication whether there is any tendency for appraised cap rates to consistently understate or overstate the transaction cap rates or whether the errors are randomly spread around zero.
Hypothesis 2 | Cap rates determinants To test this hypothesis, the determinants of the appraised cap rates and transaction cap rates are compared. The multiple regression model is used to analyze the cap rate determinants for both appraised and transaction cap rates, using the available variables pertaining the context, location and property elements. Office-users elements could not be entered to the models due to the lack of availability of adequate data. The regression is done once by using appraised cap rates and the other time transaction cap rates as a dependent variable using a hierarchical method (blockwise entry) of entering the independent variables in the regression model, based on their theoretical importance, and based on the context (or time-series), location and property categories.
Hypothesis 3 | The myth of vacancy and valuation accuracy To test this hypothesis, the differences between appraised and transaction cap rates are compared with different types of vacancy risk: market conformed vacancy risk, potential structural vacancy risk, and structural vacancy risk. The vacancy risk is calculated as based on the vacancy ratio relative to its direct surroundings. A one-way ANOVA test is used to examine the relation between valuation accuracy and the different types of vacancy risk.
Empirical findings Hypothesis 1 | Overstated and smoothed appraised cap rates The results indicate consistently overstated and smoothed appraised cap rates in the Amsterdam office market from 2004 till 2011, compared to the transaction cap rates. The transaction cap rates are on average lower and more volatile compared to appraised cap rates. This indicates that appraised cap rates (WOZ-values), are understating the property values compared to their actual market value (transaction prices). An average deviation of 50% is the result of the differences between appraised cap rates and the transaction cap rates, which corresponds with the same deviation between appraisal value and transaction prices.
Figure ii shows the cap rate development transaction, appraised (both WOZ and aggregated cap rates in market reports), from 2004 till 2011 in Amsterdam office market.
Figure iii indicates the development of the cap rates (both transaction and WOZ cap rate) in different years in Amsterdam, which clearly emphasizes on the higher volatility and sensitivity of transaction cap rates to different submarkets in Amsterdam, and smoothing in appraised cap rates.
Hypothesis 2 | Forward looking investors versus backward looking appraisers The findings deduced from testing this hypothesis show that investors in the Amsterdam office market are more concerned with the cross-sectional and property specific variations in cap rates, whereas the appraiser are more concerned with the time-series variations in cap rates. Figure iv compares the explanatory power of context, location, and property related variables, for transaction Valuation accuracy in vacant office properties vii
Figure ii, cap rate Transaction cap rate 0,12 development in Appraised (WOZ) cap rate Amsterdam from 2004 to 2011. Appraised (market) cap rate 0,10
Error bars: 95% CI 0,08
Mean 0,06
0,04
0,02 Amsterdam Submarkets 0,20 Center New-West 0,00 2004 2005 2006 2007 2008 2009 2010 2011 0,18 North East SaleYear West 0,16 Amsterdam Submarkets WestPoort 0,20 Figure iii, cap rate Center AmsterdamSouth districts New-West 0,14 AmsterdamSoutheast Submarkets 0,18 North 0,20 development (on East CenterCenter the top transaction 0,16 West 0,12 New-WestNew-West WestPoort 0,18 South cap rates, at the NorthNorth 0,14 Southeast bottom appraised East East Center 0,10 0,12 New-West 0,16 cap rates) in WestWest North WestPoortWestPoort East Amsterdam districts 0,10 West 0,08 SouthSouth WestPoort 0,14 from 2004 to 2011 SoutheastSoutheast 0,08 South Mean TP_CapRate Southeast Center Mean TP_CapRate 0,06 0,06 0,12 New-West North 0,04 0,04 East 0,10 West 0,02 WestPoort 0,02 0,08 South 0,00 Southeast
Mean TP_CapRate 2004 2005 2006 2007 2008 2009 2010 2011 0,00 0,06 YearOfSale
Amsterdam 2004 2005 2006 2007 2008 2009 2010 2011 0,20 0,04 Submarkets Center YearOfSale 0,18 New-West North 0,02 East 0,16 West WestPoort South 0,14 Southeast 0,00 Center New-West 0,12 North East 2004 2005 2006 2007 2008 2009 2010 2011 West 0,10 WestPoort South YearOfSale Southeast 0,08 Mean WOZ_CapRate 0,06
0,04
0,02
0,00
2004 2005 2006 2007 2008 2009 2010 2011 YearOfSale
and appraised cap rates. Whereas Figure v shows the differences of the explanatory power of time- series (year dummies), location, and property related variables, for transaction and appraised cap rates.
Hypothesis 3 | Structural vacancy as a Paradoxical phenomenon The result of the test shows a paradoxical situation when there is structural vacancy risk, both appraisers and investors weighted the vacancy risk in a more similar way when there is a market conformed vacancy ratio. In this case, the appraisers put less emphasis on the vacancy and the differences between appraised cap rates and those of transactions become greater. However, the reliability of the statistical results is very low and not statistically significant, due to the unbalanced Page 1 Page 1
Page 1
Page 1
Page 1 viii Valuation accuracy in vacant office properties Hypothesis 2 | Forward looking investors vs. Hypothesisbackward looking 2 | Forward appraisers looking investors vs. backward looking appraisers
RTP RV RTP RV
step 1 2%< 11% step 1 Year dummies 9%< 18%
step 2 30%> 23% step 2 30%> 19%
step 3 19%> 6% step 3 15%> 5%
2 2 R 51% 40% R 54% 40% 20 21 Figure iv, explanatory power of context, location and Figure v, explanatory power of year dummies, property specific variables respectively in transaction location and property specific variables respectively and appraised cap rates regression in transaction and appraised cap rates regression
distribution of the samples in each vacancy risk category. In the total sample data, less than 5% of the transactions contain properties with a potential structural vacancy risk or structural vacancy risk.
Conclusion and further research The research findings indicate transaction-valuation differences in cap rates as well as contributing factors to these differences. The transaction cap rates are determined by mostly the location and property related variables, whereas macroeconomic and context variables determine the appraised cap rates vastly in the Amsterdam Office market. The low amount of transactions of vacant office properties indicate that selling an office building, being structurally vacant, seems to be an exceptional situation in the Amsterdam office market. This since there are not many of these type of offices, being sold in Amsterdam. One can interpret this as a possibility of asking a higher value than an investor is willing to pay. Unfortunately, no concrete conclusion can be made due to the lack of market evidence and available data to further investigate on this problem.
Further research can be done by using appraised values for the commercial purposes (sale or finance), rather than WOZ values which are appraised for tax purposes in order to improve the degree of comparability between transaction and appraised cap rates. In addition, using transaction cap rates, which are not calculated ex-post, one can reduce the number of assumptions to estimate the transaction cap rates. This can lead to better results of the research. Furthermore, the research findings can be improved in case of multi-tenant and multi-owner properties that are also included in the database in addition to the properties with a single tenant and a single owner that this thesis uses. The degree of comparability between transaction and appraised cap rates can be enhanced when including the transaction of other cities in the Netherlands. This gives opportunity to compare cross-sectional differences among various office markets (e.g., Rotterdam, Utrecht, etc.). Ultimately, these all enhance the chance of analyzing properties with different vacancy rates (including those with potential structural and structural vacancy levels. Valuation accuracy in vacant office properties ix
Table of contents
Preface II Executive summary III
Chapter 1: Introduction 1 1.1 Target audience 1 1.2 RESEARCH OUTLINE 1
Part I: Research Proposal 2 CHAPTER 2: A glance at the Dutch Office market 4 2.1 Dynamics of DUTCH OFFICE MARKET 4 2.2 Market disequilibrium 5 2.3 Replacement market 6 2.4 Adaptive re-use 7
Chapter 3: Problem field 10 3.1 Lack of financial feasibility - lack of willingness 10 3.2 Book Value versus Market Value 10 3.3 commercial and fiscal accounting perspectives 11 3.4 book values and type of investors 12 3.4.1 Institutional investors & book value 12 3.4.2 Private investors & book value 12 3.4.3 Corporate real estate & book value 13 3.5 Valuation accuracy: APPRAISED MARKET VALUE VERSUS ACTUAL MARKET VALUE 14 3.6 Direct capitalization and its fundamental input variables 15 3.7 Problem Statement 16 3.8 research Goal 17 3.9 Research Questions 18 3.10 Research hypotheses 19 3.11 Research scope 20 3.12 RESEARCH APPROACH 20 3.13 RESEARCH DESIGN 20 3.14 QUALITATIVE RESEARCH METHODS 20 3.15 QUANTITATIVE RESEARCH METHODS 21 3.16 Scientific and societal relevance 22 3.16.1 Scientific relevance 22 3.16.2 Societal relevance 23
Part II: Theoretical framework 24 Chapter 4: Determinants of cap rate, a background study 26 4.1 Cap rate Determinants in international literature 26 4.2 cap rate Determinants in Dutch literature 32 4.3 Cap rate determinants conclusion 33 x Valuation accuracy in vacant office properties
Chapter 5: From fundamental to dynamic cap rates theory 37 5.1 Gordon model 37 5.2 Discount rate (r) 38 5.2.1 Band of investment model 38 5.2.2 Capital Asset Pricing Model (CAPM) 38 5.2.3 Summation technique 39 5.3 The New Risk premium Model 41 5.4 The new Dynamic Cap rate model 42 5.5 The new cap rate regression model specification 42
Chapter 6: Context, location, building and office users as cap rate determinants 45 6.1 context 45 6.2 location 48 6.3 property 48 6.4 office-users 50
Part III: Empirical research 51 Chapter 7: DATA analysis and Synthesis 53 7.1 DATA DESCRIPTION 53 7.1.1 GBA database 53 7.1.2 TU/Delft property database 53 7.1.3 complimentary database 54 7.2 Hypothesis 1 | appraised versus transaction cap rates 54 7.2.1 Appraised cap rates 55 7.2.2 Transaction cap rates 55 7.2.2 Method | Total variance test 59 7.3 Hypothesis 2 | cap rates determinants 59 7.3.1 Inventory of input Variables 60 7.3.2 Calculating the relative vacancy risk 64 7.3.3 Method | Regression analysis, a multiple regression model 65 7.4 Hypothesis 3 | the myth of vacancy and valuation accuracy 66 7.4.1 Cap rates Differences versus vacancy risk 66 7.4.2 Method | One-Way ANOVA test: comparing multiple means 67
Chapter 8: Empirical Findings 70 8.1 Descriptive statistics 70 8.1.1 Outliers 70 8.1.2 Sale transactions per year 70 8.1.3 Sale transactions per city district 71 8.1.4 Cap rate development in Amsterdam 72 8.2 Hypothesis 1 | Overstated and smoothed appraised cap rates 75 8.3 Hypothesis 2 | forward looking investors versus backward looking Appraisers 78 8.4 Hypothesis 3 | Structural vacancy as a Paradoxical phenomenon 83 Valuation accuracy in vacant office properties xi
Part IV: conclusions 85 Chapter 9: Conclusion 87 9.1 Cap rate determinants, the applicability of the new dynamic Cap rate model 87 9.2 valuation accuracy 88 9.3 appraised cap rates versus transaction cap rates 88 9.4 myth of vacancy and accuracy 89 9.5 overall conclusion 89
Chapter 10: recommendation for further research 91
References 93 appendix 1 - cap rate determinants per reviewed article 97 appendix 2 - Transaction cap rate Calculating models 102 appendix 3 - regression model outcomes 107 1 INTRODUCTION chapter 1: introduction 1
Chapter 1: Introduction This thesis studies the determinants of capitalization (cap) rate, a rate of return on real estate investment, which reflects the risk associated with a property investment. Capitalization rate is a real estate valuation measure used in the most common valuation method in the Netherlands, namely the direct capitalization method.
Due to limitations associated with the commercial real estate market (lack of transparency, information asymmetry, infrequency of transactions, etc.), investment decision making procedures and investment risk assessing procedures (to ultimately determine the property value), are prone to some uncertainty. These procedures are mostly combined with a qualitative assessment, due to difficulties in identifying the risk sources in real estate investment and the complexity of measuring it, which results in uncertainty and inaccuracy. To define the risk sources more specifically, this thesis aims at determining the cap rate components and quantifying the qualitative aspects of investment decision making and property valuation, by decompounding the determinants of capitalization rate. Because the risk is decompounded, the resulting cap rate model is more structured and flexible, which reduces the uncertainty and qualitative aspects of risk assessment procedures and helps to solve the problems associated with assessing the real estate investment risks. As a result, a new model is created which enhances the accuracy and consistency in real estate valuation, as it creates a dynamic and flexible method to measure the cap rates. This model can be used by many market parties (investors, appraisers, developer, etc.) to more precisely identify the risk inherited in the property investment which ultimately leads to determining the property value more accurately.
1.1 Target audience This newly created model and its results can be used by investors, appraisers and researchers who want to measure the risk associated with real estate in a more systematic and flexible way. Additionally this thesis can also be used as a starting point for further researching the risk sources that are associated with real estate.
1.2 RESEARCH OUTLINE Part I of this research discusses the research proposal, in which an introduction to the current Dutch office market is given in Chapter 2. Chapter 3 continues with further identification of the research problem and discussing the societal and scientific relevance of this research. It discusses the research questions, the main goal of the research, the research methodology and the main research approach, as well as appropriate methods per research question.
Part II focuses on the theoretical framework of this research. Chapter 4, focuses on the background studies related to cap rates determinants. Chapter 5 explains the dynamic cap rate model specification. Chapter 6 is an overview of the variables found in the literature which have a significant effect on cap rates.
Part III focuses on the empirical research. Chapter 7 introduces the sources of data used in this research. This chapter continues with discussing the data analyses and syntheses performed to test the research hypotheses. In Chapter 8, the main results of the empirical research are explained. Part IV addresses the overall conclusions of this thesis. Chapter 9 answers the research questions, while Chapter 10 provides some recommendations for the further research in this field. Part I: Research Proposal
CHAPTER 2: A glance at the Dutch Office market
CHAPTER 3: problem field A glance at the Dutch Office market 2 4 Valuation accuracy in vacant office properties
CHAPTER 2: A glance at the Dutch Office market This chapter provides an introduction into the current situation of the Dutch office market. Section 2.1 discusses the dynamics of the Dutch office market and their interrelations. Section 2.2 explains the Dutch office market disequilibrium and its underlying causes. Section 2.3 explains the replacement market as a consequence of the gap between office supply and demand. Finally, in Section 2.4, the possible solutions to overcome this oversupply are discussed.
2.1 Dynamics of DUTCH OFFICE MARKET The vacancy rate rise of office markets in European cities is a phenomenon that requires more and more attention in order to deal with the risk of structural vacancy in the office stock (Remøy & Van der Voordt, 2011). The Dutch office market is no exception regarding this problem. According to fact sheets of mid-2014 by DTZ Zadelhoff (2014b), the vacancy rate of office buildings in the Netherlands is 15.7% which equals 7.8 million square meter of the total office stock. This is relatively high in comparison to a normal vacancy rate of 3% to 6% (Remøy, Koppels, Van Oel, & De Jonge, 2007).
The Dutch office market is experiencing fundamental changes. On one hand, the low dynamics of the office market caused by the financial, plus real estate crises, and the changes in the behavior of office users reduced the required office space in this market (in 2014 7% lower take-up than 2013) (CBRE, 2013; Colliers, 2014; DTZ Zadelhoff, 2014a; Remøy & Van der Voordt, 2011). On the other hand, continuous overproduction and oversupply of office stock caused by accelerating expansion of this market from the 1980’s and onwards results in the high aforementioned vacancy rate, which indicates a relatively huge gap between demand and supply in the office market (Remøy & Van der Voordt, 2011).
These facts caused the Dutch office market to become so off balance that this market never recovered since the 2001 crisis in real estate, even before the financial crisis in 2008 hit this market (Remøy & Van der Voordt, 2011). In 2014, fewer office spaces were taken up, creating a greater gap between supply and demand ratios, which contributed to the aforementioned 15.7% vacancy rate (CBRE, 2013; NVM, 2013; Remøy & Van der Voordt, 2011).
Understanding the dynamics of this system can explain the current situation of the office market in the Netherlands, thereby identifying the underlying causes of its high vacancy rate. From a macro- economic perspective, Geltner, Miller, Claytonand Eichholtz (2014) argue that the real estate market is a system that consists of three interrelated markets: the space market, the asset market and the development industry.
The space market is the market for the use of space. This market is often referred to as the rental market which determines the rent level and the amount of cash flow a property can generate (Geltner et al., 2014).
The asset market is the market for the ownership of properties. This market is also often referred to as the property market which determines the property market value and the flow of financial capital to the real estate market (Geltner et al., 2014).
The development industry is the linkage between the property market (asset market) and the rental market (space market). It converts financial capital into physical capital by constructing new chapter 2: A glance at the Dutch Office market 5
Figure 2.1, the real estate system and the interaction among three major components of space market, asset market and development industry, own illustration based on Geltner et al. (2014).
buildings, renovating and/or converting the existing buildings, thereby governing the supply stock in the space market (Geltner et al., 2014).
Figure 2.1 illustrates an overview of this system (real estate market) and the interaction among its three components: space market, asset market and development industry.
2.2 Market disequilibrium In an efficient office market, due to the long-run equilibrium between and within the space and asset market, the quantitative and qualitative supply of office space is approximately equal to the demand (Lokhorst, Remoy, & Koppels, 2013). During the economic boom, the market shows signs of scarcity, while during economic recession a higher vacancy rate is dominant (Keeris, 2007). A vacancy rate of 3% to 6% of the total supply in office stock (frictional vacancy) is necessary to enable the mobility in the market (Rabianski, 2002; Remøy et al., 2007). Therefore, in an efficient office market, frictional vacancy is considered a normal status that is a requirement for providing fast solutions for the very dynamic demands for office space (Lokhorst et al., 2013; Rabianski, 2002).
Conversely, in an inefficient real estate market, with a significant office surplus, the vacancy rate could increase considerably and excess the normal vacancy rate required to allow easy movement of office users from one place to another (Lokhorst et al., 2013; Rabianski, 2002). An example of such a market is the Dutch office market as explained in § 2.1.
Even though the Dutch economy started growing slowly from 2013, there is no evidence of a decrease in the vacancy rate in this market since many companies continue focusing on optimizing 6 Valuation accuracy in vacant office properties their location strategy, namely consolidation and decrease in space usage, meaning that there is no demand for expansion in this market (Savills, 2014).
Besides that, a large share of vacant office stock is located in mono-functional areas with few or no other amenities, which do not match qualitatively to the demand of office users and is the result of the non-integrated planning policy of the Dutch municipalities with a lack of coordination between them (Rodermond, 2011).
These all contribute to the oversupply in the Dutch office market due to a both quantitatively and qualitatively gap between the office supply and office demand, causing a high vacancy rate in this stock (Remøy & Van der Voordt, 2011).
2.3 Replacement market As (Remøy, 2007) argued “the office market has become a replacement market, since the stock in use is relatively stable and has no demand for expansion.” The rise of the replacement market and lack of quantitative need for new office buildings is a consequence of overproduction in the Dutch office market after 2000 (Remøy & Van der Voordt, 2013). In fact the construction activity has dropped to a relatively low level historically in the Netherlands. There is rarely any construction of new offices, unless the developers/investors are sure of future tenants (CBRE, 2012). In such a market, new buildings take the place of old and low quality buildings, which is caused by office-user preferences for certain types of buildings and locations. The emergence of the replacement market in which office buildings age at an ever increasing rate , resulted in obsolete office buildings which lead to a higher structural vacancy rate (Remøy, 2010).
Structural vacancy, defined as vacancy of office properties for three or more years (Remøy, 2010), is a very critical issue in the Dutch office market. This is explained by the fact that the large amount of vacancies in this market (47%) are office buildings that are vacant for three or more years heading towards the obsolescence of these office buildings (NVM, 2013; Remøy & Van der Voordt, 2011).
Nevertheless, obsolescence is not merely related to the age of the buildings (natural depreciation of the buildings) (Bullen & Love, 2011), but also represents aesthetic, functional, social, legal, economic and environmental obsolescence (Baum, 1993). This indicates that the occupancy of buildings is impacted by their potential to meet the current demand of both the office users and the investors. When this is not the case, the buildings are defined as obsolete (Bullen & Love, 2011).
Dealing with vacancy in such a market is even more challenging, as many office buildings offered for rent or sale are no longer meeting current requirements of office users (e.g. sustainability), especially, considering the fact that a large amount of the total office stock (66%) consists of buildings over 18 years old (NVM, 2013).
In such an unbalanced market, where large amounts of building stock are considered obsolete office buildings that reached the end of their functional and economic lifespan, the need for interventions are crucial to overcome this ever growing structural vacancy in the Dutch office market (Remøy & Van der Voordt, 2011). chapter 2: A glance at the Dutch Office market 7
2.4 Adaptive re-use Adaptive re-use is defined as “a process that changes a disused or ineffective item into a new item that can be used for a different purpose” (Australian Government, 2004). As mentioned in the §2.3, the high vacancy rate is for a the large part attributed to properties that do no longer meet the current demand of office users and are therefore out of the active office property market (CBRE, 2013; NVM, 2013; Remøy & Van der Voordt, 2011). In essence, intervention in terms of transformation or adaptation of the existing buildings, is necessary to re-use these properties in the office market and to decrease the risk of obsolescence (Remøy & Van der Voordt, 2011).
Several authors (Bullen & Love, 2011; Langston, Wong, Hui, & Shen, 2008; Remøy & Van der Voordt, 2011; Remøy & Van der Voordt, 2014) mentioned the adaptive re-use as an integral strategy to enhance the financial, social and environmental performance of buildings. In addition, several possible strategies for dealing with structural vacant offices are proposed, such as consolidation, renovation, demolition and new-build, and lastly, conversion to new functions (Remøy & Van der Voordt, 2014). Among these, the conversion of office buildings is seen (partly) as a solution to balance the oversupply of the office market (Remøy, Schalekamp, & Hobma, 2009; Remøy & Van der Voordt, 2011; Wilkinson, Remøy, & Langston, 2014).
Remøy and Van der Voordt (2011) consider adaptive re-use in operational continuity of an obsolete office property either by renovation and within use adaptation of obsolete office buildings, or conversion to new use.
Recent workplace adaptation strategies of the New Ways of working (NWoW), sustainability and the New Office Concept (NOC) are some examples of within use adaptation of obsolete office buildings. Figure 2.2 shows an example of the within use adaptation of the monumental building of De Rode Olifant which was vacant for 3 years before its adaptation plan (De Rode Olifant, 2011; Spaces, 2014).
The possibility of conversion of structurally vacant offices to new use, is the conversion of obsolete office buildings into housing. Remøy and Van der Voordt (2014) argue that this decreases the shortage of the Dutch housing supply while simultaneously ameliorating the performance of obsolete office buildings by introducing a new use. This emphasizes on the fact that, if all office properties are adapted to accommodate modern office uses, the oversupply of office space will persist quantitatively. Therefore, functional transformations, demolition and new-build are inevitable strategies in order to develop an efficient office market (Remøy & Van der Voordt, 2014).
Even though the adaptive re-use strategy is mentioned to be a possible solution to balance the oversupply of the Dutch office market and decrease the current structural vacancy (Remøy & Van der Voordt, 2014), they are often obstructed by a lack of financial feasibilities and interest by property owners as well as the developers (Remøy et al., 2009; Remøy & Van der Voordt, 2007; Scheltens, Van der Voordt, & Koppels, 2009). 8 Valuation accuracy in vacant office properties
Figure 2.2, Red elephant (Rode Olifant), within use adaptation (New Office Concept): this monumental building is located at the business district of the Hague. It was built in 1921 as the oil company Esso headquarters, providing an office area of over 10,000 m2. Between 1943 until the end of II World-War it was occupied by Germans for their own use. In 1993, this building was listed as a monumental building in the Netherlands. From 1990 to 2009, it accommodates the attorney firm of De Brauw & Westbroek, Blackstone. From 2009 to 2012 the building was vacant until Spaces bought the property and fully renovated it to the New Office Concept.This building now has 8,500 m2 of office area (small to mid-size offices), workspots, a business club for 500 persons, 12 meeting rooms, a cafe deli, a restaurant, conversations rooms, a library and 70 parking lots (Figure iv). Spaces made the building representative but also inspiring (e.g. for create brainstorm sessions). Additionally Spaces offer extra services such as storage, printing facilities, in house catering and massages. The same type of facilities are available at all the buildings owned by Spaces.By buying the building, Spaces created a cluster of office buildings that work together with the other locations in Amsterdam (Zuidas, Herengracht and Vijzelstraat). Source: (De Rode Olifant, 2011; Spaces, 2014). Problem field 3 10 Valuation accuracy in vacant office properties
Chapter 3: Problem field This chapter discusses the research problem area further. Section 3.1 identifies one of the underlying causes for the lack of financial feasibility as one of the main bottlenecks of the transformation of obsolete offices. Section 3.2 defines two concepts of book value and market value. Section 3.3 elaborates on the various interpretations of book value while Section 3.4 determines the regulatory principle related to book value per type of investor. Section 3.5 sheds light on the ambiguity of the main cause for the lack of financial feasibility by providing a better insight into appraised value and its implication for vacant office properties. Section 3.6 discusses the common valuation method in the Netherlands and its fundamental input variables. In Section 3.7, the problem statement, the main research problem and its consequences are discussed. Section 3.8 focuses on the goal and objectives of this research. In Section 3.9, the main research questions and their subsequent sub- questions are formulated. In Section 3.10, the research hypothesis are generated. After this, the scope of this research is determined in Section 3.11. Section 3.12 discusses the overall research methodology used to conduct this research by explaining the main research approach and the most appropriate research strategy to conduct this research. Section 3.13 clarifies the research design to fulfill the main objectives of the research. Section 3.14 discusses the qualitative and Section 3.15 addresses the quantitative methods and technique used to collect and analyze the data. Finally, Section 3.16 addresses the scientific and societal relevance for conducting this research.
3.1 Lack of financial feasibility - lack of willingness As mentioned in Chapter 2, adaptive re-use strategies as a possible solution to balance the oversupply of the Dutch office market, are often obstructed by a lack of willingness to sell by the property owners, as well as a lack of willingness to buy by the developers, due to a lack of financial feasibilities (Remøy & Van der Voordt, 2014).
The lack of willingness to sell by the property owners leads to a situation that among all aforementioned possible strategies to deal with structural vacant offices in § 2.3, most property owners choose for the most passive attitude, namely consolidation. This means that they retain the status quo and opt for a wait-and-see tactic hoping for better times since selling is not an option for them. They are unwilling to make a loss on their investment (Remøy & Van der Voordt, 2014; TransformatieTeam, 2011). Such a behavior is explained by the prospect theory, where loss aversion refers to a tendency in whic avoiding losses is preferred over acquiring gains. Psychologically, losses are twice as powerful as gains (Haigh & List, 2005; Kahneman & Tversky, 1979).
On the other hand, the willingness to buy and transform by the developer is low, when considering the costs of transformation and the future income of the transformed building (Remøy & Van der Voordt, 2014). The developers thus consider the transformation too risky compared to the expected return and thus avoid taking such a risk.
3.2 Book Value versus Market Value One of the underlying causes for the unwillingness of the property owners, found in the literature (Remøy et al., 2009; Remøy & Van der Voordt, 2007; Scheltens et al., 2009), is the difference between book value and market value of vacant properties.
According to the International Valuation Standards Council (IVSC) (2014), Book Value (BV) or Carrying Amount is defined as “The amount at which an asset is recognized in the financial statements of Chapter 3: PROBLEM FIELD 11 an entity after deducting any accumulated depreciation and any accumulated impairment losses”, whereas Market Value (MV) is defined as “The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.”
The difference between book value and market value of vacant properties can be partly explained by the fact that even though the definition of book value in the financial book keeping is unique (IVSC definition), the interpretation to determine the book value varies with different accounting frameworks. In addition, each type of investor/property owner is obliged to follow the applicable accounting rules for them, which can differ for each type of investor. Therefore, in order to understand the relevant definitions and implications of book value, it is crucial to firstly define the different accounting frameworks and then to determine which type of investor should act under which accounting framework.
3.3 commercial and fiscal accounting perspectives According to Aart Hordijk, Director of the ROZ Real Estate Council (personal interview, October 20, 2014) and the definition of the IVSC (2014), book value is the value at which an asset is carried on a balance sheet. In the Dutch accounting framework, there are two types of balance sheets recognizable: commercial balance sheet and fiscal balance sheet. These two balance sheets fall under the individual annual account category (Van den Berg, 2011).
A commercial balance sheet is used for general external reporting purposes (together with the profit and loss account), and provides information on the financial position of an entity. This type of individual annual account, namely the commercial one, is meant for performance measurement of the entity. According to the directives of the Council of Annual Reporting 930.9 (Richtlijnen voor de Jaarverslaggeving), this annual account is used as a base for a wide range of users to take economic decisions (e.g. employees, shareholders, debt investors, the government, etc.). The source and guidelines of commercial account reporting in the Dutch law are embedded in title 9, book 2 of the Dutch Civil Code, which indicates that the commercial account should be prepared based on acceptable norms in society (Van den Berg, 2011).
On the other hand, the fiscal (tax) balance sheet determines the amount of tax which an entity is obliged to pay by considering the profit and loss account. This accounting framework is meant merely for the tax authority. The sources of fiscal accounting rules are determined according to sound business practice (goed koopmansgebruik) and relevant specific regulations in the Dutch tax law (Van den Berg, 2011).
The Dutch accounting system is influenced by the International Financial Reporting Standards (IFRS). The IFRS aims to provide a global standard for external financial reporting and are established under the International Accounting Standards Board (IASB). The purpose of the IFRS is to provide a true and fair indication of the financial position of an entity (Van den Berg, 2011). The Dutch legislators define clearly in title 9, book 2 of the Dutch Civil Code, when an entity may use the Generally Accepted Accounting Standards in the Netherlands (Dutch GAAP) or IFRS, which depends on the size of the legal entity. 12 Valuation accuracy in vacant office properties
3.4 book values and type of investors According to Aart Hordijk (personal interview, October 20, 2014), three types of investors can be recognized in the Dutch office market: institutional investors, private investors and corporate real estate (owner-occupied). For each of these investors/property owners, the book value principles are determined in this section.
3.4.1 Institutional investors & book value Institutional investors consist of pension funds, insurance companies, banks, investment institutions and investment funds (Cuppen, 2011). The institutional investors are tax-exempt and therefore they are only obliged to prepare the commercial annual account. This is used as a performance measurement and should follow the International Accounting Standards (IAS) 40 investment properties (Hordijk, personal interview, October 20, 2014).
The IAS 40 allows either the fair value model or the cost model as its accounting policy for investment property. Under the fair value model, the investment property is reappraised to fair value. The fair value is defined as “an amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction (IAS 40.5). Fair value should reflect the actual market state and circumstances as of the balance sheet date (IAS 40.38). The best evidence of fair value is normally given by current prices on an active market for similar properties at the same location and in the same condition and subject to similar lease and other contracts (IAS 40.45).” (Deloitte, 2014c)
On the other hand, under the cost model, an investment property is valued at cost of replacement/ reproduction minus accumulated depreciation and any accumulated impairment losses. However, when an entity adopts the cost model, they must still obtain fair values as IAS 40 specifies that reporting the fair values within the financial statements are mandatory. Therefore, it is more beneficial to use the fair value model than the cost model, when fair values still have to be estimated (Collings, 2012).
This means that institutional investors are obliged to adjust their book value annually in order to reflect the actual market value. Therefore, in principle, there is no difference between book value and fair market value estimated by the professional appraisers. As a result, for the institutional investors, book value is in fact the appraised fair market value.
3.4.2 Private investors & book value Private investors are a relatively heterogeneous group of real estate investors, who cannot be specified as one group (Cuppen, 2011). Private investors have two types of balance sheets, namely a commercial balance sheet and a fiscal balance sheet (Hordijk, personal interview, October 20, 2014).
The fiscal balance sheet which is used for tax purposes, is the one that integrates depreciation into the book value. This depreciation is more related to the structural and physical condition of a building that is used for taxes under the Dutch GAAP. However, private investors under fiscal Box 3 (incomes from savings and investments), whom have a fixed presumed gain of 4% of the market value under the Box 3 assets minus debt, are taxed at the flat rate of 30% (Deloitte, 2014d). This is in addition to 1.2% over the market value which they always have to pay (Hordijk, personal interview, October 20, 2014). Chapter 3: PROBLEM FIELD 13
For the private investors’ commercial balance sheet, they get advice on the market value from the appraisers/ accountants based on the Dutch GAAP (the Generally Accepted Accounting Standards in the Netherlands). However, the final decision to implement the advised value (appraised market value) to the commercial balance sheet depends on the willingness of the private investors. The economic decision making about the market value is thus not based on the current book value, but rather on the judgment of investors about the re-appraised value.
Therefore, it is very hard to judge whether the appraised commercial book value of private investors reflects the actual market value. Clarifying this issue requires a lot of resources and is limited due to the confidentiality of such information.
3.4.3 Corporate real estate & book value Corporate real estate is the real property occupied or held by a business entity for its own operational use and/or to support corporate expansion (Krumm, 2001).
Corporate real estate investors have two types of balance sheets, namely a commercial balance sheet and a fiscal balance sheet (Van den Berg, 2011).
Non-listed corporate real estate investors have to follow the IAS 16 Property, Plant and Equipment for preparing their fiscal balance sheet. Under the IAS 16 property, plant and equipment is measured at its cost, under either using a cost model or revaluation model. Furthermore, it is depreciated in a way that the depreciable amount is allocated systematically over its useful life (Deloitte, 2014a). Figure 3.1, the type of property owners, their accounting frameworks and regulatory standards 14 Valuation accuracy in vacant office properties
Listed corporate real estate investors have to follow the IAS 36 Impairment of Assets. The IAS 36 Impairment of Assets seeks to ensure that an entity’s assets are not carried at more than their recoverable amount (Deloitte, 2014b). The interpretation of the IAS 36 is that the book value in the financial statement of a company should be corrected downwards to the fair market value. This is due to the fact that book value is the asset minus liability and the value of the assets may decrease due to depreciation over a period of time by an asset (IVSC, 2014). Therefore, according to Aart Hordijk (personal interview, October 20, 2014), their balance sheet must be devaluated.
Figure 3.1 summarizes the relation of the different accounting frameworks, the type of property owners and the applicable regulatory principles per type of investor and accounting framework that is discussed in § 3.3 and § 3.4. Considering the aforementioned sources of determining the book value, it can be argued that the statement about the high book value in comparison to the market value of vacant properties (Remøy et al., 2009; Remøy & Van der Voordt, 2007; Scheltens et al., 2009), is in fact the high appraised value estimated by the professional appraisers. This is because economic decisions regarding an asset (or a portfolio) are not based on the book values, but rather on the appraised values.
3.5 Valuation accuracy: APPRAISED MARKET VALUE VERSUS ACTUAL MARKET VALUE As the real estate market is a very thin market with no frequent transactions as well as lack of public information (transparency), property appraisers are playing an essential task in real estate market as a substitute for selling prices (Fisher, Miles, & Webb, 1999; Hordijk, 2005). As a result, studying the differences between the appraised market value and the actual selling price of a property is an essential task to reflect the true market volatility (Hordijk, 2005).
Actual market value is the selling price of a property at which a deal is actually done, namely the transaction price (Geltner et al., 2014). As mentioned in § 3.2 and § 3.4.1, appraised market value is defined as “an amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction” (Deloitte, 2014c). Lusht (2012) elaborates on this and mentions that, in fact “market value is ‘the most probable transaction price’ which a specified interest in real property is likely to bring.”
Studying the differences between the appraised market value and the transaction price of a property falls under the main topic of valuation accuracy which according to Baum, Crosby, Gallimore, McAllister, and Gray (2000) is defined as “the probability of a valuation being within certain parameters of a sale price”.
In the valuation accuracy literature, smoothing and lagging are mentioned as sources of inaccuracy in real estate valuations (Baum et al., 2000; McAllister, Baum, Crosby, Gallimore, & Gray, 2003). Smoothing refers to an under-measurement of actual variance and anchoring on past appraisals, while lagging refers to the fact that appraised values cannot accurately capture the timing of market movement and fall behind prices (Baum et al., 2000).
However, uncertainty is not only limited to the lagging effect and capturing an accurate market movement (McAllister et al., 2003), but is also embedded in determining the market value of a vacant office building, since it generates no rental income and may have a relatively low promise for future tenancy (Rodermond, 2011; Schiltz, 2007). French and Gabrielli (2004) argue that the latter Chapter 3: PROBLEM FIELD 15 leads to more uncertainty in the estimation of the market value in comparison to a valuation of a property which has been just let and is not vacant.
Schiltz (2007) argues that measuring the risk associated with vacancy on appraised market values creates substantial difficulties for professional appraisers. Schiltz (2007) believes that vacancy is a threat embedded as a risk for all types of real estate, which exist or will happen eventually, whether the property is already let on long term leases or not. Therefore, all the risks associated with vacancy, should be reflected in the property value. Van Gool and Rodermond (2011) support the argument pertaining vacancy risk by Schiltz (2007), and emphasize on its importance, specifically on the problematic situation of structurally vacant offices. This because these are office properties which are vacant for a considerable amount of time and are characterized by having a relatively low promise for future tenancy. Determining the market rent for these offices is thus problematic. In addition, it is not certain how many years of vacancy should be taken into account for value estimation. Above all, the last and the most complicated issue is to determine a correct capitalization rate due to the lack of any market transactions in order to finally calculate the value of the property.
These three reasons show clearly that common valuation approaches, sale comparison or income approach, are not the best approaches to estimate the value of vacant properties, since there is a lack or even no available input for these methods. Thus, making it very difficult to determine market value for vacant office properties.
3.6 Direct capitalization and its fundamental input variables Even though the income approach, which determines the value based on the building operating income, is not the most appropriate method to estimate the price of a structurally vacant office property (as mentioned in § 3.5), research shows that this approach is the most common approach in appraising a vacant office property in the Netherlands (Hendershott, 1996; Hordijk & Van de Ridder,Where; 2005;= Ten+ Have,∗ − 2000). + More 1 − precisely, ∗ + the most+ frequent+ − and common method within the = risk free rate, income approach used in Dutch practice, according to Rodermond (2011), is the direct capitalization = Loan-to-value ratio, method. = rate of return on debt, ⁄ = premium from participation in real estate, = premium on location attributes, In this method, as shown in equation (1), the property’s Net Operating Income (NOI) of the initial year = premium on property-itself attributes, is divided by the cap rate (also known as Net Initial Yield (NIY) or going-in cap rate), to substantially = premium on property-user attributes, estimate the property value (Geltner et al., 2014; Lusht, 2012): = a constant expected rate of growth in the NOI. From equation (1), it is clear that there are two fundamental determinants of value in direct capitalization, namely cap rate and NOI. As mentioned in § 3.5, vacancy risk is reflected in the
(1) (1) = Where; V = property value, NOI = Net Operating Income in the first year, Ro= overall capitalization rate (%). property value (Schiltz, 2007), therefore it should be included in calculating the NOI and/or cap rate. Vacancy is reflected in rental income, as in the case of vacant property, the object is valued (2) based upon the assumption of ‘market value, as if let on the valuation date’. Then, the latter value will beWhere;= corrected ex-post for certain losses on void periods, which are the expected timeframe that = expected required rate of return (discount rate %). a property remains vacant and generates no rental income. However, vacancy risk is also reflected
(3) Where;= = expected required rate of return (discount rate %), = expected rate of growth in the NOI.
(4)
=− (5) Where; == ∗ + 1− ∗ = overall cost of capital, = Loan-to-value ratio,
= cost of debt, ⁄ = cost of equity.
(6)
Where;= + (̅ −) = expected return on property, = risk free rate, = expected market return, = equity beta ( ). ̅ (,)⁄ 16 Valuation accuracy in vacant office properties in the used cap rates (or in general both gross and net yields; gross yield when value is calculated by gross potential income, and net yield when value is calculated by use of net operating income). This is confirmed with the research done by Schiltz (2007) to study the impact of vacancy on value and gross yields used by property appraisers, in two forms of occupancy rate and the remaining lease term. This study ascertains that appraisers are prone to uncertainty when apprising a vacant property, as the variation in (value and yield) outcomes are larger in comparison to a let property. Schiltz (2007) shows that deviations in both value and yield between appraisers are higher when a property has a shorter remaining lease term or is vacant, compared to a property with a longer remaining lease or the probability of renewing the lease by current tenants. The study by Schiltz (2007) shows that the changes in yields and value are thus proportional to the property occupancy rate.
In addition, the study performed by De Roo (2014) shows that there is a huge gap (45%) between the transaction-based cap rates and appraisal-based cap rates (in this study the assessed value cap rates) for non-prime locations with a large number of structural vacant offices in Amsterdam, which has a high amount of obsolete office buildings (40%).
All these show that vacancy is a risk inherent for any property and is reflected in the value of real estate in two ways: on the expected cash flow, and on yield (both gross and net). However, this thesis argues that even though there are uncertainties in estimating the NOI, with considerable effort both appraisers and potential buyers arrive to a reasonable accurate NOI. Whereas, variations in the yields and therefore value studied by Schiltz (2007) and De Roo (2014), show that determining an accurate yield is a relatively challenging task, given the fact that the available information on property transactions relating to structurally vacant offices are scarce in the current office market. However, structural vacancy and therefore lack of transaction in the market should also be considered as market evidence and should be incorporated as one of the risk components, when determining cap rates (in case of calculating the value with a NOI rather than a gross potential income).
3.7 Problem Statement Real estate valuation plays an essential role in a nontransparent and thin property market, specifically the office property segment, where properties are not frequently sold. These valuations are the basis for negotiation in transaction processes, advice on property financing (lending) decisions, property taxation, and finally the recorded performance of the overall property market (Baum et al., 2000).
Previous research has indicated that a high degree of uncertainty in determining the value of a vacant property has a negative influence on valuation accuracy (Rodermond, 2011; Schiltz, 2007). Besides the fact that appraisal-based indices (both value and cap rate indices) tend to be smoothed and lagged when compared with those of transaction-based indices, many parties (e.g. investors, financiers, redevelopers, etc.) believe that valuations of vacant offices are too high in comparison to their actual market value (Rodermond, 2011).In addition, variations in the yields (gross and net) used to capitalize the property rental income show that determining an accurate yield is a relatively challenging task, given the fact that the available information on property transactions relating to structurally vacant offices are scarce in the current office market (De Roo, 2014; Schiltz, 2007).
The inaccurate valuations have a negative impact on adaptive re-use strategies (adaptation and conversion of current office stock) due to a lack of financial feasibilities, even though they are Chapter 3: PROBLEM FIELD 17 mentioned to be a possible solution to balance the oversupply of the Dutch office market and decrease the current structural vacancy (Remøy et al., 2009; Remøy & Van der Voordt, 2007; Scheltens et al., 2009).
Another consequence of inaccuracy in estimating property valuation is that it influences the estimation of the solvency rate and judgment about the financial performance of property owners. Solvency rates (short-term and long-term) are ratios which intend to provide information regarding the investors’ ability to meet their financial obligations, or in other words whether cash flow income of investors is sufficient to meet their liabilities (Hillier, Ross, Westerfield, Jaffe, & Jordan, 2013). An overestimated solvency rate provides a false indicator of the investors’ financial position. This creates an increased risk for the financial institutions in the Netherlands and ultimately for the Dutch society.
Since valuations are the basis for estimating property taxes, inaccuracy in valuations has an influence on the cash flow of the property owner. The higher the assessed value (the WOZ-value), the more tax property owners have to pay. For the Dutch municipalities, a high WOZ-value could be interesting, since they receive more tax money. On the other hand, it also works against them, since it raises a lot of objections in court against them which exhausts a lot of time and resources from the municipality (De Roo, 2014).
In addition, the inaccuracy in valuation of vacant offices illustrates a different volatility in appraisal values throughout time compared to the real market values. As a result of such a difference, in a volatile market, valuations do not show the true volatility of the real estate market (Baum et al., 2000; Hordijk, 2005). This has a relatively high impact on appraisal-based indices such as the IPD index in the Netherlands as a market performance measurement (Schiltz, 2007).
These all show that an inaccurate appraised valuation in comparison to the actual market value (transaction price) of vacant offices has many consequences for the Dutch real estate market, Dutch financial institutions, Dutch municipalities as well as the Dutch society.
3.8 research Goal The purpose of this research is to contribute to the body of knowledge of valuation accuracy for structurally vacant office buildings in the Netherlands by determining the cap rate components as one of the important input variables for determining the property value. Since there is some degree of valuation inaccuracy and inconsistency between appraisals and transactions (Baum et al., 2000; De Roo, 2014; Hordijk, 2005; McAllister et al., 2003; Rodermond, 2011; Schiltz, 2007), the main goal of this thesis is to understand the differences and similarities in pricing processes of two main market players, namely appraisers (for their valuation) and investors (for the actual transactions) to enhance accuracy and consistency in office property valuation in the Netherlands.
The two main objectives of this research are: to examine the main determinants of office property cap rates respectively for appraisers (valuations) and investors (transactions); subsequently, to gauge whether the differences between appraised cap rates and transaction cap rates are significantly larger for vacant offices in comparison to the non-vacant offices. In other words, whether any variation in accuracy depends upon the variation in vacancy rate. This is all with the hope to increase awareness about valuation accuracy for vacant office properties among various market players (e.g. 18 Valuation accuracy in vacant office properties investors, appraisers, developers, etc.) by increasing transparency in the pricing process of these parties by studying the variation in their cap rates. Hopefully, such a transparency can enhance reasonable pricing of properties which facilitate the adaptation process of the obsolete office stock and overcome the oversupply of the Dutch office market.
3.9 Research Questions Based on the problem statement mentioned in § 3.7 and the objectives of this research mentioned in § 3.8, the main question of this research reflects the two folded objectives of the research and consists of two sub-parts:
1. To what extent do appraised cap rates correspond with transaction cap rates?
2. Can the differences between appraised cap rates and transaction cap ratesbe explained (partly) by structural vacancy risk?
The sub research questions related to the first sub-part of the main question are categorized around the three major themes of: determinants of cap rates, valuation accuracy and the variation in pricing mechanism of appraisers and investors.
I. What are the main determinants of the capitalization rate? a. How does the background context, such as macro-economic, capital market, real estate market and sale conditions affect variations in cap rates? b. How do macro and micro location characteristics affect variations in cap rates? c. How do property-specific conditions, such as vacancy rate, age, and leasehold conditions, affect variations in cap rates? d. How do office users and their lease terms affect variations in cap rates?
II. How large are the differences between the appraised cap rates and transaction cap rates? e. How large are the average absolute differences between appraised cap rates and transaction cap rates? f. Is there any tendency for appraised cap rates to consistency understate or overstate the transaction cap rates?
III. What are the differences and/or similarities between appraised cap rate and transaction cap rates? g. What are the determinants of cap rate respectively for appraisers (valuations) and investors (transactions)? h. Do appraisers and investors weigh cap rate components differently and if so how?
The sub research questions related to the second sub-part of the main question are categorized around the theme of valuation accuracy of vacant office properties.
IV. How is accuracy of the estimated cap rates associated with variations in vacancy rates? i. What are the different types of vacancy? j. How are different vacancy types correlated with differences between appraised cap rate and those from transactions? Chapter 3: PROBLEM FIELD 19
Figure 3.2 illustrates the conceptual model of this research and the relation of the main research questions and the main themes.
3.10 Research hypotheses Based on the existing literature that views the inaccuracy of valuation as one of the bottlenecks in the transformation of vacant offices in the Netherlands (Remøy et al., 2009; Remøy & Van der Voordt, 2007; Scheltens et al., 2009), the following hypotheses are generated.
Hypothesis 1 The appraised cap rates of Dutch offices during the rising market are lower (appraised value is higher) than the transaction cap rates (prices), to a larger extent than the declining market (after financial crisis).
Hypothesis 2 Appraisers put more weight on easily observable elements in determining office cap rates whereas investors are more concerned with macro-economic variations over time.
Hypothesis 3 The differences between appraised cap rates and transaction cap rates of an office property have a positive correlation to its vacancy risks.
Figure 3.2, conceptual model showing the relation among various themes and subquestions of this research 20 Valuation accuracy in vacant office properties
3.11 Research scope This research focuses on the Dutch office market, specifically on the asset market (property market) which is one of the three main components of the real estate system as explained in § 2.1. This research focuses within the Dutch office market, on the office properties in Amsterdam. This is due to availability of data and greater number of office transactions in this city. Within the Amsterdam office market, it narrows down to the accuracy of property market value. Within the process of determining the property value, it focuses on the determinants of cap rates as the most important factor in property investment analysis. Furthermore, it zooms in on the valuation accuracy of vacant office properties.
3.12 RESEARCH APPROACH This research uses a mixed methods approach where qualitative and quantitative research strategies are combined (Kumar, 2014). The main rationale for using a mixed methods research is to answer the different types of research questions defined for this research (Bryman, 2012). This approach is the most appropriate method as it achieves the two-folded objectives of this research the best (see § 3.8).
The qualitative method in this research is a descriptive and exploratory approach used to develop a theoretical framework for the empirical part of the study. This is to understand the background as well as the different aspects of each sub-part of the research problem (Bryman, 2012; Kumar, 2014). The research hypotheses are constructed based on this qualitative descriptive and exploratory study. Whereas, the quantitative research is used to determine the extent of the research problem by providing statistically significant findings. In addition, the quantitative research is used as a correlational study to establish association (if any) among aspects under the study (Kumar, 2014).
3.13 RESEARCH DESIGN The research as a whole is designed in a two-phase study based on the previously mentioned two- folded objectives of the research in § 3.8. The sequential research design is chosen to fulfill the main objectives of this research for each phase. The sequential order begins with a descriptive and an exploratory qualitative method which is followed by an exploratory and a correlational quantitative study (Kumar, 2014).
Figure 3.3 illustrates the different stages designed to conduct this research. The TU/Delft graduation processes (P1 to P5) are also integrated in this scheme.
3.14 QUALITATIVE RESEARCH METHODS Qualitative research is used, firstly to provide a theoretical framework to support formulating and analyzing the research problem regarding valuation accuracy. It is also performed to create a general attitude towards valuation of vacant office properties (in theory and practice) and the difficulties and uncertainties pertained to appraise a (partly) vacant office. Secondly, it is used to enrich the theoretical framework to answer the first sub-part of the research question (first fold of the research objective) in regards to the three main themes of: determinants of cap rates, valuation accuracy and the variation in pricing mechanism of appraisers and investors. This implies a qualitative study to explore determinants of cap rates, and to understand the causes of inaccuracy in valuation by explaining certain behaviors and processes in valuation by different parties. Qualitative research is used for the second sub-part of the research question to identify different types of vacancy relevant for determining office cap rates. Chapter 3: PROBLEM FIELD 21
Figure 3.3, research design and research planning
The required data for the qualitative part is obtained both through primary and secondary sources. The method used to collect primary data was through unstructured interviews with experts in the property appraisal field, namely appraisers and academic researchers. In contrast, content analysis of the existing literature is used as a method to provide data for the qualitative research study. These include sources such as academic publications, official documents from the European Union, the Dutch government or private sources, press releases, and newspapers, all in relation to the main themes of the research questions. Both literature study (content analysis) and unstructured interviews were used for research sub-questions I, III, and IV.
3.15 QUANTITATIVE RESEARCH METHODS Quantitative methods are firstly used to determine what the components of cap rates are that are used in the Dutch office market, by appraisers and investors respectively. Secondly, they are used to determine the extent of the research problem by quantifying the differences between appraised and transaction cap rates and to ascertain the magnitude of variation in appraised cap rates to transaction cap rates due to the variation in vacancy rate.
The method used in the quantitative part is secondary data analysis of data collected by other researchers and by public and private organizations in the course of appraised cap rates, transaction cap rates and determinants of cap rates for office properties in the Netherlands. The sample for data analysis is selected based on the following criteria:
- office transactions in Amsterdam from 2004 till 2011; - properties with various vacancy rates; - properties which have appraised market values available for the same as the transactions took place; - samples for years before and after the credit crunch. 22 Valuation accuracy in vacant office properties
Statistical analysis is used for the quantitative research part. The statistical method used for sub-question II is a total variance test, to quantify differences between appraised cap rates and transaction cap rates. For sub-questions III, a multiple regression technique is used to examine the determinants of cap rates in the Dutch office market for both appraisers and investors. Finally, for sub-question IV, One-Way ANOVA test is applied to analyze the mean variation for differences in appraised and transaction cap rates and different office vacancy rates. The research techniques are implemented using SPSS software for statistical analysis. These methods are explained thoroughly in Chapter 7.
3.16 Scientific and societal relevance This section describes the two major relevancies for conducting this research: the scientific relevance that emphasizes on the knowledge gap, and the societal relevance that focuses on the consequences of a less accurate appraised market value of vacant offices for the Dutch society.
3.16.1 Scientific relevance There are several studies related to valuation accuracy in the Netherlands, which are discussed in this section.
For the first time in the Netherlands, Hordijk (2005) studied the valuation accuracy concerning commercial real estate based on the ROZ-IPD index over the years 1995-2002. This was a comparison between the achieved selling price and the latest valuation. An average deviation of 7.9% was the result of the differences between appraisal value and the transaction price. This is a relatively high number when compared to the USA (-0.1%) and the UK (5.7%) (Hordijk, 2005). However, the time frame of this study was related to the economic expansion and the result does not represent the depressed market after the 2008 financial crisis in the Netherlands. In addition, the focus of this study was not on the valuation accuracy of vacant offices.
Rodermond (2011) has studied the differences between the transaction prices and previous valuation of 19 vacant office properties from 2008 to 2011 in the Netherlands, which resulted in an average difference of -11.72%. However this study does not cover the period before the 2008 crisis.
A more recent study which compared valuations and sale price in 12 national markets from 2000 to 2013 including the Netherlands was done by IPD (2014). The weighted average absolute difference between 2004 and 2013 in the Netherlands is 8.1% (IPD, 2014). Even though this analysis covers the time frame of before and after the financial crisis, it does not focus on the commercial real estate market and especially not on the differences between valuations and sale prices of vacant office properties.
Besides the literature on valuation accuracy which focused on comparing the property value among appraisers (appraised value) and investors (transactions), a recent study by De Roo (2014) shows the inaccuracy in valuation by examining the differences between appraisal-based cap rates and those of transactions. The results of this study show a huge gap of 45% between the appraised cap rates and transaction cap rates in office areas in Amsterdam with a high vacancy rate. This study illustrates the importance of micro location (submarkets) and structural vacancy in variation of cap rates. However, this study does not quantify the exact correlation of structural vacancy with used cap rates. Chapter 3: PROBLEM FIELD 23
In fact, there are not many studies in the Netherlands to analyze determinant of yields in the Dutch office market except those of Van Norren (2007) and Verhaegh (2005), which show that cap rates are strongly determined by macro-economic variables rather than aspects such as micro location and property-specific elements including the risk of structural vacancy.
Based on previous studies (De Roo, 2014; Hordijk, 2005; Rodermond, 2011), it is clear that there is some degree of inaccuracy in Dutch valuation practice. Unfortunately, none of the studies mentioned focus on understanding the pricing mechanism which results in such an inaccuracy in valuations. Therefore, this research emphasizes on the need for a more comprehensive research in this field, to study the differences between the appraisers’ and investors’ pricing mechanism. This research focuses on a larger time frame (before and after the credit crunch), cap rate determinants of both appraisers (valuations) and investors (transaction prices) and specifically focuses on the relation of the valuation accuracy with vacant office properties.
3.16.2 Societal relevance As mentioned in § 3.7, an inaccurate estimation of a property value may lead to a false indicator of the investors’ ability to meet their long-term obligation in respect to the cash flow obtained from the subject property. For instance, because the value of the property assets does not reflect the fair market value there is no accurate indication of the solvency rate of important financial institutions that have large investment portfolios in real estate (e.g. pension funds, insurance companies, banks, etc.). As a result, the financial stability of the important financial institutions is unclear. This worries both the Dutch Central Bank (DNB) as well as the European Union (Van Hoeken & Bruyn, 2014; Vermeulen, 2014). Therefore, the Dutch Central Bank (DNB), together with the AFM decided to conduct research in 2012 on the solvency rate of the Dutch banks. This was to establish a more accurate value of the property assets financed. Unfortunately, this research has not been made public.
The property market thus has its influence on the capital market, which in turn has an influence on society (Figure 3.4). A recent example where real estate almost caused the bankruptcy of a bank is that of the SNS bank in the Netherlands. This bank bought the “plagued” Bouwfonds from ABN AMRO which later caused the downfall of the SNS bank (Van Hoeken & Bruyn, 2014). SNS’ property finance portfolio consisted of many high risk loans. To prevent the bank from bankruptcy, the Dutch state nationalized the bank. The direct costs involved with this were 3,7 billion euro, which increased the Dutch budget deficit in 2013 with 0.6% to 3.3%. The national debt rose with 1.6% and other banks had to pay a total amount of 1 billion euro in 2014.
It is thus of societal relevance to research the valuation accuracy in relation to the fair property value to determine the actual solvency rate and thereby the financial stability of the financial institutions.
Figure 3.4, the impact of property market (real estate crisis) on the capital property market capital market society market (financial crisis) and society (economic crisis) Part II: Theoretical framework
Chapter 4: Determinants of cap rate, a background study
Chapter 5: From fundamental to dynamic cap rates theory
Chapter 6: Context, location, property & office-users Determinants of cap rate, a background study 4 26 Valuation accuracy in vacant office properties
Chapter 4: Determinants of cap rate, a background study This section reviews the main determinants of cap rates as found in the academic literature. In essence, studies discussing the determinants of the office market capitalization rate, can be divided in two major categories of macro-level and micro-level variation in cap rates (Hoesli & Chaney, 2014; McDonald & Dermisi, 2008). The macro-level variation studies, focus on market-specific variables that capture cap rate variations over time (time-series), such as those that depend on capital market, macro-economic variables and the Metropolitan-Specific Area (MSA). The micro-level variation studies emphasize on property-specific factors which vary from property to property and/or per location (cross-sectional).
The rest of this section reviews these studies chronologically based on the country of focus (international and Dutch literature), their methodology, data and ultimately their results.
4.1 Cap rate Determinants in international literature One of the earliest studies on determinants of cap rates is by Froland (1987) in the U.S. According to the author, the movement on the total investment market is more crucial on cap rate variation than simply observing the changes in the real estate market. According to Froland (1987), this is due to the fact that real estate investment is merely one of the various investment opportunities for the investors. Froland (1987) argues that cap rates for property valuation, function the same as price-earnings ratios for the stock exchange market. As a result, they must be approximately equal to the opportunity cost of capital of investors, increased with a risk premium for real estate. To prove this, Froland (1987) examines whether cap rate movement is driven by the capital market and whether its movement is comparable to other yields in the asset trading market. This study analyzes the American Council of Life Insurance (ACLI) dataset from 1970 to 1986, based on transactions done by large institutional investors in the United States. Froland (1987) finds a positive correlation between cap rates and mortgage rates. Cap rates are associated inversely by the earnings/price ratio and ten-year bond rates. In addition, Froland’s study reports a negative effect of economic cycle factors on the cap rate, such as national vacancy rate, the percentage change in real Gross National Product (GNP), and capacity utilization. However, Jud and Winkler (1995) criticize Froland’s work as Froland’s empirical results were not set up based on any theoretical framework; secondly, through using the stepwise regression approach, the mortgage rates, the earnings/price ratio and ten-year bond rates could explain around 86% to 95% of the variation in cap rates. In addition no corrections for autocorrelation were tested.
Ambrose and Nourse (1993) used the same ACLI dataset as Froland (1987); however, unlike Froland (1987), their study does not suffer from a lack of ground theory. Ambrose and Nourse (1993) explain the cap rate based on the band of investment model, also known as the Weighted Average Cost of Capital (WACC) in the corporate finance literature (Jud & Winkler, 1995). The WACC approach is based on the theory that the overall cost of capital is the weighted average of debt cost and equity cost (Ambrose & Nourse, 1993; Lusht, 2012).
Ambrose and Nourse (1993) analyze transaction-based cap rates of several commercial properties (office, retail, industrial, hotel, etc.) in the U.S. from 1966 to 1988. They use two different statistical techniques to model cap rates: Seemingly Unrelated Regression (SUR) and cross-sectional/time- series regression. Their empirical results show that using SUR, no significant correlation between cap rates and either the earnings/price ratio or the bond risk premium spread is found. The results of Chapter 4: determinants of cap rate, a background study 27 their cross-sectional/time-series regression (panel data), record that cap rates are positively related to the percentage of equity investment, cost of debt, and expected inflation, while being negatively related to earnings/price ratio. In addition, they show that cap rates vary significantly by property type (office, retail, industrial, hotel, etc.). However, cap rate is not strongly tied to a location.
Jud and Winkler (1995) elaborated on the study of Ambrose and Nourse (1993) by examining the relation between cap rates and financial variables, in an ad hoc approach. This is achieved by formulating a cap rate model derived from the financial literature, not only based on the WACC model, but also combining it with the Capital Asset Pricing Model (CAPM). The CAPM is a model that describes the relationship between risk and expected return on equity with two factors: time value of money (the risk-free interest rate) and expected market return. In accordance with Ambrose and Nourse (1993), Jud and Winkler (1995) suggests that cap rates are determined by required returns in the debt and equity market. Their findings show that cap rates and capital market returns are significantly related. However, they do not adjust quickly to capital market changes (lagged). In addition, the market relationships change strongly across different locations. According to their empirical findings, Jud and Winkler (1995) ascertain the fact that the property market is not an efficient market and does not fully integrate with the national capital market.
Another study explaining macro-level variation in cap rates by analyzing aggregated cap rate data, is from Sivitanides, Southard, Torto, and Wheaton (2001). The authors believe that real estate markets are naturally segmented by metropolitan area and that macro local market conditions play an important role in determining variations in cap rates, both through time and across metropolitan areas. They formulate a cap rate model as a function of the risk-adjusted discount rate and the expected growth rate of income. Their final model was a Time-Series Cross-Section (TSCS) regression model which uses a logarithm of cap rates as a dependent variable, which in turn is related to six regressors: the logarithm of cap rates of the previous year, a Metropolitan-specific real rent index, an annual percent change in the metropolitan- specific real rent index, Government Bond Return Rate as an indicator of the risk-free opportunity cost of capital, the yearly percentage change in CPI as an indicator for inflation expectation, and finally MSA (Metropolitan-specific area) dummies as a fixed effect for each individual market. They investigate the determinants of appraisal-based cap rates using the database of the National Council of Real Estate Investment Fiduciaries (NCREIF). This database contains annual office cap rates for 14 metropolitan areas in the U.S. from 1984 to 2000. The empirical results of their research contains three main aspects. First, cap rates vary persistently across markets due to differences in fixed market characteristics. These characteristics influence the investor’s perceptions of both future income growth and associated risk. Second, changes in market-specific cap rates consist of components which are shaped by historical trends in rental growth and rent levels in the specific market. Such a relationship with historical trends and movements in cap rates, indicates that appraisal-based valuations strongly rely on past evidence in the market, rather than having a forward looking perspective. This is consistent with the arguments regarding anchoring behavior of appraisers by (Baum et al., 2000; Hordijk, 2005; McAllister et al., 2003). Third, cap rates are influenced by national developments in capital market and economy. In addition, Sivitanides et al. (2001) argue that investors are acting irrationally when estimating cap rates as they do not consider the mean reversion of real rents in their expectation about real rental growth. In fact, they use lower (or higher) cap rates when rental cyclical peaks (or troughs), resulted in having overvalued (or undervalued) properties. 28 Valuation accuracy in vacant office properties
McDonald and Dermisi (2008) continue with the model developed by Jud and Winkler (1995) to formulate their cap rate model. In addition, they enrich their model with variables that may indicate a value change of office properties from the perspective of an investor. McDonald and Dermisi (2008) intended to explain the investors’ behavior to show how they use several variables, such as class and age of buildings, as proxies for forecasting changes in the market value of office properties. Therefore, their study employs not only macro-economic and financial variables that depend on the capital market, but also explain micro-level variations in cap rates by considering individual properties as the unit of observations. The authors apply their model on a database that consists of 132 office building sales in Chicago between 1996 and 2007. Their findings show that a newer building, a class A building, a building which has been renovated, had a negative effect on cap rates, while a decrease in office employment and increase in the local market’s vacancy rate, has a positive relation with cap rates. The latter shows that investors pay close attention to changes in the vacancy rate and its magnitude in that specific market, to forecast the changes in office property prices, as McDonald and Dermisi (2008) suggest in their study.
The study by Netzell (2009) is a significant step forward in explaining the micro-level variation in appraisal-based capitalization rates in Sweden. Netzell (2009) examines the rationality of the Swedish property valuations in terms of whether the appraisal cap rates follow the economic theory. This is achieved not only by adding extra micro-level variables, such as micro location dummies (submarkets within the macro office market), but also by comparing the cap rate model to the micro-level explanatory factors with the macro-level and time-series variables. This study explores the micro level variation of both appraisal-based going-in and exit cap rates in three Swedish office markets, namely Stockholm, Gothenburg and Malmö. The author constructs the cap rate model according to the Gordon model (1962) where cap rate equal the difference between property expected required rate of return and rental growth. In Netzell’s model, cap rates are regressed on both property-specific variables and broad time-series variables. The author applies the feasible generalized least squares (FGLS) regression technique to overcome the heteroskedasticity (when the variances of the observations are unequal) and serial correlation in dataset. In addition, the author included location variables to show cross-sectional and time-series variation in cap rates at two levels. The first level includes three Swedish office markets: Stockholm, Gothenburg and Malmö; while the second level includes locational dummies for three segments in each office market: CBD, city center and peripheral property submarkets. The explanatory used as proxies for the property quality included in the regression equation, are the age of the property, ground lease dummy, rent ratio between current rent and market rent and vacancy gap (the difference of current vacancy and long-run vacancy). Moreover, explanatory factors expressing broad time-series variations such as ten-year governmental bond, earnings per share and real earnings on stock are also used in the regression.
As mentioned in the previous paragraph, the strength of this study is that the author compares cap rate model regressed only to the micro-level explanatory factors with those that were based on macro-level and time-series variables. This is done by using three different approaches in modeling cap rates where the results of each model is compared with the others to explore different level variation of cap rates. The first is a regression model which is ran using year dummies to examine the existence of any variation over time which is common for all properties. The second is a regression model, which initially ran using fundamental time-series variables to study the effect of macro level variation of cap rates over time. Substantially, this model was tested by means of a two-way Chapter 4: determinants of cap rate, a background study 29
ANOVA test for cross-sectional differences in cap rates, which resulted in showing around 85-90% of variation in cap rates in the three office markets. Finally, the third model tested, is a regression model using merely cross-sectional explanatory variables in the model to compare it with the first two models (Netzell, 2009).
The results of Netzell’s (2009) empirical study show that a lower market rent and higher long run vacancy rate indicate the quality of a property and are associated with higher cap rates. Going-in and exit cap rates are both negatively associated with higher market rent at the property level. In addition, cap rates are positively related to long run vacancy rates, though exit cap rates are more sensitive to this than going-in cap rates. The age of the property was only significant in one of the Swedish office markets, and not significant for the other cities. A higher cap rate is associated with properties with a ground lease. This is due to the fact that leasehold conditions result in having less control over the property, and therefore are associated with higher risks for the investors. Also, properties located in the peripheries are positively related with cap rates. These all show economically reasonable relations. Going-in cap rates are significantly related to how the actual (current) rent in the first year deviates from the market rent. The same is valid for the deviation of the current vacancy from the long run vacancy rate for the property. In addition, cap rates are positively related to risk-free rate and negatively related to the earnings per share on stock (Netzell, 2009).
The overall findings deduced from this research indicate, that first, the variation in cap rate is more related to cross-sectional than time-series variables. Second, it shows that submarket locations (segments) are strongly effecting the determinants of cap rates in Sweden. Furthermore, the direction and magnitude of the explanatory cross-sectional variables are consistent with economic theory (in general with what happens in the market), thereby showing the rationality of Swedish property appraisals. The results for the determinants which indicate broad time-series variations, however, are partly inconsistent with other literature. This may be the result of the short time span of this research, as the time-series variables exhibit different results for different office markets (three cities) and their segments (Netzell, 2009).
Chervachidze and Wheaton (2013) argue that a large number of previous cap rate studies considered cap rates are determined by risk-free interest rates and market fundamentals, essentially rent levels and rental growth. This indicates that cap rates are modeled pursuing an adjustment process around equilibrium values. The authors describe this as a ‘Null hypothesis’, meaning a standard literature-based model which uses real estate fundamentals and risk free rates in explaining cap rate variations. However, Chervachidze and Wheaton (2013) believe that the impact of macro-economic capital flows, namely the debt availability on cap rate and property value, is very strong. This study is conducted using the ordinary least squares (OLS) regression model combined with the fixed effects panel technique on appraisal-based data of the NCREIF Property Index in the U.S. since the 1980s. The fixed effects panel technique increases the model coefficients and efficiency. This is achieved by correcting the model for both time-series and cross-sectional variation among metropolitan-specific areas using MSA dummies. According to the authors “this framework is consistent with theoretical expectations that market-specific unobserved characteristics will lead to permanent differences in capitalization rate trends across markets, and the fixed effects method allows us to estimate the effect of these unobservables and test for their statistical significance.” 30 Valuation accuracy in vacant office properties
Chervachidze and Wheaton (2013) follow a three stage specification progression of cap rate model equations. First, they specified the null hypothesis model which is the most comprehensive model reflecting the standard approach used in the previous literature such as Sivitanides et al. (2001). The authors term this as The “Null” Specification: Market fundamentals and Treasury Rates where cap rates are determined around the equilibrium values. According to Chervachidze and Wheaton (2013), “the equilibrium is estimated at the same time as the adjustment and is determined by two sets of influences: first, the influences of a discount rate that reflects both the opportunity cost of capital and systematic market risk; second, fundamental factors that shape investors’ income growth expectations. This is in line with the literature, which usually uses rental fundamentals and some proxy for interest rate to explain cap rates.”
The second model specification is extended by including a risk premium, which according to Chervachidze and Wheaton (2013) is defined as economy wide risk premium over the risk-free rate. This explanatory variable is estimated by subtracting the Moody’s AAA Corporate Bond Index and the 10-year T-Bond. The results of this test show that this variable is positively related to cap rates, due to the fact that investors require to be compensated for a higher risk for a lower property value with the same rental income. Adding the aforementioned variable resulted in a higher goodness of fit tests and adjusted R2 statistics. Chervachidze and Wheaton (2013) emphasis on the significant influence of the risk premia required by investors on property values and criticize the existing literature for omitting it.
In the third model, Chervachidze and Wheaton (2013) extended their model specification by adding a debt availability variable. This variable is proxied by the yearly change in total debt outstanding to the GDP.
Even though traditional financial economics argue that, in an efficient market, financial structure and the ratio between debt and equity should not impact the property value (Lusht, 2012), recent macro-economic theories view debt availability as a frequent cause of financial crises, while micro- economic argues that debt can enhance property liquidity. This is explained with the fact that when the availability of debt is limited, real estate transactions are more difficult and consequently the property values drop down and, become lower than their fundamental value. As Chervachidze and Wheaton (2013) argue, the easy debt boosts the property transactions which leads to an increase in the property values (even higher than their fundamental prices). This is mentioned to be one of the possible underlying causes of the formation of the price ‘bubbles’ in the property market.
The results of the last model show that debt availability is negatively related to cap rates due to the fact that investors associate debt scarcity with illiquidity and higher cap rates.
The overall findings deduced from Chervachidze and Wheaton (2013) show that local property fundamentals (rent) can merely explain a small part of the variations in cap rates. However, the macro-economic factors of real T-rate, bond risk premium debt availability affects cap rates strongly. This is because these variables vary at macro level over time and have no cross-sectional variations (cross MSA). Therefore, Chervachidze and Wheaton (2013) argue that the importance of the location, as one of the most important factor for the real estate does not seem to be valid in their study.
However, Chervachidze and Wheaton (2013) examine the association of the property values and the Chapter 4: determinants of cap rate, a background study 31 overall growth of debt in national economy. This is while, as the authors mention, only 6% of the total current (public and private) debt is devoted to commercial real estate debt.
Hoesli and Chaney (2014) complement the earlier research about cap rate determinants not only by adding several property-specific factors which were not tested by previous literature, but also they are the first who compare the determinants of appraisal-based cap rates with transaction-based cap rates in detail. By this, they attempt to enhance the understanding of the underlying reasons behind the differences between valuations and transaction values. They conduct their research on the IAZI database, the largest real estate database in Switzerland, for the timeframe between 1985 and 2010.
This study formulates a cap rate model based on the Gordon model (1962) and further develops it as a function of the risk-adjusted discount rate (sum of risk-free interest rate and risk premium), and the expected growth rate of income. Subsequently, they split both risk premium and the expected rate of growth into micro and macro contributions. This is based on the aforementioned two categories of research that have studied either cap rate variations at a macro- or micro-level. In addition, for their empirical model they use variables from previous research in three main streams of: the capital markets, the risk associated with the investment related to local market conditions as well as the individual property, and the investors’ assumption about property value changes in the future, which rely on local market conditions as well as the individual property.
As an indicator for the risk-free rate, they considered the yield on government bonds with a maturity of ten years. To include the macro-level risk premium component of cap rates, like previous studies, the connection between stock market is considered. However, to show the micro-level risk premium, variables such as ownership leverage (an existing leasehold or easements), land leverage, sale conditions (auctions, at arm’s length, off-market transactions), tenants risk and diversification, refurbishment risk (age and property condition), illiquidity risk (building volume), and the quality of the location are included in their model. Compared to the previous literature, Hoesli and Chaney (2014) were the first one to include new variables such as auctions, off-market transactions, easements, tenant risk, and construction and building quality at the property level to explore cap rates variations. Finally, as an indicator for rental growth, vacancy rates, rent, GDP and inflation are considered.
Their empirical results show that the aforementioned property-specific risks are significantly associated with variations in cap rates. For instance, the ownership leverage (an existing leasehold or easements) is positively correlated with cap rates while construction quality and building condition are negatively associated with variation in cap rates. In addition, factors such as the condition under which a transaction is performed, whether on a free and transparent market, auction or off-market transactions (e.g., between family members or a related legal entity), are used with investors as a proxy for micro-level risk premium and have a strong explanatory power for variations in cap rates.
By comparing the determinants of appraisal-based cap rates with transaction-based cap rates, Hoesli and Chaney (2014) confirm that there are differences between appraisers and investors in the way they percept real estate risk which ultimately results in a divergence of the property value (appraised and transaction prices). According to Hoesli and Chaney (2014), the most obvious differences are that risk-free rate, the ratio of rent to average rent, age and volume are more 32 Valuation accuracy in vacant office properties important for investors while building condition and macro location are considered more important for appraisers. In addition, investors put more weight on factors such as vacancy rate and risk-free rate, rent relative to average rent whereas these factors are not or less significant for appraisers. Instead, appraisers overweight factors such as building condition and micro location while these are less significant for investors. However, variables such as macro location, price to earnings ratio of stock and GDP are equally significant for appraisers and investors. In addition, in opposite to the findings of Chervachidze and Wheaton (2013), Hoesli and Chaney (2014) suggest that the well- known real estate dictum of ‘location, location, location’ is confirmed as location has a significant role in the pricing mechanism of properties for both appraisers and investors. However, it should be mentioned that appraisers put more weigh on location than investors.
Overall findings of Hoesli and Chaney (2014) suggest that investors and appraisers focus on different factors when estimating cap rates and therefore the property value. The appraisal-based cap rates vary more across property and less over time in comparison to the transaction related cap rates. In fact, appraisers put more weight on elements that are easy to observe (property-specific characters) whereas investors are more concerned with macro-economic variations over time. As Hoesli and Chaney (2014) argue, this is consistent with the appraisal smoothing discussion and clarifies one of the underlying causes of the smoothing effect, as property-specific factors (as the focus of appraisers), hardly vary over time. Another remark by Hoesli and Chaney (2014) regarding investors, is that they focus on a portfolio level and are more concerned with non-diversifiable risks which cannot be eliminated in the portfolio, and less with the risks associated with the individual property when determining cap rates.
4.2 cap rate Determinants in Dutch literature None of the previously discussed literature is determining the cap rates variation in the Netherlands. In fact, the research about determinants of cap rate are very scarce in the Dutch literature. Among all, three master thesis are reviewed to understand the main components of yield (gross and net yields) in the Dutch office market. The first study focuses on determinants of the Gross Initial Yield (GIY) (Verhaegh, 2005), whereas the second study examines the drivers of cap rate (Van Norren, 2007). The last (third) study has a focus on comparing the appraise-based cap rate and those of transactions in the Netherlands (De Roo, 2014).
Verhaegh (2005) examines the relevant determinants of the gross initial yield (GIY) at both macro and location level, and micro level (property specific variables) in the Dutch office market, using the ROZ/IPD Property Index, the main benchmark index for Dutch real estate investments of institutional investors in direct property. The database includes 1410 office properties for 2002 and 2003. Due to the limitation of available data, Verhaegh (2005) was not able to include all the relevant determinants of the gross initial yield (GIY) in the analyses. The main five determinants in this study are rent gap or potential measured as the difference between the real rent and market rent, market rent, remaining lease term, operating costs and the age of the property. Data is analyzed with a multiple regression model including the GIY as the dependent variable and the five aforementioned variables as independent variables which resulted in an explanatory power of 40% of variation in GIY. The results show that all the variables, except operating costs and age, are negatively associated with GIY. However, it seems that the age of the property has only limited impact on the GIY. In addition, Verhaegh (2005) adds four main regions in the Netherlands, namely Amsterdam, Rotterdam, Utrecht and The Hague to the model and concludes that GIY varies strongly per region. The overall result of Chapter 4: determinants of cap rate, a background study 33 this study indicates that the GIY is more associated with macro-economic and location factors than property-specific variables. However, since this study is performed for a very short time period of 2 years (2002 and 2003), the results should not be generalized as they do not provide strong market evidence.
To determine cap rate variations, Van Norren (2007) creates a cap rate model using both macro- economic factors and local factors (four major cities of Amsterdam, Rotterdam, Utrecht and The Hague) between 1986 to 2006. In total, four separate models are created where the annual cap rate per city is used as the dependent variables separately per model. The main variables Van Norren (2007) determines for these multiple regression models are respectively yearly inflation rate, real risk-free interest rate, GDP (as an indicator of the economic growth), investment volume, the previous cap rate itself, the performance of the stock market, changes in absolute vacancy rate, and rent ratio measured by dividing the current rent level by the long run average rent. However, Van Norren (2007) mentions that due to the lack of available data, merely a few of these variables could be used in order to make a comprehensive cap rate model for the Netherlands. The overall findings of this study show that cap rates are strongly determined by macro-economic factors where their influence on cap rates barley differentiates per location. Among all macro-economic factors, the ten-year government bonds rate has the most explanatory power in variation of cap rates in all the cities. A contrary finding of this research is that vacancy rate did not indicate a strong association with cap rates, except for Utrecht. This is inconsistent with Hoesli and Chaney (2014), McDonald and Dermisi (2008) and Netzell (2009), there vacancy rates are used as a proxy to indicate the changes in the local market and rental growth.
De Roo (2014) compares the transaction-based Net Income Multiplier (NIM), the reciprocal of the cap rate, to the assessed value NIM (in Dutch the WOZ-waarde kapitalisatiefactor) in the Amsterdam office market from 2004 to 2013. The findings show that there is a huge gap between the NIM of the transactions and the assessed value. The results show that the differences between these two NIM (of transaction and of assessed value) are not always showing the same relation (always higher or lower). In fact, at the prime office locations in Amsterdam (center and south), the assessed value NIMs are 20% lower (cap rates are higher) than transaction-based NIMs (cap rates). Whereas, for structural vacant offices located in the non-prime locations in Amsterdam (west and south-east), the assessed value NIMs are 45% higher (cap rates are lower) than transaction-based NIMs (cap rates). De Roo (2014) argues that the underlying cause of this difference, especially in the non-prime office locations with a lot of structural vacancy, is that office properties are barley sold as vacant, and when that happens, there is a huge decrease in the property value. This is while one of the base assumptions in determining the assessed value in the Netherlands is that the property should be valued as it is vacant. Therefore, such a decrease in the value in the actual market value is not considered by appraisers as valid market evidence, which results in a huge gap of 45% between assessed value NIMs and those of the transactions. However, it should be mentioned that even though this research points out the differences between transactions (investors) and assessed value (appraisers), it does not fully examine the relevant determinants of cap rates (or NIMs) as the underlying causes of such differentiation.
4.3 Cap rate determinants conclusion It is clear that there are two main approaches towards determining cap rate variations. Those that indicate the dominance of macro-economic and time-series variations in cap rates and the others 34 Valuation accuracy in vacant office properties where micro-level and property-specific factors are more powerful in explaining cap rate variations. These differences in macro- and micro-level cap rate variations is partly caused by the type of data (transaction-based cap rates or appraisal-based cap rates) which was examined and/or the country of focus.
Mostly where cap rate models are based on appraisal-based data, the results show a higher association of cap rates with the historical trend on cap rates (serial correlation) or overweighting variables that barely vary over time (individual property), which both support the appraisal smoothing theory. Whereas when the transaction-based cap rates are modeled, cap rates are more associated with macro-economic variables, capital market and expected income growth.
In general, in most of the U.S. studies, the influence of macro-economic and financial variables is more dominant (Ambrose & Nourse, 1993; Chervachidze & Wheaton, 2013; Froland, 1987; Jud & Winkler, 1995; Sivitanides et al., 2001) than the presence of micro-level variation with a focus on individual property, except for McDonald and Dermisi (2008). Among all, indicators of capital market such as required rate on stock and government bonds, financial variables such as availability of debt, macro-economic factors such as growth in GDP, the differences between rent from its historical trend, vacancy rates in the macro location are used to explain car rate variations.
In contrary, more recent studies in Europe, namely in Sweden (Netzell, 2009), Switzerland (Hoesli & Chaney, 2014) show the importance of micro-level factors in determining cap rates. Among all, property age, condition and size, quality and type of users, leasehold, ratio of current rent to median (market) rent, sale conditions and location are mentioned frequently.
Finally, the limited studies performed in the Netherlands (Van Norren, 2007; Verhaegh, 2005), show that cap rates are strongly determined by macro-economic factors where their influence on cap rates barely differentiate per location. However, the recent study of De Roo (2014) indicates a gap between appraisal-based NIM and those of transactions, illustrating the importance of micro location (submarkets) and structural vacancy in variation in NIM (also in cap rates).
Table 4.1 summarizes the cap rate determinant related studies, their focus (macro or micro level variation in cap rates) and the main limitation.
For the complete list of variables found in the studies and their relations to cap rates see Appendix 1. Chapter 4: determinants of cap rate, a background study 35
Table 4.1, the cap Name Year Country Used data Focus Main limitation rate determinant related studies, Froland 1987 U.S. transaction-based macro level did not model cap rates their used data, based on any theoretical their focus (macro framework or micro level variation in cap Ambrose and 1993 U.S. transaction-based macro level cap rates are not strongly rates) and their Nourse tight to a location main limitation Jud and Winkler 1995 U.S. appraisal-based macro level did not considered micro level cap rate variations Sivitanides, 2001 U.S. appraisal-based macro level did not considered micro Southard, Torto, level cap rate variations and Wheaton Verhaegh 2005 Netherlands appraisal-based macro level not all the relevant determinants of GIY were used, specifically the micro level determinants Van Norren 2007 Netherlands - macro level due to the lack of available data, merely a few of these variables could be used in order to make a comprehensive cap rate model McDonald and 2008 U.S. transaction-based both It studies only one city in Dermisi the U.S. Netzell 2009 Sweden appraisal-based both the expected sign for the time series variables were not consistent with other studies due to the short time span used Chervachidze 2013 U.S. appraisal-based macro level this study ignores the micro and Wheaton level variations in cap rates Hoesli and 2014 Switzerland both both their cap rate model is Chaney based on the Gordon model which is rather primitive De Roo 2014 Netherlands both - does not fully examine the relevant determinants of cap rates From fundamental to 5 dynamic cap rates theory Chapter 5: From fundamental to dynamic cap rates theory 37
Chapter 5: From fundamental to dynamic cap rates theory This chapter focuses on the main theoretical frameworks used for modeling cap rates, as previously discussed in Chapter 4, and further develops them to build a dynamic cap rate model. The chapter beginsWhere; with= the + use∗ of the− basic + 1and − static ∗ direct+ capitalization+ + formula− (equation 1, mentioned in § = risk free rate, 3.6), and step by step develops it by integrating the Gordon’s model, a dynamic discount rate model = Loan-to-value ratio, and its related = rate of returntheory on estimations debt, such as the band of investment model (or WACC), the CAPM and ⁄ summationWhere; == premium technique, + from∗ participation −and a +risk 1in realpremium − estate, ∗ concept+ +to finally+ define− the dynamic cap rate model = risk= premium free rate, on location attributes, specification. = = premium Loan-to-value on property-itself ratio, attributes, = =rate premium of return on onproperty-user debt, attributes, ⁄ 5.1 Gordon= premium mode from participationl in real estate, = a constant expected rate of growth in the NOI. As mentioned = premium in § on2.6, location the direct attributes, capitalization method, estimates the property value by capitalizing = premium on property-itself attributes, the property’s Net Operating Income (NOI) of the initial year by the cap rate (equation 1). = premium on property-user attributes, = a constant expected rate of growth in the NOI. (1) (1)
Where; = + ∗ − + 1 − ∗ + + + − = = risk free rate, Where; = + ∗ − + 1 − ∗ + + + − V = property = Loan-to-value value, ratio, = risk free rate, NOI = =rate Net of Operating return on Income debt, in the first year, (1) ⁄ = Loan-to-value ratio, Ro= =overall premium capitalization from participation rate (%). in real estate, = rate of return on debt, =⁄ Where; = premium on location attributes, = premium from participation in real estate, V = property value, When a level == premium premium cash on onflow property-itself location is expected attributes, attributes, to be gained in perpetuity, the discount rate can replace the cap NOI = Net Operating Income in the first year, = premium on property-user attributes, rate and =be premium used onto property-itselfcapitalize the attributes, annual NOI, as a shortcut to estimate the value of the property (2) Ro= overall capitalization rate (%). = =a premiumconstant expectedon property-user rate of growth attributes, in the NOI. (Lusht, 2012) which results in equation (2): Where;= = a constant expected rate of growth in the NOI. = expected required rate of return (discount rate %).
(2) (2)
(1) Where;= (3) = expected required rate of return (discount rate %). (1) = Where; =V = property value, Where; However,NOI = this Net Operatingis valid when Income no in thechanges first year, in the future income is expected till perpetuity and does not V == expectedproperty value,required rate of return (discount rate %), Ro= overall capitalization rate (%). takes NOIinto = =expected accountNet Operating rate the of Income growthchanges in in the the in first NOI.the year, future value of a property due to the increase or decrease in (3) R o= overall capitalization rate (%). the operating income. Where;= = expected required rate of return (discount rate %), ((2)4) To overcome = expected this rate limitation, of growth thein the Gordon NOI. model (1962) considers a growing perpetuity at a constant rate of g and expresses that the property value equals a perpetual future NOI cash flow divided by a (2) =− Where;= constant expected required rate of return (discount rate), minus a constant expected rate of growth (5) = expected required rate of return (discount rate %). Where;= in the NOI, as shown in equation (3): (4) Where; = expected == required∗ rate+ of1− return (discount∗ rate %). = overall cost of capital, =− = Loan-to-value ratio, (5) (3) (3) = cost of debt, ⁄ = cost of equity. (3) Where; == ∗ + 1− ∗ Where;= = overall cost of capital, = expected required rate of return (discount rate %), Where;= = Loan-to-value ratio, = expected rate of growth in the NOI. = = expected cost of debt, required rate of return (discount rate %), (6) ⁄ = cost of equity. = expected rate of growth in the NOI. By rearranging equation (1) and (3), the overall capitalization rate can be calculated as follows: Where;= + (̅ −) = expected return on property, (4) = risk free rate, (4) (6)(4) ==− expected market return, (5) = equity beta ( ). Where;= =− + (̅ −) ̅ (5) = expected return on property, Where; ==( ∗ ,+ )⁄1− ∗ = risk free rate, = overall cost of capital, Where; = expected == market∗ return,+ 1− ∗ = Loan-to-value ratio, == overallequity betacost of( capital, ). = cost of debt, ̅ = Loan-to-value ratio, ⁄ = cost of equity. ( , )⁄ = cost of debt, ⁄ = cost of equity. (6) (6) = + (̅ −) Where; = expected return on property, Where;= + (̅ −) = risk free rate, = expected return on property, = expected market return, = risk free rate, = equity beta ( ). ̅ = expected market return, = equity beta ( ). ( , )⁄ ̅ (,)⁄
Where; = + ∗ − + 1 − ∗ + + + − 38 = risk free rate, Valuation accuracy in vacant office properties = Loan-to-value ratio, = rate of return on debt, ⁄ = premium from participation in real estate, Considering equation (4), cap rates can be written as a function of discount rate (r) and growth in = premium on location attributes, NOI (g) which indicates factors affecting r and g, may affect cap rates as well. = premium on property-itself attributes, = premium on property-user attributes, 5.2 Discount = a constant rate expected (r rate) of growth in the NOI. The discount rate (the required rate of return by investors), considers both time value of the money, and the uncertainty and risk associated with the future cash flow of a specific investment, compared to risks offered by other types of investment in the capital market. In other words, it in fact reflects the opportunity cost of capital and market risk considering the similar risks of an alternative (1) investment = (Geltner et al., 2014; Lusht, 2012). Where; V = property value, Due toNOI the = Net nature Operating of theIncome real in theestate first year, market (heterogeneous, infrequent transactions, and lack of transparency),Ro= overall capitalizationmentioned rate in (%).§ 2.5, estimating the discount rate is a challenging task in comparison to other types of investment such as treasury bills or corporate bonds (Lusht, 2012).
The next sections discuss the most used methods in order to forecast the discount rate, which has (2) been used as a base theory by many authors (Ambrose & Nourse, 1993; Chervachidze & Wheaton, Where;= 2013; Hoesli = expected & Chaney, required rate2014; of return Jud & (discount Winkler, rate 1995; %). Netzell, 2009; Sivitanides et al., 2001) mentioned in chapter 4, to model cap rates.
5.2.1 Band of investment mode l (3) As mentioned in § 4.1, the band of investment model, or the WACC approach (Weighted Average Cost ofWhere;= Capital), is used by Ambrose and Nourse (1993), Jud and Winkler (1995) and McDonald and Dermisi = expected (2008), required to ratemodel of return cap (discountrates and rate to%) , measure the impact of financing on the return on = expected rate of growth in the NOI. investment. According to Jud and Winkler (1995), the WACC, as defined in equation (10), used in corporate finance literature, is in fact the required rate of return (discount rate) on projects funded by firms using both debt and equity received form capital markets. (4)
=− (5) (5) Where; == ∗ + 1− ∗ = overall cost of capital, = Loan-to-value ratio,
= cost of debt, ⁄ = cost of equity. In the appraisal literature, the band of investment model calculates the overall cost of capital as the sum of the weighted average of expected cash returns to the lender and the investor (Brueggeman (6)
& Fisher, 2011; Lusht, 2012). The rationale for the band of investment model explained by (Lusht, Where;= + (̅ −) 2012) is = expectedthat since return most on property, properties are purchased by the use of both debt and equity, therefore the return = risk to free these rate, parts (debt and equity) should be provided by the annual NOI of a property. = expected market return, The debt cost (debt service) is a return to the lender, while the residual income of NOI after debt = equity beta ( ). payment̅ is a return on equity to the investor. As a result, the overall cost of capital is the weighted (,)⁄ average of debt cost and equity cost.
5.2.2 Capital Asset Pricing Model (CAPM) The CAPM is another approach to estimate the discount rate by suggesting that the expected return on equity (r) is time-varying (as the investors should be compensated for time value of money), and dependent on expected market return (r ̅_m) as shown in equation (6):
Where; = + ∗ − + 1 − ∗ + + + − = risk free rate, = Loan-to-value ratio, = rate of return on debt, ⁄ = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes, = a constant expected rate of growth in the NOI.
(1) = Where; V = property value, NOI = Net Operating Income in the first year, Ro= overall capitalization rate (%).
(2)
Where;= = expected required rate of return (discount rate %).
(3) Where;= = expected required rate of return (discount rate %), = expected rate of growth in the NOI.
(4)
=− (5) Where; == ∗ + 1− ∗ = overall cost of capital, = Loan-to-value ratio,
= cost of debt, ⁄ Chapter = 5:cost From of equity. fundamental to dynamic cap rates theory 39
(6) (6)
Where;= + (̅ −) = expected return on property, = risk free rate, = expected market return, = equity beta ( ). ̅ (,)⁄ By considering the fact that the expected return on investment consists of two slices of debt and equity, from equation (5) and (6), the discount rate is written as equation (7):
(7) (7) = ∗ + 1 − ∗ →= + ∗ − + 1 − ∗ (̅ −) Where; = + (̅ −) = expected return on property, = risk free rate, = expected market return, = equity beta ( ). ̅ (,)⁄ There are some drawbacks associated with the CAPM approach. As shown in equation (11), to apply (8) the CAPM theory, three parameters of the risk free rate (r_f), equity beta (β) and the market risk Where; < < ̅ premium = expected(r ̅_m) should return on be property, calculated. Estimating the risk-free rate and the market risk premium are = risk free rate, straightforward and equal for all investments. However, the calculation of equity beta (β) requires = expected market return (of stocks). the availability of the price series of assets traded in a transparent and liquid market and is specific ̅ to the type of business under analysis. Unfortunately, for the real estate market (specifically the (9) income properties due to their characteristics such as heterogeneity, lack of liquidity and high transactionWhere; = costs),+ it is very difficult to estimate property betas in comparison to other type of = risk free rate, assets, for= risk instance premium. stocks and bonds (Damodaran, 2012). 5.2.3 Summation technique (10) To overcome the drawback in calculating equity beta (β), mentioned in § 5.2.2, an alternative (7) <= + < ̅ approach= to∗ estimate+ 1 − the ∗ discount rate, is the use of the summation technique. Consistent with (11) →= + ∗ − + 1 − ∗ (̅ −) the CAPM = theory, + (̅ Hoesli, − Jani,) and Bender (2006) argue that the discount rate, used for a property Where; = ( −) completely = expected financed return byon property,the equity investor, is higher than the market-observed risk free rate,(12) yet = risk free rate, lower than the historical return of the stock market. Thus, the following relation holds among these Where; == expected + market return, three different= equity beta rates ( of returns: ). = premium from participation in real estate, ̅ = premium on( property-specific, )⁄ attributes. (8) (8) Where; < < ̅ (13) = expected return on property, 1 2 Where; == risk free+ rate, + = risk free rate, = expected market return (of stocks). = premium from participation in real estate, ̅ = premium on property-specific attributes. Therefore, equation (6) can be rearranged as the expected required rate of return on real estate, (9) based on the relation mentioned in equation (8), as a sum of risk free rate (r_f), and a risk premium Where; = + (r_p), which is asked by investors to compensate for risks associated with investing in the real estate = risk free rate, = risk premium. market. The result is equation (9): = + ∗ − + 1 − ∗ ̅ − → = + ∗ − + 1 − ∗ + = ̅ −= + (10)
< = + < ̅ (14) (11)
= ( −) (12)
Where;= + = premium from participation in real estate, (15) = premium on property-specific attributes. = + + + (13)
1 2 Where; = + + = risk free rate, = premium from participation in real estate, = premium on property-specific attributes.
= + ∗ − + 1 − ∗ ̅ − → = + ∗ − + 1 − ∗ + = ̅ −= +
(14)
(15)
= + + +
(7) = ∗ + 1 − ∗ →= + ∗ − + 1 − ∗ (̅ −) Where; = + (̅ −) = expected return on property, = risk free rate, (7) = expected market return, = ∗ + 1 − ∗ = equity beta ( ). →= + ∗ − + 1 − ∗ (̅ −) ̅ Where; = + (̅ − ) ( , )⁄ = expected return on property, (7) (8) = risk free rate, = ∗ + 1 − ∗ = expected market return, Where; < < ̅ →= + ∗ − + 1 − ∗ (̅ −) = equity= beta+ (̅ ( −) ). Where; = expected return on property, ̅ = expected return on property, 40 = risk free rate,( , )⁄ Valuation accuracy in vacant office properties = risk free rate, (8) = expected market return (of stocks). = expected market return, ̅= equity beta ( ). Where; < < ̅ ̅ (9) (9) = expected return( on ,property,)⁄ = risk free rate, (8) = + Where; = expected market return (of stocks). = risk free rate, Where; < < ̅ ̅ = risk premium. = expected return on property, (9) = risk free rate,
By inserting = expected equation market (9) return in equation (of stocks). (8), the risk premium that investors require when investing in a (10) Where; = + specific =property, risk free rate, changes between two boundaries of risk free interest rate and the historical return ̅ < = + < ̅ of stocks = riskand premium. is always a positive amount, as Hoesli et al. (2006) argue. (9)(11) = + Where; = ( − ) (10) (10) = risk free rate, (12) = risk premium. <= + < ̅ Where;= + (11) Comparing equation (6) and equation (9), mathematically, the following relation in equation (11) is = premium from participation in real estate, (7) valid between the CAPM theory and risk premium concept: (10) = premium on property-specific attributes. = ( − ) = ∗ + 1 − ∗ (12) →= + ∗ − + 1 − ∗ (̅ −) < = + < ̅ Where; = + (̅ − ) (11) (7) (11) Where;= + (13) = expected return on property, = = premium∗ + from 1 −participation∗ in real estate, = =risk ( free rate,− ) →= + ∗ − + 1 − ∗ (̅ −) 1 2 Even Where;though== =premium + mathematically,+ (̅ on+ property-specific− ) the attributes. CAPM theory is in consistent with the introduction of the(12) risk Where; = expected market return, = risk free rate, == expectedequity beta return ( on property, ). premium, the applicability of this approach is limited. Empirical research shows that the premium Where;̅ == =risk premium free+ rate, from participation in real estate, per equity beta unit,( which,) ⁄is calculated by subtracting the expected market return from the risk (13) == expected premium market fromon property-specific participation return, in attributes.real estate, (8) = equity beta ( ). free interest = premium rate, onis constantlyproperty-specific rejected attributes. (Fama & French, 2004). In addition, as mentioned in § 5.2.2, ̅ 1 2 Where; = + + determining < = ( −) <= + < ̅ (12) (12) (15) (11) Where; == ( + −) = + + + (12) = premium from participation in real estate, = premium on property-specific attributes. Where; = + (15) = premium from participation in real estate, == premium+ on property-specific+ + attributes. The discount rate can thus be written as equation (13): (13) 1 2 Where; = + + = risk free rate, (13) (13) = premium from participation in real estate, 1 2 Where; = + + = premium on property-specific attributes. = risk free rate, = premium from participation in real estate, = premium on property-specific attributes. Therefore, equation= + (11)∗ can be− replaced + 1 with − equation ∗ ̅ − (12), and combined with equation (7), which → = + ∗ − + 1 − ∗ + = ̅ −= + = + ∗ − + 1 − ∗ ̅ − → = + ∗ − + 1(14) − ∗ + = ̅ −= + (14) (15) = + + + (15) = + + + (7) = ∗ + 1 − ∗ →= + ∗ − + 1 − ∗ (̅ −) Where; = + (̅ −) = expected return on property, = risk free rate, = expected market return, = equity beta ( ). ̅ (,)⁄ (8) Where; < < ̅ = expected return on property, = risk free rate, = expected market return (of stocks). ̅ (9) (7) = + = ∗ + 1 − ∗ Where; →= + ∗ − + 1 − ∗ (̅ −) = risk free rate, Where; = + (̅ −) = risk premium. = expected return on property, = risk free rate, = expected market return, (10) = equity beta ( ). ̅ <= + < ̅ ( , )⁄ (11) (8) = ( − ) Where; < < ̅ (12) = expected return on property, = risk free rate, Where;= + = premium from =participation expected market in real estate,return (of stocks). = premium on property-specific attributes. ̅ (9) (13) Where; = + = risk free rate, = +Chapter1 5:2 From fundamental to dynamic cap rates theory 41 Where; + = risk premium. = risk free rate, = premium from participation in real estate, = premium on property-specific attributes. (10) results in equation (14): <= + < ̅ (11) (14) = ( − ) (12) = + ∗ − + 1 − ∗ ̅ − → = + ∗ − + 1 − ∗ + Where;= = ̅+ −= + 5.3 The= N premiumew R fromisk participationpremium in real M odeestate,l = premium on property-specific attributes. (14) The model described in equation 14, has several drawbacks. For example, the risk premium has a qualitative nature which is not well defined. This is caused by the limitations associated with the commercial real estate market (lack of transparency, information asymmetry, thin market, etc.). (13) Therefore, investment1 2decision making and assessing the risk to determine the property value, Where; = + + is prone = riskto freesome rate, uncertainty and is combined with a qualitative assessment (15)in the real estate investment = premium decisions. from participationThe discussion in real aboutestate, the investor sentiment and their expectations about the = premium on property-specific attributes. =property+ +income+ and thus the future value, emphasizes on the qualitative nature of this process. There is thus, a need for a more careful estimation of the risk premium component of the discount rate mentioned in § 5.2.3, to be able to transform a partly qualitative assessing procedure, as well = + ∗ − + 1 − ∗ ̅ − as investment decision-making procedures regarding the income → properties, = + ∗to a more− reliable + 1 − risk ∗ + assessment, by quantifying = ̅the qualitative−= aspects+ of decision making. (14) To achieve a more careful estimation a new model is introduced: The new risk premium model. The new model rearranges the risk premium on the property-specific attributes proposed in equation (12) to the following equation (15): (15) (15) Where; = + + + = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes. This is to measure the property-specific risk premium applied to the real estate investment, specifically to the office segment, by decompounding it into the three components of location, the property-itself and the user (office-user) attributes. Due to an increase of the investors’ awareness and interest in the quality and characteristics of properties included in the investment funds, and also the= advancement+ ∗ −in Big + Data 1 − and ∗availability + of large volume of information (structured and/ → = + ∗ − + 1 − ∗ + + + or unstructured) =regarding+ the + property + characteristics, this model is much more applicable than the previously mentioned model. This model provides a better specification of the risk premium (16) which leads to more careful measuring of the risk associated with an investment, especially in the problematic situation of the Dutch office market. This is consistent with the ‘future-proof real estate’ concept introduced by FGH Bank (2015), which argued that “the value of real estate and user demand in the long term is found= – in the combination of location, the specific property and the → = + ∗ − + 1 − ∗ + + + − user demand = in + the∗ longer − term. + 1− The ∗future + value + of +real estate therefore depends on the interplay of these factors”… “In (17)the most stable situation for real estate, location, property and use form a united entity.” Where; = risk free rate, = Loan-to-value ratio, = rate of return on debt, ⁄ = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes, = a constant expected rate of growth in the NOI. (18) Where; =+ ∑ + ∑ +∑ + ∑ + = constant or intercept term, = the coefficient of variables indicating context, location, property and office users factors, α = the error term. ε (19) 1 Where; = = Appraised cap rate (%), = net income multiplier. (20) = Where; = overall capitalization rate (%), = property value (gross transaction price), = Net Operating Income in the first year. Where; Where; = premium from participation in real estate, = premium = frompremium participation on location in real attributes, estate, 42 Valuation accuracy in vacant office properties = premium on location attributes, Where; = premium on property-itself attributes, = premium = premium from on participation property-itself in realattributes, estate, = premium on property-user attributes. = premium on property-user attributes. = premium on location attributes, By considering the fact that the risk premium on investment consists of four slices mentioned in = premium on property-itself attributes, equation (15), the discount rate in equation (14) is transformed to equation (16): = premium on property-user attributes. Where; (16) = + = ∗premium − from + participation 1 − ∗ in real+ estate, = + ∗ − + 1 − ∗ → + = + ∗ − + 1 − ∗ + + + = premium on location attributes, → = + ∗ − + 1 − ∗ + + + = + + + = + + + = premium on property-itself attributes, 5.4 The new Dynamic Cap rate model = + ∗ − + 1 −(16) ∗ + = premium on property-user attributes. → = + ∗ − + 1 − ∗ + + + In § 5.3, the new risk premium model(16) is specified and used to calculate the discount rate (equation = + + + 16). By combining the derived discount rate with the static cap rate model, mentioned in § 5.1, equation 9, the new (16)dynamic cap rate model is written as follows: = – → = + ∗ − + 1 − ∗ + + + − = + ∗ − + 1 − ∗ += – + + (17) → = + ∗ − + 1 − ∗ + + + − = + ∗ − + 1 − ∗ + + + (17) = – Where; (17) = + ∗ − + 1 − ∗ + → = + ∗ − + 1 − ∗ + + + − = = risk+ free ∗rate, − + 1 − ∗ + + + → = + ∗ − + 1 − ∗ + + + = Loan-to-valueWhere; (17) ratio, = + + + = rate of = return risk free on debt, rate, ⁄ Where; = premium = from Loan-to-value participation ratio, in real estate,(16) = risk free= premium rate, on location attributes, = rate of return on debt, ⁄ = Loan-to-value = premium on ratio, property-itself attributes, = premium from participation in real estate, = rate of= premiumreturn on on debt, property-user attributes, ⁄ = premium on location attributes, = premium = a constant from expectedparticipation rate ofin growthreal estate, in the NOI. = premium on property-itself attributes,= – = premium on location attributes, → = + ∗ − + 1 − ∗ + + + − = premium on property-user attributes, = + ∗ − + 1 − ∗ + + + = premium on property-itself attributes, = a constant expected rate of growth in the NOI. = premium on property-user attributes,(17) (18) = a constant expected rate of growth in the NOI. Where;=+ Where;∑ + ∑ +∑ + ∑ + These = constant all or indicate intercept term, that cap rates are a function of amount of risk free rate, loan-to-value ratio, = risk free rate, = the coefficient of variables indicating context, location, property and office users factors, (18) αthe return on debt, premium from participation in real estate, location attributes, property-itself = the error term. = Loan-to-value ratio, (18) attributes,Where; = rate property-user of return on debt, attributes, and growth in NOI as shown in equation (17). ε ⁄ =+∑ + ∑ +∑ + ∑ + = constant= premium or fromintercept participation term, in real estate, Where; =+ ∑ + ∑ + ∑ + ∑ +(19) = the coefficient of variables indicating context, location, property and office users factors, = constant or1 intercept= premium term, on location attributes, 5.5 Theα new cap rate regression model specification = the coefficient = the of errorvariables term. indicating context, location, property and office users factors, Where; = α = premium on property-itself attributes, = theBy error= usingAppraised term. the cap new rate (%), dynamic cap rate model described in § 5.4, and further developing it by putting the ε = premium on property-user attributes, = net income multiplier. variables used in equation 17 into four categories: background context, location, property, and lastly ε = a constant expected rate of growth in the NOI. (19) office-users, the new cap rate regression model specification is defined in equation(19) 18. 1 1 = (20) Where; Where; = = Appraised cap rate (%), = (18) = AppraisedWhere; cap= rate net (%),income multiplier. (18) = net= incomeoverall capitalization multiplier. rate (%), = propertyWhere; value (gross transaction price), =+∑ + ∑ +∑ + ∑ + = Net =Operating constant Income or intercept in the first term, year. (20) (20) = the coefficient of variables indicating context, location, property and office users factors, α = the= error term. = Where; Where; ε = overall capitalization rate (%), = overall capitalization rate (%), Figure 5.1= property illustrates value (gross the transactioninterrelation price), among these four categories. The background context, = property value (gross transaction price), (19) = Net Operating Income in the first year. =addresses Net Operating the Income1 overall in the conditions/circumstances first year. at the time that investments take place. It consists Where; = of variables related to the macro-economic conditions, capital market expectations, office market = Appraised cap rate (%), trends, and= net sale income conditions. multiplier. This category focuses on elements that mostly change over time (time- series). The second category, location, considers the property location at both macro- and micro- level and examines both cross-sectional and time-series changes of cap rates. The third category(20) addresses variables pertaining the property itself (property-specific characteristics) while the last = categoryWhere; focuses on elements that are associated with the office-users (tenants). The next chapter, = overall capitalization rate (%), Chapter =6, property explains value the (gross proxies transaction of these price), categories separately. = Net Operating Income in the first year. Chapter 5: From fundamental to dynamic cap rates theory 43 Figure 5.1, context interrelation among four categories of background context, location, property, and lastly office- users. context location property office-users Context, location, 6 property & office-users Chapter 6: Context, location, building & office users as cap rate determinants 45 Chapter 6: Context, location, building and office users as cap rate determinants This Chapter continues with the theoretical framework explained in Chapter 5 and completes this framework, based on the most important variables found in the literature, as discussed in Chapter 4. The underlying reason is that variables have an impact on determining cap rates. The rest of this chapter discusses these variables for each of the four aforementioned categories: context, location, property, and finally office-users. 6.1 context The context related variables are the proxy for the overall conditions/circumstances, where both transactions and valuations take place. As mentioned in § 5.4, these variables are related to the macro-economic conditions, capital market expectations, office market trends, and sale conditions. The variables focus on elements that mostly change over time (time-series), or occur as a condition at the time of sale on a property, thus in the context. Macro-economic conditions The following variables are considered indicators of the macro-economic conditions: real Gross Domestic Product growth (GDP), inflation expectation, and office job index. The real GDP growth gauges the national productivity and the value of the finished services and goods produced within a country on a yearly basis. It is corrected for the inflation (in comparison to the nominal GDP growth rate) and used as a proxy of the growth rate (g) and expectations of growth in the property’s NOI. The reason for using the real versus nominal GDP growth is to measure the impact of the real economic growth and general inflation separately. This variable can be interpreted by the real estate investors in two different ways due to the mean-reversion in the GDP growth. When the GDP is higher than its historical trend, a forward looking investor anticipates a lower income growth, whereas a backward looking investor simply expects a further increase in the rental income of a property. As a result, the GDP growth can be both positively or negatively associated with the cap rate, based on the investors’ rationality and interpretation of the GDP growth (Hoesli & Chaney, 2014). The second variable used to reflect the macro economic conditions which can be considered as a proxy for the property rental growth (g), is the inflation expectation. There are two different methods to measure the inflation expectation. The first method uses the spread between the long term and short term government bonds rate, while the second method uses the annual percent changes in the Consumer Price Index (CPI). The CPI reflects the changes in the cost of living and the changes in the price value of the goods and services purchased by households. Sivitanides et al. (2001) suggest the use of the changes in the CPI as a preferred proxy to gauge the inflation expectation. Considering the CPI as an indicator of the inflation expectation, cap rates and inflation expectation are expected to be negatively related (Sivitanides et al., 2001; Van Norren, 2007), as higher inflation expectations and thus, higher nominal rental growth, leads to acceptance of a lower income return for a property by investors (Sivitanides et al., 2001). This is due to the inflation hedging capacity of the real estate, which indicates during a period of high inflation, that investing in real estate becomes more interesting for investors. The last variable used as a proxy to reflect the macro economic conditions are the changes in the 46 Valuation accuracy in vacant office properties office employment. An increase in office employment is expected to increase the demand for office space, thereby decreasing the vacancy, increasing the rents and as a result increase the property value. As a result, a lower risk is associated with the investment when the office employments increases, thus cap rates are expected to be negatively related to office employments. Capital market expectations To measure the impact of the capital market on cap rate variations, the following key variables: risk free rate, return on stock market, investment volume ratio and debt to equity ratio are considered. The risk free rate, theoretically, reflects the return an investor may expect from a complete riskless investment. Even though, this is not the case in practice, as risk, even very small, is inherited in any type of investment. Hence the government bonds are considered as the proxy for the risk free rate. Considering the long term investment horizon of the real estate market, as a proxy for the risk free rate, the real return on the Dutch government bonds with the maturity of ten years is used. Empirically tested, it is expected that this rate is positively correlated with the cap rate (Chervachidze & Wheaton, 2013; Hoesli & Chaney, 2014; McDonald & Dermisi, 2008; Netzell, 2009; Sivitanides et al., 2001; Van Norren, 2007). The influence of the stock market on determining cap rates is proved to be significant in several studies (Ambrose & Nourse, 1993; Froland, 1987; Hoesli & Chaney, 2014; McDonald & Dermisi, 2008; Netzell, 2009). As a proxy for the stock market, thus, the proxy for the risk premium required by participating in the real estate investment market (see § 5.2.3), two indicators are used. The first are the changes in the annual total return on the S&P 500 Index as widely used by international studies (Ambrose & Nourse, 1993; Froland, 1987; Hoesli & Chaney, 2014; McDonald & Dermisi, 2008; Netzell, 2009). The second are the changes in the Amsterdam Exchange (AEX) index as a proxy for the Dutch stock market. It is expected that the stock market and cap rates are negatively associated. The rationale for this negative correlation is that when a large amount of capital is invested in the stock market, a lower willingness remains to invest in the real estate market. This leads in asking a higher cap rate for investing in the real estate market. Whereas, the time period where investing in the stock market decreases, capital flows from the stock market (partly) into the real estate market. This results in a decrease in the required cap rates due to the increase in the competition and interest in investing in the real estate market, thus, a lower risk premium is required by the investors (Hoesli & Chaney, 2014). The investment volume ratio is calculated as the ratio of the office segment investment volume to the total investment in commercial real estate in the Netherlands, which considers both domestic and international investors investing in the Dutch real estate market. This variable is expected to have a negative impact on the required cap rates. This follows the same rationale mentioned in the last paragraph regarding the increase in the investing competitiveness in real estate. The last variable used to gauge the impact of the capital market expectation on cap rates is the debt- to-equity ratio. As mentioned in § 4.1, financial structure and the ratio between debt and equity affects the property value, even though this is not in line with the traditional financial economics (Lusht, 2012). Due to the fact that availability of debt can enhance property liquidity when limited, real estate transactions become more difficult and, consequently, the property value decreases. This is while easy debt facilitates property transactions and leads to a boost in property values, even Chapter 6: Context, location, building & office users as cap rate determinants 47 higher than their fundamental values. The latter is mentioned by Chervachidze and Wheaton (2013) as one of the possible underlying causes for the creation of price ‘bubbles’ in the real estate market. To explore the impact of the availability of debt for the real estate market, the average loan to value (L/V) ratio per year for the office properties is used. The L/V ratio is expected to be negatively related to cap rates as a higher L/V ratio increases the investment liquidity, thus decreasing the required cap rates. Office market trends Other background context elements affecting cap rates are market trends in the office market such as market rent, vacancy rate and cap rates on an aggregated level. Market rent shows the development of the current rent, relative to median rent through time in the office market. The relation of this variable with cap rates, depends on the rationality of the investor. A forward looking investor interprets a high rent relative to the median rent as a temporary situation, which reflects itself positively in the cap rate. Whereas, a backward looking investor literally extrapolates the increase or decrease in the rent level which results respectively in a decrease or increase in cap rates. This means that a backward looking investor considers a negative correlation between the market rent (relative to median rent) and cap rates. Vacancy rate reflects changes in the demand and supply in the office market, thus showing a cyclical effect. An increase in the current vacancy rate relative to median vacancy rate through time in the office market, indicates the inefficiency (oversupply) in the market, which results in a higher cap rate. This means that vacancy rate is positively related to cap rates (Froland, 1987; Hoesli & Chaney, 2014; McDonald & Dermisi, 2008; Netzell, 2009; Van Norren, 2007). Cap rate considers the changes in market cap rates on an aggregated level, as published by office market reports. This variable, in a lagged form, is expected to be positively related to the estimated cap rate used by the investor or appraiser. This is explained by the characteristics of the real estate market (infrequent transaction and non-transparent market), which results in the fact that the aggregated cap rates published in the market reports have a strong impact on the cap rates that both investors and appraisers use (Chervachidze & Wheaton, 2013; Sivitanides et al., 2001; Van Norren, 2007). Sale conditions The last background context variable category are the property selling conditions. This consists of three general options: an open market at arm’s length transaction, auction (forced sale), and finally a transaction which was neither an auction nor done in an open market at arm’s length (e.g. when the sale was performed in relation with a related legal entity or to a family member). Based on the findings by Hoesli and Chaney (2014), the auction sales condition is positively related to the cap rate variation. This is because selling a property at an auction is associated mostly with fewer potential buyers in comparison to the open market at an arm’s length condition. Selling a property in such circumstances, decreases the transaction value, which consequently realizes a higher return on investment. In cases that the property was sold between family or legal entity related parties, the cap rates were lower than the regular selling situation (an open market at arm’s length). Therefore, correction for these selling conditions, by using a dummy variable in the cap rates regression model, is necessary. These is while Hoesli and Chaney (2014) reported an increase of return by 9%, in case 48 Valuation accuracy in vacant office properties of an auction, and an average decrease of 3% in cases that properties were sold to a family member or a related legal entity. 6.2 location In order to capture the fix effect of the location on cap rate variations, location is modeled in two levels: macro and micro location. When studying an office market limited to one city/region, macro location reflects the sub-markets variation of capitalization rates across various sub-markets within the city/region. While, micro location indicates the fix effect of the direct neighborhoods on the cap rate variations. In addition, two attributes of the macro location, namely an average vacancy rate per year per submarket (city districts) and a ratio of current rent to the historical trend per submarket, are used to model the cap rates with respectively a positive and double relation effect on the cap rate variations, depending on the rationality of investors. The impact of vacancy is positive due to the fact that a higher vacancy rate in each surrounding district limits the potential of the rental growth for the property and is therefore associated with a higher cap rate. Whereas an increase in rent can be interpreted as potential rental growth or vice versa. 6.3 property As mentioned in Chapter 4, more recent cap rate studies (Hoesli & Chaney, 2014; McDonald & Dermisi, 2008; Netzell, 2009; Verhaegh, 2005) show the importance of property specific attributes in determining cap rates. Several property specific variables such as property age, condition, size, use, ownership (e.g. leasehold), rent ratio, and vacancy gaps are studied in the cap rate literature (Hoesli & Chaney, 2014; McDonald & Dermisi, 2008; Netzell, 2009; Verhaegh, 2005). Consistent with other studies, variables such as building quality, vacancy ratio, and rent ratios are used, hence, the proxies of these variables are defined differently in previous studies. In addition to the aforementioned variables, a couple of new property specific attributes are introduced which are found to be crucial for the Dutch office market. These include variables indicating whether a property is a listed building (monument), or whether there are any environmental conditions imposed on the property (contaminated soil or asbestos). Property condition (or quality) In order to gauge the impact of property conditions on cap rate variations, five key variables: property age, newly-built, overdue maintenance, renovation, and monumentality are considered. The age of the property is estimated basically as the year of construction and it is expected that cap rates are positively correlated with the property age. As property ages, the effect of the age reduces. The newly-built property is defined as a property which is not older than three years. This variable is expected to be negatively related to cap rate, because of the long remaining effective age of the building. The overdue maintenance shows whether the building has a long delayed maintenance and whether there is a need for refurbishment of the property. This is positively related to the cap rate, since it influences the property cash flow. A complementary variable, the renovation dummy, is considered to provide information regarding the property refurbishment risk, which in case of a recent renovation, has a negative expected impact on the cap rate. Finally, the monumentality dummy shows whether the property is listed, which can be interpreted in two ways. Monumentality condition may negatively impact the cap rate (positively the value) due to the uniqueness. However, it may be positively related to cap rate as it imposes some regulatory restriction on the property due to its monumental status. Chapter 6: Context, location, building & office users as cap rate determinants 49 Size (m2) The bigger the size the higher the risk, since it reduces the liquidity of the property. Hence, the larger the office property, the higher the chance for a single tenant and full occupancy. As a result it can be positively and negatively associated with the cap rate. Rent ratio The rent ratio is calculated as the current rent compared to the potential market rent, which shows the positive potential rental growth when the current rent is lower than the potential market rent and a negative rental potential when it is higher than the market rent. As mentioned in §6.1, the effect of the rent ratio depends on the investor’s rationality and interpretation pertaining the rent growth potential based on the market fundamentals and cyclical character of the asset market. Vacancy ratio Except Netzell (2009), none of the studies considered the vacancy rate at the property level in a relative term. This thesis uses the concept of vacancy gap developed by Netzell (2009) and extends it by considering the vacancy rate at the property level, and calculates the vacancy ratio relative to its direct surroundings. This is because when looking at a vacant property itself, the vacancy is an issue, while if the property is situated at a location which is not a prime location for an office function, then it is clear that the vacancy is not caused by the building, but rather caused by the location of the property. For instance if the same property was located at a prime office location (a better location), it would not have such a high vacancy rate. On the other hand, a property situated at a good location, compared to a property at a non ideal office location, may have a lower vacancy rate. However, when it is compared with the surrounding properties (a good location), that specific property has a high vacancy rate, relative to the other properties in the direct neighborhood. Lagged cap rates In order to capture any serial correlation between the cap rates with the previously estimated cap rate at the property level, the logarithm of the annual capitalization rate (of the previous year) is used. This variable is significantly correlated with the cap rate, which supports the appraisal smoothing discussion, mentioned in § 4.1. Ownership status To measure the influence of ownership status on the property, the dummy variable of leasehold, namely the existence of the ground lease is considered. A higher cap rate is associated with properties with a ground lease. This is due to the fact that leasehold conditions result in having less control over the property, and therefore are associated with higher risks for the investors. Usage status Two dummy variables: multi-tenant property and mixed use are used as a proxy to measure the influence of the use condition on cap rates. The multi-tenant defines whether the property can be let to more than one tenant (or single tenant) which increases the property flexibility, thereby decreasing risk. This variable is expected to have a negative relation with the cap rate. As a proxy for the possibility of mixed use, the dummy variable for the existence of the residential 50 Valuation accuracy in vacant office properties part in the property is used. In case there is a residential usage in the building, the cap rate is shown to be lower (Hoesli & Chaney, 2014). This shows a negative relation of the cap rates and mixed-use. Accessibility and amenity In order to measure the accessibility and amenity for the property, three variables: the distance to public transport, the distance to motorways (to measure accessibility), and the Google walk score (to measure the amenities), are mentioned to be influential on the value of a property, therefore expected to be positively associated with cap rates. Environmental condition In order to measure the impact of environmental conditions on cap rate variations, two dummy variables: asbestos, and contaminated soil are selected. The existence of such variables indicates higher risks and costs, and therefore higher cap rates. 6.4 office-users This category focuses on elements that are associated with the office-users (tenants). This consists of two main categories: tenant type and the contract term. Tenant type The tenant type indicates whether the current office-user is a public agency or a private entity. Since the governmental tenant is a more secure type of a tenant, therefore, it is associated with a lower cap rate. Rental Contract The contract status focuses on the legal binding of office-users to the property. In order to gauge the impact of contract status on cap rate variations, three variables: remaining lease term (in months), option year and incentives are considered. The remaining lease term is negatively related to cap rates. The longer the remaining lease term, the lower the cap rate as the occupancy rate, thus the rental income is more secured (Englund, Gunnelin, Hoesli, & Söderberg, 2004). The option year reflects any terms on the contract for correction, which may increase the uncertainty. Therefore, it is positively related to cap rates (e.g. renegotiation on rent and contract length). Finally, the lease incentive is defined as any element, whether financially or not financially (e.g. in terms of rent free periods, or financial discounts) given by the landlord, which is not reflected in the contract rent, yet used to motivate and or enable the tenants to decide about their accommodation (Harding, 2012). In other words, the lease incentives are the rental difference between the contract rent and the effective rent. Whereas the effective rent is the actual rent that tenants pay during their entire lease contract, thus it is the contract rent corrected for the incentives (Van Gool, 2011). It is expected to positively relate to cap rates as higher incentives reduce the real rent achieved by the property owner in comparison to the contract rent. As a result, it is associated with a higher risk. Part III: Empirical research Chapter 7: data analysis and synthesis Chapter 8: empirical findings 7 DATA analysis and Synthesis Chapter 7: DATA analysis and Synthesis 53 Chapter 7: DATA analysis and Synthesis This section explains the data sources and addresses the data processing (analysis and synthesis) for the hypotheses mentioned in §3.10. Firstly, it introduces the formation of the main database for this research. Subsequently, it explains the variables used, or calculated for, each hypothesis, as well as the methodology used to test these hypotheses. 7.1 DATA DESCRIPTION The data for this research is gathered by combining two databases. Firstly the Amsterdam Municipal Tax office (in Dutch Gemeentebelastingen Amsterdam, from now on used as GBA), and secondly the TU/Delft property database. In addition to these databases, a complimentary database is created from different sources including: the Central Bureau of Statistics in the Netherlands (CBS), De Nederlandsche Bank (DNB), and a several real estate agencies such as Jones Lang LaSalle (JLL), Cushman & Wakefield (C&W), and DTZ Zadelhoff. 7.1.1 GBA database The GBA database consists of four main data categories: WOZ-values, sale-transactions, rent- transactions, and tax vacancies. All these data categories have a unique Tax ID which is used as a reference (link) between them. WOZ-value data consists of the yearly WOZ-value (Waardering Onroerende Zaken , in English the Valuation of Immovable Property), the rental incomes, and the used cap rates by the municipality, from 2001 till 2015 for office properties in Amsterdam. WOZ-values are calculated and announced to property owners at the beginning of each year (January or February) as their property assessed value, which is used to impose tax on them. This means the property assessed in 2014 is used to impose tax on the property owner in 2015. Sale-transaction data includes sale transaction data of office properties in Amsterdam, which is combined with a questionnaire filled by the property buyers. In this dataset, information regarding the transaction price, the time of the transaction, the conditions at the time of transaction on the property, land, relation between seller and buyer, and/or the sale itself are included. These data are linked automatically by the Kadaster (the Dutch Cadastre, Land Registry and Mapping Agency), to the GBA database. Rent-transaction data contains data related to rental transactions of office properties in Amsterdam. The dataset is created through rental questionnaires sent by the municipality to the tenants. In this dataset, information regarding the contract rent and time, the amount of incentives, and the leasing agreements are provided. Tax vacancy data registered data pertaining the vacancy in the tax unit (WOZ object, an object or unit with a single owner and single tenant). The vacant WOZ object is differentiated from a leased WOZ object when there is no rental income to be taxed. In this case, the WOZ object is classified as tax vacant (in Dutch leegstandsheffing). 7.1.2 TU/Delft property database The TU/Delft property database consists of two data sets, namely the DTZ Zadelhoff and TU/Delft data sets. The DTZ Zadelhoff data contains information related to the office supply and office take- up, while the TU/Delft data includes information related to the effective rents and office stock 54 Valuation accuracy in vacant office properties information. All these data categories have unique ID’s (Supply ID’s, Take-up ID’s, Effective Rent ID’s and BAG Property ID’s) which are used as a reference (link) between them. Office supply data contains data regarding the office supply while Office take-up data consists of data related to the office take-up, both spanning the period from 1990 to 2012 for Amsterdam. They are used to determine the occupancy levels for office properties in Amsterdam for the different years that transactions occurred. Effective rent dataprovides information pertaining contract rents, effective rents (the actual rent that tenants pay during their entire lease contract), and incentive percentages for the rental transactions from 2002 till 2011 in Amsterdam. This includes not only effective rent of rental transactions that occur in the property itself, but also provides the effective rents of properties based on the average effective rent of the rental transactions in the radius of 500 m, 1000 m of the property, or average effective rents per Amsterdam districts at the selling time, when no actual rental transaction occurred for that specific property. Office stock data contains data related to the Amsterdam office stock property characteristics. This includes information such as building size, the year the building was built or renovated, the office location (Amsterdam submarket), Google walk score, nearest (distance) to train station with a distinction between ‘normal’ train stations and intercity train stations and finally nearest motor way (highway entry/exit). 7.1.3 complimentary database In addition, context related variables, consisting of variables related to the macro-economic conditions, capital market expectations, Amsterdam office market trends, are added to the aforementioned databases (GBA and TU/Delft property database). As mentioned in §7.1, this complimentary database gathers data from different sources including CBS, DNB, JLL, C&W and DTZ Zadelhoff. The Data mentioned in §7.1.1, §7.1.2 and §7.1.3 are combined by their unique ID’s as the connecting variables to BAG Property ID’s which is an agreed registration of all the addresses and buildings in the Netherlands (in Dutch Basisadministratie Adresssen en Gebouwen). Figure 7.1 illustrates the data mining process that aforementioned individual databases are combined and later classified in a newly created database based on the four categories of context, location, property and office users. By combining these databases, the variables required for testing the hypotheses can be found in the newly created database. However, there are a couple of variables which are required as a base for this thesis that are not included in the used databases. In the cases that these variables can be calculated ex-post from other available data, then the calculations and the steps are explained in sections, §7.3, §7.4 and §7.5. 7.2 Hypothesis 1 | appraised versus transaction cap rates The first hypothesis mentioned in §3.10 states that: “The appraised cap rates of Dutch offices during the rising market are lower (appraised value is higher) than the transaction cap rates (prices), to a larger extent than the declining market (after financial crisis).” To test this hypothesis, the appraised cap rates and transaction cap rates should be compared per year before and after the financial crisis. Where; = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes. Chapter 7: DATA analysis and Synthesis 55 Figure 7.1, an overview of Where; = + ∗ − + 1 − ∗ + different databases = premium from participation in real estate, → = + ∗ − + 1 − ∗ + + + used. The created = premium = on location+ attributes,+ + database is = premium on property-itself attributes, classified based on (16) = premium on property-user attributes. the four categories of context, location, property and office users = – → = + ∗ − + 1 − ∗ + + + − = + ∗ − + 1 − ∗ + + + (17) = + ∗ − + 1 − ∗ + → = + ∗ − + 1 − ∗ + + + Where; = + + + = risk free rate, = Loan-to-value ratio, (16) = rate of return on debt, ⁄ = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes,= – → = + ∗ − + 1 − ∗ + + + − = a= constant+ expected∗ − rate + of 1 growth − ∗in the +NOI. + + (17) Where; (18) = risk free rate, = Loan-to-value ratio, 7.2.1 Where;A ppraised=+ ∑ cap rates+ ∑ +∑ + ∑ + = = constant rate of return or intercept on debt, term, In the GBA⁄ database, the Net Income Multipliers (NIMs, the reciprocal of the appraised cap rates) = =the premium coefficient from of participation variables indicating in real estate, context, location, property and office users factors, are calculatedα = ex-ante, thus appraised cap rates are simply obtained from equation (19): the= premium error term. on location attributes, = premium on property-itself attributes, ε = premium on property-user attributes, (19) (19) = a constant1 expected rate of growth in the NOI. Where; = = Appraised cap rate (%), = net income multiplier. (18) Due toWhere; the =+ fact that ∑ WOZ-values + are∑ calculated at +the∑ beginning of each + ∑year (one moment + in(20) time), = constant or intercept term, they lag one year compared to transaction prices (confirmed also by law). Therefore, for the sake of = the= coefficient of variables indicating context, location, property and office users factors, comparison,Where;α = the error the term. NIMs of one year after the sale transaction are selected as an input for equation 19. = overall capitalization rate (%), ε = property value (gross transaction price), 7.2.2 Transaction = Net Operating Income cap in rates the first year. (19) The used databases1 do not include transaction cap rates. Hence, the transaction cap rates are calculatedWhere; = ex-post through a direct capitalization model (equation 1, discussed in Chapter 3, § 3.6), = Appraised cap rate (%), by rearranging= net income the formula multiplier. to equation (20), to calculate the transaction cap rate as follows: (20)(20) = Where; = overall capitalization rate (%), = property value (gross transaction price), = Net Operating Income in the first year. To determine the validity of the calculated cap rates, beside the calculation model presented in equation 20, a second conventional method is used. In the latter method, corrections such as 56 Valuation accuracy in vacant office properties correction for the difference between actual rent and market rent, corrections for vacancy and its related costs, and correction for overdue maintenance are calculated ex-post using direct capitalization model. Appendix 2 explains the details of the calculation for this method, together with four different outcomes by using these two methods, while using different inputs for estimating the rental values in the two aforementioned calculation models. Subsequently, Appendix 1 compares the results of these four outcome models. However, the results of the conventional method (cap rates with corrections) are not used for the purpose of this research. The main reason for not using this method, which is a permitted valuation model in the Netherlands, is that the calculated cap rates in this model, do not fully reflect all the risk associated with the investment. This is due to the fact that aforementioned corrections (e.g., vacancy and overdue maintenance) are imposed ex-post on the value, thus these type of risks are not reflected in the cap rates. This results in the fact that the calculated cap rates are closer to the aggregated cap rates published by the real estate agencies and are far from the pure cap rates indicating all the risks (including property specific risks) which is the desired cap rate for the purpose of this research. As a result transaction cap rates are calculated based on equation 20, where all risks, including the property-specific risks, tenant’s risk, and location risks, etc., are reflected in the cap rate. To arrive to the transaction cap rate, the NOI and transaction price are calculated separately and divided by each other based on equation (20), in § 7.2. Figure 7.2 illustrates the main steps performed to estimate the transaction cap rate ex-post (see also Appendix 2 for the calculating model). It is clear that in order to estimate the NOI forward steps, and to calculate the transaction prices, a reverse step should be performed respectively. In addition, transactions including parking spaces are omitted. The reason is the lack of available information regarding parking prices. Therefore, no corrections can be made in order to include them in calculating the transaction cap rate. Section 7.2.2.1 and 7.2.2.2 explains the calculation of the NOI and gross transaction prices separately. Figure 7.2, main steps of calculating transaction cap rates Chapter 7: DATA analysis and Synthesis 57 Figure 7.3, visualization of how the ERVs are calculated based on the actual ERV within the property, if not available if not available the average effective then 500 m then rents of rental 1000 m transactions in the radius of 500 m, 1000 m around the property, or average effective rents per within property ave. in the radius 500 m ave. in the radius 1000 m Amsterdam district at the selling time if not available then ave. in property’s district 7.2.1.1 Calculating NOI The NOI as an input for the direct capitalization method, is calculated by estimating the total rental income (TRI) as stated in equation (21): (21) (21) Where; = ∗ = total lettable floor area (m2), = effective rental value. LFA (22) Effective rental value (ERV) EffectiveWhere; rental = value ∗ (1 (ERV) − ) is the actual annual rent (per LFA m2), which tenants pay and equals the contract = Net rent Operating corrected Income for in the the first incentives year, (Van Gool, 2011). The rental development published = total rental income, by market = operatingreports expensesis based ratio on of the total face rental rents income (asked (%). rent level) or contract rents which are not corrected for incentives. As giving incentives is a very common act in the Dutch office market, the market development based on the face rents or contract rents, are not showing the actual market development (Boots, 2014). As a result, in order to calculate the actual TRI, the actual rents (namely the ERV), should be used. The TU/Delft database contains the ERVs of the Amsterdam office market, = ∗ 100 when a rental transaction was registered from 2002 till 2012. It also provides ERVs of a property (if (24) available), or it calculates it based on the average effective rents of rental transactions in the radius of 500 m, 1000 m around the property, = or ∑ average effective ∗ 100 rents per Amsterdam district at the (23) selling time, when no actual rental transactions were present for specific properties (see Figure 7.3). The effective rents provided by the TU/Delft property database are calculated based on the following = ∑ ∗ 100 (25) assumptions and steps (Boots, 2014): (26) Where; = = vacancy ratio, = property current vacancy, = vacancy rate in properties’ macro location (submarkets). (27) , < 1, < (, ) = , ≥ 1, ≤ < 3 Where; , ≥ 1, ≥ 3 = vacancy ratio, = time on market, = average vacancy period. (28) =+∑ + ∑ +∑ + ∑ + (29) =+∑ + ∑ +∑ + ∑ + (20) = 58 Valuation accuracy in vacant office properties - the initial contract rent per transaction is corrected for parking lots and incentives in terms of rent free periods (in months/years) and rental discounts (in Euros); - all the aforementioned incentives are considered at the start of the lease term; - the Discounted Cash Flow (DCF) model is used to discount the future rental income; including the incentives during the entire lease period till the transaction year which results in the Net Present Value (NPV); - the differences between the NPV of the contract rent and incentives equals the effective rent per contract term (per m2 LFA). Ultimately, the ERVs of the first year are multiplied by lettable floor area of a property to arrive to the total annual cash flows (TRI). (21) Subsequently,Where; = the ∗ NOI is obtained by subtracting the operating expenses (as a percentage of the total income)= total from lettable the floor total area rental (m2), income as shown in equation (22): = effective rental value. LFA (22) (22) Where; = ∗ (1 − ) = Net Operating Income in the first year, = total rental income, = operating expenses ratio of total rental income (%). The operating expenses consist of fixed operating expenses, variable expenses, maintenance and repair, and reserve for replacement (Lusht, 2012). Since all the properties are located in Amsterdam, a part of the property expenses such as property tax, sewerage tax etc., are the same. However, = ∗ 100 for the other parts of the operating expenses, namely variable expenses, maintenance and repair, (24) and reserve for replacement, it is too difficult to make an accurate correction for the operating expenses, since it depends on many variables = ∑ such as the age ∗ 100of the building the structural condition, (23) the size, the location, variable costs such as management costs, etc. As a result, an assumption regarding the total operating expenses percentage is made based on the average total operating expenses for office properties in Amsterdam. This in turn is based on published operating costs in = ∑ ∗ 100 (25) KengetallenKompas Bouwkosten. The outcome is an Operating Expenses Ratio (OER) of 10%. The total rental income is corrected for the OER of 10% in order to obtain the NOI.(26) 7.2.1.2Where; Cal = culating Gross transaction price The corrected = vacancy gross ratio, transaction price as an input for the direct capitalization method is estimated = property current vacancy, reversely from = the vacancy net rate transaction in properties’ price macro (the location realized (subm pricearkets). in euro when the sale occurred). This is done by correcting it for the transfer tax and legal fees (in Dutch Kosten Koper), which again is based on the criteria publish yearly in KengetallenKompas Bouwkosten as stated in Table 7.1. Transaction price KK% Table 7.1, Kosten Koper (KK)(27) as a up to € 100,000 , < 1, < 7% percentage of the sale price € 100,000 (, - € 200,000) = , ≥ 1, ≤ <6.5% 3 Where; € 300,000 - € 500,000 , ≥ 1, ≥ 3 6.4% = vacancy ratio, € 600,000= - time € 1,500,000 on market, 6.3% = average vacancy period. € 1,750,000 - € 4,000,000 6.2% € 5,000,000 and above 6.1% (28) =+∑ + ∑ +∑ + ∑ + (29) =+∑ + ∑ +∑ + ∑ + (20) = Chapter 7: DATA analysis and Synthesis 59 (21) Where; = ∗ = total lettable floor area (m2), 7.2.2 Method= effective | Trentalotal value. variance test In orderLFA to measure the differences between appraised cap rates and transaction cap rates, a total variance test as Cullen (1994), Hordijk (2005), Lizieri and Venmore ‐Rowland (1991) and McAllister (22) (1995) use for measuring the differences between appraised values and transaction prices is seen Where; = ∗ (1 − ) (21) as the most = Net appropriate Operating Income technique. in the first The year, total variance test examines the difference between each appraised= totalcap rentalrate income,and the subsequent transaction cap rate and expresses this difference as a Where; = = operating ∗ expenses ratio of total rental income (%). percentage: = total lettable floor area (m2), = effective rental value. LFA (23) (22) = ∗ (1 − ) Where; = ∗ 100 = Net Operating Income in the first year, Where RTP= totaland rental RV respectively income, are the transaction cap rate and the substantial appraised cap rate of (24) the property. = operating expenses ratio of total rental income (%). (21) (23) = ∑ ∗ 100 In order Where; to = estimate ∗ the Average Absolute Differences between the appraised and transaction cap = total lettable floor area (m2), rates, the= average effective rentalabsolute value. error for each year is calculated using equation (24): LFA = ∑ ∗ 100 (25) = ∗ 100 (22) (24) (24) (26) Where; = ∗ (1 − ) = Net Operating Income in the first year, = ∑ ∗ 100 (23) = This shows Where;= total the rental absolute income, difference between the appraised and transaction cap rates, ignoring the = =vacancy operating ratio, expenses ratio of total rental income (%). fact whether the= property appraised current cap vacancy, rate is higher or lower than the transaction cap rate. This means = vacancy rate in properties’ macro location (subm arkets). that the sign (positive or negative) of the individual differences is ignored (Fisher et al., 1999; IPD, = ∑ ∗ 100 (25) 2014; McAllister, 1995). This is an appropriate indicator to see how different, on average, the typical transaction cap rate is from the appraised cap rate. (26) = ∗ 100 In orderWhere; to = estimate the Average Directional Differences between the appraised market value and (24)(27) = vacancy ratio, , < 1, < transaction price,= property the average current vacancy, error for each year is calculated as: (23) (, ) = , = ∑ ≥ 1, ∗ 100 ≤ < 3 = vacancy rate in properties’ macro location (submarkets). Where; , ≥ 1, ≥ 3 = vacancy ratio, = time on market, (25) = average vacancy period. (25) = ∑ ∗ 100 This provides an indication whether there is any tendency for appraised cap rates to consistently (27) understate or overstate the transaction cap rates or whether the errors are randomly(26) spread around , < 1, < (28) zero. In( ,addition, ) =this allows positive , and negative ≥ 1, errors to ≤cancel (28) (20) =+∑ + ∑ +∑ + ∑ + = (29) =+∑ + ∑ +∑ + ∑ + (20) = 60 Valuation accuracy in vacant office properties Chapter 6 discussed the main determinants of cap rates found in academic literature. By combining the GBA and the TU/Delft property database, together with the complimentary database mentioned in §7.1, almost all the variables found in the literature in Chapter 6, can be found in the newly created databases. However, there are a couple of variables, such as vacancy and rent ratios which are not included in the used databases and must be calculated. In addition, the variables that are calculated in §7.2 (the transaction cap rates), are used in to test hypothesis 2 as well. The following sections explore the inventory of input variables for testing the second hypothesis, explain the variables which are missing and are estimated ex-post based on the available data, and finally discusses the methodology to test hypothesis 2, the cap rate determinants. 7.3.1 Inventory of input Variables For this study, after connecting all the individual datasets mentioned in §7.1, the created database is classified based on context, location, property, and lastly office-users, as mentioned in Part II (Theoretical Framework), Chapter 5 and 6. This process is visualized in Figure 7.1. Table 7.2, Table 7.3, Table 7.4 and Table 7.5 provide an inventory overview of the available variables and summarize respectively the context related, the location related, the property related, and the office-user related variables. These tables show the definition of the aforementioned variables, their expected impact on cap rates, whether they are used in the other cap rate studies, and finally their original data source, before being combined in the BAG. Table 7.2, Context summarizes the Variable Indicator Definition/explanation Impact Used by other authors Data source context related variables, their category definition, expected Macro- real GDP as a proxy for growth rate +/- (Van Norren, 2007), CBS/DNB impact on cap rates (in case of an economic growth (Hoesli & Chaney, 2014) increase), whether inflation annual nominal consumer - (Sivitanides et al., 2001) CBS they are used in the other cap expectation price index (CPI) percentage (Van Norren, 2007) rates literature, as a proxy for growth rate and finally their original source of office office job index - (McDonald & Dermisi, DTZ data, before being employment 2008)s combined in the BAG. Capital risk free rate real return on the ten-year + (Sivitanides et al., 2001), CBS market Dutch government bonds (Van Norren, 2007), (McDonald & Dermisi, 2008), (Netzell, 2009), (Chervachidze & Wheaton, 2013), (Hoesli & Chaney, 2014) Chapter 7: DATA analysis and Synthesis 61 credit rating expected rate of return for - (Froland, 1987), DNB the entire capital market (Ambrose & Nourse, (S&P 500) 1993), (McDonald & Dermisi, 2008), (Netzell, 2009), (Hoesli & Chaney, 2014) investment a ratio of the investment - (Van Norren, 2007) JLL volume ratio volume in the office segment of the total investment in the real estate Office market rent ratio of current rent +/- (Sivitanides et al., 2001), ex-post market to historical trend in (Verhaegh, 2005), (Van using DTZ trends Amsterdam Norren, 2007), (Netzell, & TU/Delft 2009), (Chervachidze & Wheaton, 2013), (Hoesli & Chaney, 2014) vacancy rate annual Amsterdam vacancy + (Froland, 1987), DTZ rate (Van Norren, 2007), (McDonald & Dermisi, 2008), (Netzell, 2009), (Hoesli & Chaney, 2014) cap rate lagged cap rate as reported + (Sivitanides et al., C&W in the office market reports 2001), (Van Norren, at an aggregated level 2007), (Chervachidze & Wheaton, 2013) Sale auction a forced sale + (Hoesli & Chaney, 2014) GBA conditions other sale whenever the transaction - (Hoesli & Chaney, 2014) GBA conditions was neither an auction nor done in an open market at arm’s length e.g. when the sale was e.g. in relation with a related legal entity or to a family member 62 Valuation accuracy in vacant office properties location* Table 7.3, summarizes the Variable Indicator Definition/explanation impact Used by other authors Data source location related category variables, their definition, expected Macro city districts used to capture variation (Ambrose & Nourse, TU/Delft & impact on cap location (Wijk) in α (fixed effect per each 1993), GBA rates (in case of increasing), whether sub-markets) (Jud & Winkler, 1995), they are used in (Sivitanides et al., the other cap rates literature, and 2001), (Verhaegh, finally their source 2005), (Netzell, 2009), of data, before being combined in (Chervachidze & the BAG. Wheaton, 2013), (Hoesli & Chaney, 2014)* vacancy rate average vacancy rate per + (McDonald & Dermisi, TU/Delft year per district 2008) rent a ratio of current rent to +/- ex-post the historical trend per using TU/Delft district Micro direct used to capture variation (Netzell, 2009), (Hoesli GBA location neighborhood in α (fixed effect per each & Chaney, 2014) (Buurt) sub-markets) * In this thesis, as all the properties are located in Amsterdam, therefore macro locations will be city districts, while for the other authors, that studied different cities in a country, their macro location is city. However, only Netzell (2009), Hoesli and Chaney (2014) use a lower level location, meaning the different districts within one city. For this thesis this can be shown by different neighborhood in one district to measure the fix effect of various neighborhood on cap rates. Property Table 7.4, summarizes the Variable Indicator Definition/explanation Impact Used by other authors Data source property related category variables, their definition, expected Building age year of sale -year of + (Verhaegh, 2005), Ex-post using impact on cap condition construction (McDonald & Dermisi, TU/Delft and rates (in case of increasing), whether (quality) 2008), (Netzell, 2009), GBA they are used in (Hoesli & Chaney, 2014) the other cap rates literature, and new dummy for new building if the - (Hoesli & Chaney, 2014) Ex-post using finally their source year of sale -Year of TU/Delft and of data, before being combined in construction =< 3 GBA the BAG. overdue as a dummy variable + (Hoesli & Chaney, 2014) GBA & TU/ maintenance Delft renovation when the renovation is - (Hoesli & Chaney, 2014) GBA not older than 10 years monument as a dummy variable +/- GBA Size (m2) Lettable floor Ln (LFA) +/- (McDonald & Dermisi, GBA area 2008) ** not significant Market- rent ratio current rent (effective +/- (Verhaegh, 2005), Ex-post using externals rents) to the average (Netzell, 2009), (Hoesli TU/Delft effective rent in district & Chaney, 2014) as a potential market rent Chapter 7: DATA analysis and Synthesis 63 vacancy risk market conformed - Ex-post using vacancy level TU/Delft & GBA potential structural + Ex-post using vacancy level TU/Delft & GBA structural vacancy level ++ Ex-post using TU/Delft & GBA appraised cap from the last two years + (Sivitanides et al., 2001), GBA rate (Hoesli & Chaney, 2014) ownership leasehold dummy for the ground + (Netzell, 2009), (Hoesli GBA status lease & Chaney, 2014) Usage multi-tenant dummy for the multi- - Ex-post using status tenets (versus Single TU/Delft & tenant) GBA mixed-use residential part - (Hoesli & Chaney, 2014) GBA Accessibility distance to in logarithm - TU/Delft highway distance to in logarithm - TU/Delft station Google in three categories of - TU/Delft Walkscore low, average and high Envir. contaminated + GBA condition soil asbestos + GBA Table 7.5, office-users summarizes the office-user related Variable Indicator Definition/explanation Used by other authors Source of data variables, their category definition, expected impact on cap contract remaining in month - (Verhaegh, 2005) GBA rates (in case of lease term increasing), whether they are used in option year any terms on the + GBA the other cap rates contract for correction literature, and finally their source lease The differences + of data, before incentive % between the face being combined in the BAG. rent and the real rent (contract rent) tenant type public When the tenant - GBA of the building is a governmental agency and not a private entity (21) Where; = ∗ = total lettable floor area (m2), = effective rental value. LFA (22) Where; = ∗ (1 − ) = Net Operating Income in the first year, 64 = total rental income, Valuation accuracy in vacant office properties = operating expenses ratio of total rental income (%). 7.3.2 Calculating the relative vacancy risk As explained in § 6.3, to interpret the effect of vacancy on cap rates, at both the location and the property level, the vacancy rate at the property level should be calculated based on the vacancy = ∗ 100 (21) ratio relative to its direct surroundings. (24) Where; = ∗ = total lettable floor area (m2), In order to measure such a vacancy ratio = (at ∑ the building level ∗ 100 in a relative term), first the property- (23) = effective rental value. specificLFA vacancy ratio is calculated by using equation (26), thereafter it is categorized based on the ToM (Time on Market relative to its direct neighborhood) in the following categories: market (22) conformed vacancy, temporary vacancy and structural vacancy. Where; = ∗ (1 − ) = ∑ ∗ 100 (25) = Net Operating Income in the first year, = total rental income, (26) (26) = operating expenses ratio of total rental income (%). Where; = = vacancy ratio, = property current vacancy, = vacancy rate in properties’ macro location (submarkets). = ∗ 100 - Market conformed vacancy risk is measured as a vacancy rate less than the average vacancy rate (24) in the district (vacancy ratio <1) with the condition of being vacant less than the average void period (23) in the direct neighborhood. = ∑ ∗ 100 (27) , < 1, < - Potential (, structural ) = vacancy risk , is the condition ≥ when 1, the vacancy ≤ ratio < is 3 higher than the average Where; vacancy rate in the district and the, ToM is lower than ≥ 1, three years ≥ and 3 higher or equal to the average = vacancy ratio, = ∑ ∗ 100 (25) void period = time in the on market, direct neighborhood. This is interpreted that the vacant property has a chance of = average vacancy period. being leased within three years. (26) = - StructuralWhere; vacancy risk is a circumstance when the vacancy ratio of a property is higher than the = vacancy ratio, (28) average vacancy= property rate in current the district, vacancy, and the property remains vacant for more than three years. = vacancy rate in properties’ macro location (submarkets). =+∑ + ∑ +∑ + ∑ + Equation (27) summarizes the aforementioned conditions and calculates the relative vacancy risk as: (29) (27) =+∑ + ∑ +∑ + ∑ + (27) , < 1, < (, ) = , ≥ 1, ≤ < 3 Where; , ≥ 1, ≥ 3 = vacancy ratio, (20) = time on market, = average vacancy period. = Input variables for equation 26 and 27 are extracted from the available data in the created database. As input for property current vacancy at the time of sale, the vacancy rate of the property, where the (28) WOZ object is located, is used. The same is applied for the macro location. The average vacancy rate =+∑ + ∑ +∑ + ∑ + of the city district where the WOZ object is situated, and when the transaction sale occurred, is used. (29) The time on the market is calculated based on tax vacancy information. This period is the duration since the property became vacant till the moment of the transaction (this is when the WOZ object =+∑ + ∑ +∑ + ∑ + is registered as vacant in the tax vacancy data). Finally, the average void period calculated in § 7.2.1 (20) = Where; = premium from participation in real estate, = premium on location attributes, (21) (21) = premium on property-itself attributes, Where; = ∗ = premium on property-user attributes. Where; = =total lettable ∗ floor area (m2), 2) = totaleffective lettable rental floor value. area (m , LFA = effective rental value. LFA (22) (22) Where; = ∗ (1 − ) Where; = =Net Operating ∗ (1 −Income ) in the first year, = = total Net Operatingrental income, Income in the first year, = + ∗ − + 1 − ∗ + = =total operating rental expensesincome, ratio of total rental income (%). → = + ∗ − + 1 − ∗ + + + = operating = expenses+ ratio + of total + rental income (%). Chapter 7: DATA analysis(16) an d Synthesis 65 = ∗ 100 is used to compare the time on the market with the common (average) time on the market in the = ∗ 100 (24) direct neighborhood. = – (24) → = + ∗ − + 1 − ∗ + + + − = + ∗ − + 1 − ∗ = + ∑ + + ∗ 100 (23) 7.3.3 Method |(17) Regression ana = l∑ysis, a mu ltip ∗l 100e regression model (23) The most appropriate statistical technique to test hypothesis 2 is the multiple regression model (also Where; known as ordinary least square). The regression is done once by using appraised cap rates and the = risk free rate, = ∑ ∗ 100 (25) other = Loan-to-value time transaction ratio, cap rates as a dependent variable in the multiple regression model. This is = ∑ ∗ 100 (25) performed = rate of return to analyze on debt, the determinants of office cap rates for appraisers and investors respectively ⁄ (26) = premium from participation in real estate, in the Netherlands. (26) = premium on location attributes, Where; = = premium on property-itself attributes, 7.3.3.1Where; = = vacancy MOD ratio,EL SPECIFICATION = premium on property-user attributes, Based = vacancy on= theproperty ratio, dynamic current cap vacancy, rate specification developed in chapter 5, the cap rate regression model = a constant= property expected current rate ofvacancy, growth in the NOI. = vacancy rate in properties’ macro location (submarkets). formulated = vacancy in § 5.4, rate isin definedproperties’ as macro equation location (18): (submarkets). (18) Where;=+ ∑ + ∑ +∑ + ∑ + (27) = constant or intercept , term, < 1, < (27) = the coefficient of ,variables indicating context, location, < 1, property and office < users factors, α =( ,the error term.) = , ≥ 1, ≤ < 3 (, ) = , ≥ 1, ≤ < 3 Where; , ≥ 1, ≥ 3 εWhere; = vacancy ratio, , ≥ 1, ≥ 3 This = =vacancymodel time on ratio, market,specification is used once to regress the transaction cap rate (equation(19) 28) and = averagetime1 on market,vacancy period. subsequently to regress appraised cap rates (equation 29), as dependent variables in the multiple = = average vacancy period. Where;regression equation (18): = Appraised cap rate (%), = net income multiplier. (28) (28) (28) =+∑ + ∑ +∑ + ∑ + (20) =+ ∑ + ∑ +∑ + ∑ + = Where; (29) (29) = overall capitalization rate (%), (29) = property value (gross transaction price), ==+ Net Operating∑ Income in the+ first∑ year. +∑ + ∑ + The hierarchical method (blockwise entry) of entering the independent variables in the regression =+∑ + ∑ +∑ + ∑ + model is used to enter the variables into the regression model, based on the theoretical importance, found in other literature (mentioned in part II, Theoretical framework). The stepwise method is not used, since according to Field (2013), the stepwise method is not the best method(20) to select (20) and add the independents due to the fact that this method is merely based on mathematical logic = and eliminates= variables that mathematically have a lower semipartial correlation. However, such a small statistical difference may have a conflict with the theoretical importance of that eliminated independent variable. In the hierarchical way, respectively for transaction and appraised cap rates, first the context related variables are entered in the model. Second, the location related variables are entered, and subsequently the property related variables are entered as the third step in the model. Unfortunately due to the large number of missing variables from the fourth category (variables related to office users) this category is omitted from the regression. In addition to the first model, once the regression is ran using time dummies (transaction sale year), instead of context variables (macro-economic and financial variables). This is done to capture the 66 Valuation accuracy in vacant office properties time series variations in two ways in order to check the robustness of the model. The regression model is checked for the residuals. The major assumptions of the validity of the model is checked such as its linearity (linear relation between the dependent variable and the independents), independent errors (where the residuals are not correlated), and multicollinearity (where there is no perfect linear relation between independent variables)(Field, 2013). The error term is the residual of the differences between the model calculated values for cap rates and the data (the transaction or appraised cap rates). This residual indicates the unexplained model part. In order to create an ideal model, the goodness-of-fit of the model is checked and assessed based on the least squares method by checking the deviation between the model and the data collected (minimizing the residual between the model and the data). 7.3.3.2 Dependent variables From the available variables mentioned in § 7.3.1, not all could be used in the regression, due to the size of the sample (124 transactions between 2004 and 2011). The selection of the variables among the variable inventory is performed based on their significant and critical influence on cap rate variations according to the theoretical framework (scientific literature). The variables that are entered in both models (transaction cap rates and appraised cap rates) remain the same, for the sake of comparison. When necessary the variables are transformed to dummy variables, natural logarithm or categorical variables. Dummy variables are those that show the absence or presence of categorical and/or ordinal variables by taking the value of 0 or 1. In case a dummy variable is used, a dummy variable for one category is omitted from the regression to prevent perfect collinearity. The use of the natural logarithm functional form is because of the law of diminishing returns, which indicates the value of the dependent variable is less than proportional to the independent variable (Francke, 2014). In case of a prior structure, it is assumed for specific data that the independent variables are transformed to categorical forms. However, for the flexibility of the regression model, the categorical variables are also ultimately transformed to the dummy variables. The list of independent variables used in each step of the model (for both transaction and appraised cap rates as the dependent variable), their symbol in the regression model, and their functional forms are shown in Table 7.6. 7.4 Hypothesis 3 | the myth of vacancy and valuation accuracy The third hypothesis mentioned in §3.10 states that: “The differences between appraised cap rates and transaction cap rates of an office property has a positive correlation to its vacancy risks.” To test this hypothesis, the differences between appraised and transaction cap rates, which are calculated for hypothesis 1 per property (§7.2.2), should be compared with different types of vacancy risk, which are calculated for hypothesis 2 (§7.3.2). 7.4.1 Cap rates Differences versus vacancy risk To perform this test both the Directional differences and absolute differences between the appraised and transaction cap rates are selected from the result of testing Hypothesis 1. Chapter 7: DATA analysis and Synthesis 67 Table 7.6, list of Hierarchical Variable Independent Symbol Functional Interpretation used variables in each step of the Model category Variable form regression Step 1: Macro- office OfficeJobs interval context economic employments Capital market office investment OfficeInvest interval Step 2: Macro location city districts DD2, DD3, DD4, dummy DD2 = New-West; location DD6, DD7, and DD8 DD3= North; DD4= East; DD6=Westpoort; DD7=South; DD8=South-East. Step 3: Building age LnAge natural property condition logarithm (quality) size LnLFAm2 natural logarithm Market rent ratio RentR interval externals Accessibility distance to LnAfstDBZ_IC_ natural station Station logarithm Environmental asbestos Asbest dummy presence of condition asbestos =1; else=0. The reason that the directional differences are selected is that this calculated variable shows also whether the changes in vacancy, leads to an overstated (negative difference) or understate (negative differences) appraised cap rate in comparison to the transaction cap rate. when RV > RTP , then RTP- RV is a negative amount, therefore expecting V when RV< RTP , then RTP- RV is a negative amount, therefore expecting V>TP The absolute differences is selected to record the magnitude of the relation between the different vacancy risk (market conformed, potential structural, structural vacancy risk) and the differences in cap rates. 7.4.2 Method | One-Way ANOVA test: comparing multiple means In order to measure the relations between differences of appraisal and transaction cap rates, and different vacancy risks, the One-Way ANOVA test is used, since the directional differences between RV and RTP have interval form which is compared with a vacancy risk variable which is a categorical variable (Field, 2013). There are three categories of market conformed, potential structurally vacancy risk, and structurally vacancy risk under the vacancy risk variable, therefore the test is performed by applying post hoc tests. Post hoc tests are a multiple comparison procedures which designed to compare a combination of all different subgroups (at least three groups within a variable) to find 68 Valuation accuracy in vacant office properties possible differences without having a prior prediction about the differences in data (Field, 2013). In fact this method compares the mean of directional and absolute differences between RV and RTP with each vacancy level under the vacancy risk variable. The primarily assumption for applying the ANOVA test is provided as data are normally distributed within the groups per variable (Field, 2013). After checking the basic assumption of the normality, the test is ran and the means are compared per each category. Empirical Findings 8 70 Valuation accuracy in vacant office properties Chapter 8: Empirical Findings This chapter discusses the outcome of the empirical research as described in Chapter 7. First the descriptive statistics and the characteristics of the final database are explained. Subsequently, the results of the tested hypotheses are discussed. 8.1 Descriptive statistics The final database consists of 124 office transactions in Amsterdam from 2004 till 2011. Even though the sale-transaction data in the GBA database registers around 500 office transactions of single WOZ objects from 2004 till 2014 in Amsterdam, the final database consist of much less transactions. This is due to the fact that when combining the databases important data, needed to calculate cap rates, was missing. Missing variables include the availability of effective rent levels, WOZ cap rates, and most importantly the lack of BAG ID’s for all the WOZ objects in the database. As a result, the final database contains only data which includes both appraised cap rates and transaction cap rates (ex- post calculated) and which has a corresponding BAG ID. 8.1.1 Outliers From the 124 office transactions, 3 outliers are recognized and deleted from the sample (see Figure 8.1). In order to recognize the outliers, the z-score of the variable transaction cap rate is calculated. The outliers are defined as cases with a z-score above 2.58 (in absolute terms). The results show three significant outliers which were observations with a z-score above 3.29. These outliers are removed from the sample to avoid their influence on biasing the mean and enlarging the standard deviation in the statistical findings (Field, 2013). Figure 8.1, outliers, ,80 scatter plot transaction cap rates in Amsterdam from 2004 to 2011 ,60 ,40 Cap Rate Transaction Transaction Cap Rate ,20 ,00 2004 2005 2006 2007 2008 2009 2010 2011 TransactionTransaction Year Year 8.1.2 Sale transactions per year The number of sale transactions recorded per year varies significantly. However, the overall pattern shows a gradual increase in the number of transactions towards the financial crisis and a steady decrease in the number of transactions after the financial crisis. Figure 8.2 displays the number of transactions per year. Figure 8.3 shows the average WOZ value versus transaction prices of properties Page 1 Chapter 8: Empirical Findings 71 Figure 8.2,(right) WOZ value Error bars: 95% CI Transaction price 25 Mean the number of TransactionSale transactions, and WOZ_Value 10.000.000 Error Bars: 95% CI Figure 8.3 (left) 20 average WOZ value versus transaction 7.500.000 price per year from 15 2006 till 2011 5.000.000 Frequency Mean 10 2.500.000 5 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 YearOfSale TransactionSaleYear Year Transaction Year in Amsterdam from 2004 till 2011. The differences between the WOZ values and transaction prices increased from 2005. The average transaction prices are higher and fluctuated more when compared to the WOZ values of the same year. Page 1 8.1.3 Sale transactions per city district Within the municipality of Amsterdam, there are eight city districts: Center, New-West, North, East, West, Westpoort, South and South-East (see Figure 8.4). The number of sale transactions recorded per Amsterdam district varies considerably (see Figure 8.5). The majority of the sale transactions occur in Amsterdam Center (45 transactions from 2004 till 2011). Next to the Amsterdam Center, Amsterdam South and West have the most sale transactions, respectively 23 and 19 transactions in the eight year period of 2004 to 2011. The least number of transactions belong to the Amsterdam districts of New-West (5 transactions in total) and Westpoort (4 transaction in total). Table 8.1 shows that the number of sale transactions per year per city district from 2004 till 2011. The districts of New-West, East Westpoort show low dynamics in the office market after the financial crisis. The number of transactions per year is very scarce in these districts. The city Center on the other hand, shows a more stable market where the number of transaction remains almost the same, when compared to before and after the financial crisis. Additionally, in 2007, there were a larger number of transactions (11 in total), in comparisons to the other years. Figure 8.4,(left) 50 Amsterdam city districts, and Westpoort Figure 8.3 (right) North the number of 40 transactions per districts from 4002 West Center to 2011 New-West 30 East Frequency South 20 South-East 10 Amsterdam Districts 0 Center New-West North East West Westpoort South South-East AmsterdamAmsterdam Districts districts Page 1 Page 1 72 Valuation accuracy in vacant office properties Table 8.1, the Total # number of sale Total # of Transaction year transactions transactions per transactions year per city district 2004 2005 2006 2007 2008 2009 2010 2011 per district from 2004 till 2011 in Amsterdam Centre 5 5 5 11 3 8 4 4 45 New-West 1 - 1 1 2 - - - 5 North 3 1 2 - 1 1 1 - 9 East - - 2 - 2 1 - 2 7 West 4 1 2 5 3 3 1 - 19 City districts Westpoort 1 - - 1 - 2 - - 4 South 1 2 3 5 5 3 - 4 23 South-East - - - 1 4 1 2 1 9 Total # transactions per year 15 9 15 24 20 19 8 11 121 8.1.4 Cap rate development in Amsterdam Figure 8.6 shows the cap rate development (both appraised and transaction) from 2004 till 2011. The development of the transaction cap rates record a higher volatility in the Amsterdam office market when compared to the appraised cap rates (both WOZ cap rates and reported market cap rates by C&W). The average appraised cap rates of different years are very close to each other, which supports the appraisal smoothing theory and serial correlation by appraisers. Whereas, transaction cap rates, show a higher volatility and differ significantly per year. This is also clear when comparing the development of transaction cap rates versus aggregated cap rates reported by real estate agencies (see Figure 8.6). Overall the average transaction cap rate for the period 2004 till 2011 is about 6.00% with a standard deviation of 4.40%. While the average appraised cap rate for this period is 9.30% with a significantly lower deviation of 1.20%. Table 8.2 compares the development of transaction and appraised cap rates per year in Amsterdam. On average, the average cap rates before the crisis is lower than the used cap rates after the financial crisis, with an exception of unweighted average cap rates in 2009. This may be caused by the fact that the majority of transactions in 2009 occurs in Amsterdam Transaction cap rate Figure 8.6, cap 0,12 Appraised (WOZ) cap rate rate development (both appraised and 0,10 Appraised (market) cap rate transaction) from (source C&W) 2004 till 2011 in 0,08 Error bars: 95% CI Amsterdam Mean 0,06 Mean 0,04 0,02 0,00 2004 2005 2006 2007 2008 2009 2010 2011 TransactionSaleYear Year Page 1 Chapter 8: Empirical Findings 73 Center (8 transactions), which due to the prime location, has a lower associated risk for property investment, thus lower cape rates are recorded. Table 8.3 shows the average cap rates (both transaction and appraised) per Amsterdam district from 2004 to 2011. In general, Amsterdam South records the lowest transaction cap rates (ave. of 4.10%), as well as lowest standard deviation (2.50%), which is an excepted result due to the existence of the main business district (the Zuidas) in this district. The Amsterdam district of Westpoort has Table 8.2, development of ve. transaction and A appraised cap 2004 2005 2006 2007 2008 2009 2010 2011 / otal rates per year in T Amsterdam from 2004 till 2011 Transactions # 15 9 15 24 20 19 8 11 121 Mean 8.30 5.50 4.60 5.10 6.80 4.80 6.10 7.70 6.00 Lower 5.70 2.10 3.40 4.00 4.35 2.00 2.70 4.60 5.20 Transaction 95% Confidence Bound cap rate % Interval for Mean Upper 11.00 9.00 5.80 6.20 9.20 7.60 9.40 10.75 6.80 Bound Std. Deviation 4.80 4.50 2.20 2.60 5.20 5.70 4.00 4.60 4.40 Mean 9.20 8.80 9.00 8.60 9.20 10.00 10.20 9.60 9.30 Lower 8.80 8.00 8.50 8.20 8.80 9.10 9.30 8.80 9.00 Appraised cap 95% Confidence Bound rate % Interval for Mean Upper 9.60 9.60 9.40 9.10 9.60 11.00 11.20 10.30 9.50 Bound Std. Deviation 0.70 1.10 0.80 1.00 0.80 1.90 1.10 1.10 1.20 Table 8.3, development of ve. ast est transaction and A appraised cap est estpoort rates per district in / otal C enter W N ew- N orth E ast W W S outh S outh- E T Amsterdam from 2004 to 2011 Transactions # 45 5 9 7 19 4 23 9 121 Mean 4.95 7.40 12.20 6.00 5.40 13.20 4.10 7.30 6.00 Lower 3.90 6.10 8.80 1.30 4.00 -3.00 3.00 3.40 5.20 Transaction 95% Confidence Bound cap rate % Interval for Mean Upper 6.00 8.80 15.70 10.80 6.70 30.40 5.20 11.20 6.80 Bound Std. Deviation 3.40 1.10 4.50 5.20 2.70 10.20 2.50 5.10 4.40 Mean 9.00 9.25 10.40 10.30 9.10 10.30 8.60 10.20 9.30 Lower 8.60 8.90 9.80 9.80 8.80 9.40 8.20 9.50 9.00 Appraised cap 95% Confidence Bound rate % Interval for Mean Upper 9.50 9.60 10.90 10.8 9.40 11.20 9.10 10.90 9.50 Bound Std. Deviation 1.40 0.40 0.80 0.50 0.60 0.50 1.10 0.90 1.20 74 Valuation accuracy in vacant office properties the highest transaction cap rates of 13.20 % with a high standard deviation of 10.20%. This may be explained by the spatial differences in this area, since the areas closer to the train station (Amsterdam Sloterdijk), are the best location in this area, and by getting further than the train station, the quality of the office location is enormously reduced. Table 8.4 shows that the average transaction cap rates per year per city district in Amsterdam. This tables shows that there was an enormous increase in the used cap rates in 2008. Especially in the Center, North and South-East districts, which emphasize on the uncertain and risky investment environment just after the financial crisis in the Amsterdam office market. Whereas, a slight increase in appraised cap rates (see Table 8.5), occurs merely in 2009. Considering the fact that the used WOZ cap rates in this research were those of one year after the sale transactions, the results indicate that appraised cap rates (WOZ cap rates) are in fact lagged two years behind the transaction cap rates. Table 8.4, average Ave. transaction cap Transaction year Total ave. per transaction rates per year district per city district in cap rate % 2004 2005 2006 2007 2008 2009 2010 2011 Amsterdam from 2004 to 2011 Centre 4.30 6.40 2.90 4.50 7.80 3.95 4.60 2.70 4.95 New-West 9.10 - 7.90 6.70 6.70 - - - 7.40 North 14.30 8.00 7.80 - 20.40 8.30 14.90 - 12.20 East - - 5.30 - 3.15 2.10 - 11.65 6.00 West 7.70 4.90 4.35 6.40 2.10 3.30 8.80 - 5.40 City districts Westpoort 16.70 - - 8.80 - 13.65 - - 13.20 South 4.30 2.60 3.90 4.70 4.00 1.90 - 6.20 4.10 South-East - - - 2.70 11.50 6.40 3.30 4.00 7.30 Total ave. per year 8.30 5.50 4.60 5.10 6.80 4.80 6.10 7.70 6.00 Table 8.5, average Ave. appraised (WOZ) Transaction year Total ave. per appraised cap rates per year district per city district in cap rate % 2004 2005 2006 2007 2008 2009 2010 2011 Amsterdam from 2004 to 2011 Centre 8.90 9.00 8.30 8.60 8.30 9.90 9.80 9.30 9.00 New-West 10.00 - 9.10 9.10 9.10 - - - 9.25 North 10.00 10.00 10.00 - 10.00 11.10 12.50 - 10.40 East - - 10.00 - 10.00 11.10 - 10.55 10.30 West 8.60 8.30 9.55 8.80 9.10 10.00 9.10 - 9.10 City districts Westpoort 10.00 - - 10.00 - 10.55 - - 10.30 South 9.10 8.00 8.30 8.20 8.70 9.20 - 9.00 8.60 South-East - - - 8.30 10.00 11.10 10.55 11.10 10.20 Total ave. per year 9.20 8.80 9.00 8.60 9.20 10.00 10.20 9.60 9.30 Chapter 8: Empirical Findings 75 Amsterdam Submarkets 0,20 Figure 8.7 shows the development of the cap rates (both transaction and WOZ cap rate) in different Center yearsNew-West in Amsterdam, which clearly emphasizes on the higher volatility and sensitivity of transaction 0,18 North cap Eastrates to different submarkets in Amsterdam, and smoothing in appraised cap rates. 0,16 West WestPoort South 0,14 Figure 8.7, cap rate Amsterdam Submarkets districts Amsterdam Submarkets 0,20 Southeast 0,20 development (on Center CenterCenter New-West 0,12 the top transaction New-WestNew-West 0,18 North 0,18 cap rates, at the NorthNorth East East East 0,16 West 0,10 bottom appraised WestPoort 0,16 WestWest South cap rates) in WestPoortWestPoort 0,14 Southeast 0,08 Amsterdam districts SouthSouth Center 0,14 SoutheastSoutheast 0,12 New-West Mean TP_CapRate from 2004 to 2011 North Center East 0,06 0,10 0,12 New-West West North WestPoort 0,08 South 0,04 East Southeast 0,10 West Mean TP_CapRate 0,06 WestPoort Mean TP_CapRate 0,02 0,08 South Southeast 0,04 Mean TP_CapRate 0,00 0,06 0,02 2004 2005 2006 2007 2008 2009 2010 2011 0,00 0,04 YearOfSale 2004 2005 2006 2007 2008 2009 2010 2011 0,02 TransactionYearOfSale Year Amsterdam 0,00 0,20 Submarkets Center 0,18 New-West 2004 2005 2006 2007 2008 2009 2010 2011 North East YearOfSale 0,16 West WestPoort South 0,14 Southeast Center New-West 0,12 North East West 0,10 WestPoort South Southeast 0,08 Mean WOZ_CapRate 0,06 Mean WOZ_CapRate 0,04 0,02 0,00 2004 2005 2006 2007 2008 2009 2010 2011 Transaction Year YearOfSale 8.2 Hypothesis 1 | Overstated and smoothed appraised cap rates The result of the total variance test rejects Hypothesis 1. Hypothesis 1 states that the appraised cap rates are lower than the transaction cap rates, depending on the situation on the market (declining and rising market). The results show that not only appraised cap rates in Amsterdam are not lower than transaction cap rates, but also their relation remains the same for the period before and after the financial crisis. Unlike the pre assumption of the appraised cap rates being lower than the transaction cap rates, the overstated and smoothed appraised cap rates vastly dominate the Amsterdam office market from 2004 till 2011. On average, for the period of 2004 till 2011, appraised cap rates are around 50% higher than the transaction cap rates, considering the average absolute differences between them. However, the average directional differences between the appraised and transaction cap rates indicate a slightly lower difference of around - 40%. Nevertheless, this indicator shows a clear tendency for appraised cap rates to consistently overstate the transaction cap rates, thus understating the property values Page 1 (see Figure 8.8) Page 1 Page 1 Page 1 76 Valuation accuracy in vacant office properties 1,20 DifferencesDirectionalCapsCap rate directional differences Figure 8.8, the DifferencesAbsoluteCaps 1,00 average directional Error CapBars: rate 95% absolute CI differences 0,80 and absolute Error bars: 95% CI differences between 0,60 transaction and 0,40 appraised cap rates 0,20 per year Mean Mean 0,00 -0,20 -0,40 -0,60 -0,80 -1,00 2004 2005 2006 2007 2008 2009 2010 2011 TransactionSaleYear Year These differences are the highest in 2008 (absolute differences of 51.20%) and 2009 (absolute differences of 74.00%). This can be explained due to the fact that WOZ cap rates are lagged and therefore the differences becomes higher for those years (see Table 8.6) Even though there is a general tendency for appraised cap rates to consistently overstate the transaction cap rates (since the absolute differences between appraised and transaction cap rates remain almost the same throughout time), in the Amsterdam district of North and Westport, the appraised cap rates are lower than transaction cap rates. As a result there is a positive amount of directional differences in these districts (see Table 8.7). The average differences of around 50% (absolute) are very high considering the fact that cap rates are the key input variables for the direct capitalization model, where determining the property value is very sensitive to cap rate changes. There are a couple of explanations for such enormous differences between the transaction and appraised cap rates. The first explanation is that WOZ cap rates are used to determine the property value. The purpose of tax (WOZ-Values), is different than that of appraised cap rates (property sale or finance). This is also obvious when looking at Figure 8.6 in § 8.1.4, where the WOZ cap rates are not only higher than the transaction cap rates, but also on average 30% higher than aggregated appraised cap rates reported in market reports such as C&W. The second explanation is that despite the fact that in both appraisal processes, the value should be defined as the fair market value, and follow the RICS appraisal and valuation standards, there are however many restrictions (fictions) related to the appraisal for the purpose of the tax (WOZ values). The major contrary assumption is that when defining the assessed value (WOZ-Values), the property is considered as if vacant, which is far from reality in many cases. Office properties are barley sold as vacant, and when that happens, there is a huge decrease in the property value. Page 1 Chapter 8: Empirical Findings 77 Table 8.6, average directional ve. and absolute A differences between 2004 2005 2006 2007 2008 2009 2010 2011 / otal T transaction and appraised cap Transactions # 15 9 15 24 20 19 8 11 121 rates per year Mean -11.20 -40.00 -49.70 -45.90 - 27.45 - 57.60 - 41.50 - 20.30 -37.80 95% Lower -36.70 -72.10 -61.90 - 58.70 - 51.80 - 84.00 - 68.70 - 51.10 -45.70 Directional Confidence Bound differences % Interval for Upper 14.40 -7.80 -37.50 - 33.10 - 3.10 - 31.30 - 14.30 105.60 -29.90 Mean Bound Std. Deviation 46.20 41.80 22.00 30.30 52.00 54.65 32.50 459.10 44.00 Mean 41.40 50.20 49.70 47.20 51.20 74.00 46.40 44.00 51.50 95% Lower 30.00 29.80 37.50 35.30 38.45 61.00 26.50 30.00 46.80 Absolute Confidence Bound differences % Interval for Upper 52.90 70.60 61.90 59.10 64.00 86.90 66.30 58.00 56.30 Mean Bound Std. Deviation 20.60 26.50 22.00 28.10 27.20 25.60 23.80 20.70 26.50 Table 8.7, average ve. directional ast est and absolute A differences est estpoort otal / otal T between C entre W N ew- N orth E ast W W S outh S outh- E transaction and appraised cap Transactions # 45 5 9 7 19 4 23 9 121 rates per districts Mean -50.00 -20.20 18.10 -42.40 -40.00 31.60 -52.20 -27.90 -37.80 95% Lower -60.60 -30.60 -16.40 -85.00 -55.10 -132.10 -64.70 -67.10 -45.70 Directional Confidence Bound differences % Interval for Upper -39.60 -9.90 52.60 0.10 -24.80 195.20 -39.70 113.10 -29.90 Mean Bound Std. Deviation 34.90 8.30 44.80 46.00 31.40 102.80 28.90 51.00 44.00 Mean 55.60 20.20 38.00 58.10 43.70 79.50 56.20 49.30 51.50 95% Lower 48.10 9.90 16.70 42.90 31.50 -14.50 47.60 28.30 46.80 Absolute Confidence Bound differences % Interval for Upper 63.10 30.60 59.10 73.40 56.00 173.40 64.70 70.30 56.30 Mean Bound Std. Deviation 24.80 8.30 27.60 16.50 25.50 59.00 19.70 273.10 26.50 78 Valuation accuracy in vacant office properties 8.3 Hypothesis 2 | forward looking investors versus backward looking Appraisers Based on the regression outputs, Hypothesis 2 is not a valid statement, since it shows that investors in the Amsterdam office market are more concerned with the cross-sectional and property specific variations in cap rates, whereas the appraiser is more concerned with the time-series variations in cap rates. However, the results show a clear difference between appraisers and investors, when determining the cap rates. The regression output of the transaction cap rate model shows an R2 value of .51, which indicates that the included variables (in total 13 variables) in the regression account for 51% of the variation in transaction cap rates (see Appendix 3). The expected impact of the independent variables on cap rats shown in Table 8.8 (see § 7.3.3.2 for the complete list of the used variables in the regression), are in accordance with the previous research mentioned in Part II (see also § 7.3.1). The context variables used in the regression model are office employment index (as a proxy for the macroeconomic conditions) and office investment volume as a ratio of the total investment in the commercial real estate in the Dutch real estate market (a proxy of the capital market). An increase in the office employment caused a decrease in the used cap rates by the investors, which is explained by the demand increase for the office space, thereby decreasing the vacancy and ultimately reducing the risk associated with the investment. Even though the explanatory power of this variable is less than 1%, the impact of this variable is significant at 0.05 level. The office investment volume ratio is negatively and significantly (sig. at 0.05 level) related to the transaction cap rates. An increase of one unit in the office investment ratio results in a cap rate decrease of around 0.05 units (5%). This indicates that the availability of capital to invest in the office segment, has a significant influence on the perception of the risk by the investors in this segment. Even though the magnitude of the used context variables is significant, all in all they have a very low explanatory power of less than 1% of the variations in the transaction cap rate model. This while the explanatory power of location variables (Amsterdam districts) is 30%, which indicates that 30% of the variation in transaction cap rates depends on where the property is located in the Amsterdam office market. The fixed effect of city districts matches with the market expectation for these locations. Properties located in Amsterdam South (DD7), decreases the transaction cap rate with 3%, whereas a property situated in Amsterdam Westpoort (DD6) increases transaction cap rate with about 9%. The size of a building is positively related to the transaction cap rate. An increase of one unit results in a cap rate increase of around 0.006 units. Even though, this is not a very substantial explanatory power, the magnitude of this variable is very significant (sig. at 0.01 level). This is explained by the fact that the bigger the size of a property, the higher the risk associated with the investment, since it reduces the liquidity of property investment. The rent ratio is positively and significantly (sig. at 0.01 level) related to the transaction cap rate which explains the forward looking attitude of the investors, who interpret the higher rent level Chapter 8: Empirical Findings 79 Table 8.8, transaction cap Coefficients transaction cap rate as dependent variable rates, regression Unstandardized Standardized Unstandardized Standardized output Coefficients Coefficients Coefficients Coefficients B Std. Beta t Sig. B Std. Beta t Sig. Error Error (Constant) ,389 ,156 2,493 ,014 ,119 ,073 1,627 ,107 OfficeJobs -,002 ,001 -,175 -2,159 ,033 OfficeInvest -,053 ,022 -,173 -2,370 ,020 DD2 ,045 ,018 ,203 2,552 ,012 ,038 ,018 ,173 2,132 ,035 DD3 ,076 ,012 ,456 6,175 ,000 ,074 ,013 ,442 5,844 ,000 DD4 ,030 ,013 ,159 2,215 ,029 ,025 ,014 ,133 1,772 ,079 DD6 ,088 ,018 ,359 4,994 ,000 ,088 ,018 ,358 4,942 ,000 DD7 -,034 ,009 -,307 -3,706 ,000 -,035 ,009 -,314 -3,698 ,000 DD8 ,040 ,018 ,240 2,184 ,031 ,035 ,019 ,207 1,841 ,069 LnLFAm2 ,006 ,002 ,197 2,721 ,008 ,007 ,002 ,209 2,801 ,006 RentR ,031 ,008 ,296 3,999 ,000 ,028 ,008 ,272 3,367 ,001 LnAge ,007 ,002 ,292 3,490 ,001 ,007 ,002 ,273 3,247 ,002 LnAfstDBZ_ -,021 ,010 -,247 -2,175 ,032 -,020 ,010 -,238 -2,024 ,046 IC_Station Asbest ,024 ,012 ,145 1,989 ,049 ,023 ,013 ,139 1,809 ,073 DY2004 ,025 ,013 ,191 1,918 ,058 DY2005 ,009 ,014 ,053 ,613 ,541 DY2006 -,011 ,012 -,082 -,911 ,364 DY2007 -,010 ,011 -,094 -,960 ,340 DY2009 -,008 ,012 -,069 -,720 ,473 DY2010 -,010 ,014 -,056 -,691 ,491 DY2011 ,008 ,013 ,051 ,612 ,542 relative to the market rent as a temporary situation and thus, they applied a higher cap rate (and vice versa). The property age as it was expected, is positively and significantly associated with the cap rate. However, it has a low explanatory power of cap rate variation, since it merely contributes less than 1% to the cap rate model. The distance to the station as a proxy for accessibility is negatively and significantly (sig. at 0.05 level) related to cap rates. The resulted sign for this variable is not in accordance with the expectation of this research. This may be explained by the fact that there are other measures to gauge the accessibility of a property, such as the distance to other public transports (bus, metro, etc.) or accessibility by car, which due the sample size was not included in the regression. As a result the explanatory power of this variable is not only minor (less than 1%), but also is not consistent with previous research expectations. The existence of asbestos in the building, as a proxy for the environmental condition, is positively and significantly (sig. at 0.05 level) associated with transaction cap rate variations. Properties with 80 Valuation accuracy in vacant office properties asbestos, required a higher cap rate (about 2%), in comparison to the ones without. This indicates the magnitude of environmental conditions influences on the perception of the risk. When year dummies are used in the transaction cap rate regression model, the value of R2 improved to .54, showing an explanatory power of independent variables of 54% (see Appendix 3). Capturing the time-series variations in cap rates, by considering the fix effect of each year on transaction cap rates, improves the fitness of the model and better explains the time-series variations in cap rates than the context variables. To be precise, the time varying variables explain about 9% of changes in transaction cap rates, which is a higher than the explanatory power of context variables (2%) in the first transaction cap rate regression model. This is while the locational dummies (Amsterdam districts) account for 30% of the variation in cap rates (the same as the first model), and property specific variables account for 15% of this variation, which is slightly lower than the first model. Nevertheless, the signs of the beta coefficients and their significance for all independent variables remain the same in both model specifications (see Table 8.8). The regression output of the appraised cap rate, with the same variable used for the transaction cap rate, shows a lower value of R2 (.40), in comparison to the transaction cap rate model. This indicates that the included variables in the regression account for 40% of the variation in appraised cap rates (see Appendix 3). Context variables (office employment and office investment ratio) used in the appraised cap rate regression model, explain 11% of the variations in cap rates. This is a higher amount in comparison to the explanatory power of these variables in the transaction cap rate model. This is while the location variables and property specific variables count respectively for 23% and 6% of the appraised cap rate variations, which are lowered when compared to their explanatory power in the transaction cap rate model. When year dummies are used in the appraised cap rate regression model, the value of R2 improved to .42, showing an explanatory power of independent variables of 42% (see Appendix 3). By considering the fixed effect of each year on appraised cap rates, the fitness of the model is improved. The time-series variables explain about 18 % of the changes in appraised cap rates, which is higher than the explanatory power of context variables (11%) in the appraised cap rate regression model with context variables. This is while the locational dummies (Amsterdam districts) account for 19% of the variation in cap rates, and property specific variables account for 5% of this variation, which is slightly lower than the first model (appraised cap rate with context variables). Nevertheless, the signs of the beta coefficients and their significance for all independent variables remain the same in both model specifications (see Table 8.9). By comparing the regression output of the transaction cap rates and appraised cap rates, it is clear that appraisers are more concerned with context (macroeconomic and financial risks), and time- series variations (year dummies) in cap rates than investors. The time-series variables explain 18 % of the changes in appraised cap rates, which is two times higher than the explanatory power of them in the transaction cap rate variations (9%). On the other hand, investors are pertained more with the magnitude and significance of the Amsterdam submarkets (city districts) on cap rates, thus cross sectional variation in cap rates. Even though the appraisers expect the same influence of Amsterdam submarkets on the cap rates, the explanatory power of these submarkets are not substantial. For instance, while the fixed effect of Chapter 8: Empirical Findings 81 Table 8.9, appraised Coefficients appraised cap rate as dependent variable cap rates, regression output Unstandardized Standardized Unstandardized Standardized Coefficients Coefficients Coefficients Coefficients B Std. Beta t Sig. B Std. Beta t Sig. Error Error (Constant) ,067 ,049 1,359 ,177 ,122 ,023 5,218 ,000 OfficeJobs ,001 ,000 ,158 1,746 ,084 OfficeInvest -,016 ,007 -,183 -2,254 ,026 DD2 ,007 ,006 ,113 1,274 ,205 ,008 ,006 ,132 1,437 ,154 DD3 ,016 ,004 ,347 4,232 ,000 ,016 ,004 ,334 3,917 ,000 DD4 ,012 ,004 ,234 2,936 ,004 ,014 ,004 ,261 3,092 ,003 DD6 ,013 ,006 ,188 2,356 ,020 ,012 ,006 ,177 2,169 ,032 DD7 -,004 ,003 -,138 -1,493 ,138 -,004 ,003 -,133 -1,385 ,169 DD8 ,014 ,006 ,302 2,472 ,015 ,015 ,006 ,324 2,564 ,012 LnLFAm2 ,000 ,001 ,035 ,437 ,663 ,000 ,001 ,043 ,517 ,607 RentR -,006 ,002 -,198 -2,407 ,018 -,004 ,003 -,144 -1,583 ,117 LnAge ,001 ,001 ,170 1,830 ,070 ,001 ,001 ,192 2,022 ,046 LnAfstDBZ_ -,004 ,003 -,174 -1,377 ,171 -,005 ,003 -,203 -1,531 ,129 IC_Station Asbest ,000 ,004 -,003 -,035 ,972 ,001 ,004 ,016 ,181 ,856 DY2004 ,002 ,004 ,057 ,511 ,610 DY2005 ,000 ,005 ,001 ,007 ,994 DY2006 -,002 ,004 -,044 -,429 ,669 DY2007 -,001 ,003 -,029 -,263 ,793 DY2009 ,009 ,004 ,252 2,330 ,022 DY2010 ,009 ,005 ,177 1,924 ,057 DY2011 ,004 ,004 ,099 1,043 ,299 the South-East district shows an increase of 4% in the cap rates (β = 0.040), appraisers are less concerned with the impact of this location on the applied cap rate (β = 0.006). The weighting method of the investors and appraisers is even more different when looking at the magnitude and explanatory power of the property specific variables. The property specific variables explain only 5% of the variation in appraised cap rates, which is three times lower than the explanatory power of them in the transaction cap rate variations (15%). For example, considering the impact of rent ratio on cap rates, investors are more forward looking and interpret the positive rent ratio as a temporary market event and expect a decrease in the rent values and their returns to their market fundamental. Whereas, appraisers are more backward looking and literally extrapolate the increase in the rent with the decrease in cap rates. Complimentary to this fact, when comparing the current appraised cap rates to the ones of the previous year (a one year lagged appraised cap rate), the coefficient of the lagged cap rates is around 0.80, which shows a substantial effect on the estimation of the appraised cap rates. This emphasizes on the existence of serial correlations and anchoring on the past in appraised based indices (appraisal smoothing). Table 8.10 and 8.11 compare the coefficients of the estimated model for transaction and appraised cap rates. 82 Valuation accuracy in vacant office properties Table 8.10, Coefficients transaction vs. Appraised cap rates with context variables comparison Transaction Cap Rates Appraised Cap Rates between transaction and B Std. Beta t Sig. B Std. Beta t Sig. appraised cap Error Error rates, regression (Constant) ,389 ,156 2,493 ,014 ,067 ,049 1,359 ,177 output with macroeconomic and OfficeJobs -,002 ,001 -,175 -2,159 ,033 ,001 ,000 ,158 1,746 ,084 financial variables OfficeInvest -,053 ,022 -,173 -2,370 ,020 -,016 ,007 -,183 -2,254 ,026 DD2 ,045 ,018 ,203 2,552 ,012 ,007 ,006 ,113 1,274 ,205 DD3 ,076 ,012 ,456 6,175 ,000 ,016 ,004 ,347 4,232 ,000 DD4 ,030 ,013 ,159 2,215 ,029 ,012 ,004 ,234 2,936 ,004 DD6 ,088 ,018 ,359 4,994 ,000 ,013 ,006 ,188 2,356 ,020 DD7 -,034 ,009 -,307 -3,706 ,000 -,004 ,003 -,138 -1,493 ,138 DD8 ,040 ,018 ,240 2,184 ,031 ,014 ,006 ,302 2,472 ,015 LnLFAm2 ,006 ,002 ,197 2,721 ,008 ,000 ,001 ,035 ,437 ,663 RentR ,031 ,008 ,296 3,999 ,000 -,006 ,002 -,198 -2,407 ,018 LnAge ,007 ,002 ,292 3,490 ,001 ,001 ,001 ,170 1,830 ,070 LnAfstDBZ_IC_Station -,021 ,010 -,247 -2,175 ,032 -,004 ,003 -,174 -1,377 ,171 Asbest ,024 ,012 ,145 1,989 ,049 ,000 ,004 -,003 -,035 ,972 Table 8.11, Coefficients transaction vs. Appraised cap rates with year dummies comparison Transaction Cap Rates Appraised Cap Rates between transaction and B Std. Beta t Sig. B Std. Beta t Sig. appraised cap rates, Error Error regression output (Constant) ,119 ,073 1,627 ,107 ,122 ,023 5,218 ,000 with year dummies DD2 ,038 ,018 ,173 2,132 ,035 ,008 ,006 ,132 1,437 ,154 DD3 ,074 ,013 ,442 5,844 ,000 ,016 ,004 ,334 3,917 ,000 DD4 ,025 ,014 ,133 1,772 ,079 ,014 ,004 ,261 3,092 ,003 DD6 ,088 ,018 ,358 4,942 ,000 ,012 ,006 ,177 2,169 ,032 DD7 -,035 ,009 -,314 -3,698 ,000 -,004 ,003 -,133 -1,385 ,169 DD8 ,035 ,019 ,207 1,841 ,069 ,015 ,006 ,324 2,564 ,012 LnLFAm2 ,007 ,002 ,209 2,801 ,006 ,000 ,001 ,043 ,517 ,607 RentR ,028 ,008 ,272 3,367 ,001 -,004 ,003 -,144 -1,583 ,117 LnAge ,007 ,002 ,273 3,247 ,002 ,001 ,001 ,192 2,022 ,046 LnAfstDBZ_IC_Station -,020 ,010 -,238 -2,024 ,046 -,005 ,003 -,203 -1,531 ,129 Asbest ,023 ,013 ,139 1,809 ,073 ,001 ,004 ,016 ,181 ,856 DY2004 ,025 ,013 ,191 1,918 ,058 ,002 ,004 ,057 ,511 ,610 DY2005 ,009 ,014 ,053 ,613 ,541 ,000 ,005 ,001 ,007 ,994 DY2006 -,011 ,012 -,082 -,911 ,364 -,002 ,004 -,044 -,429 ,669 DY2007 -,010 ,011 -,094 -,960 ,340 -,001 ,003 -,029 -,263 ,793 DY2009 -,008 ,012 -,069 -,720 ,473 ,009 ,004 ,252 2,330 ,022 DY2010 -,010 ,014 -,056 -,691 ,491 ,009 ,005 ,177 1,924 ,057 DY2011 ,008 ,013 ,051 ,612 ,542 ,004 ,004 ,099 1,043 ,299 Chapter 8: Empirical Findings 83 Essentially, when determining cap rates, appraisers put more weight on the cap rate variations over time, as well as what happened in the past, whereas investors are more concerned with the cross- sectional variation (different submarkets in Amsterdam), and are pertained with the mean reversion process of the financial and growth variables (e.g. rent ratio). However, the results are not consistent with the previous research in the other countries, where transaction cap rates vary strongly by macro and time-series variables. Location, location and location seems to be a valid statement and the most influential factor in determining cap rates for the investors in the Amsterdam office market. Figure 8.9 shows the comparison of the explanatory power of context, location, and property related variables, respectively for transaction and appraised cap rates, when added to the regression model. Whereas, Figure 8.10 compares the explanatory power of year dummies (as proxies for time series Hypothesisvariations) between 2 | Forward transaction looking and appraisedinvestors cap vs. rates. backwardHypothesis looking 2 | appraisersForward looking investors vs. backward looking appraisers Figure 8.9, (left) explanatory power RTP RV RTP RV of context, location and property step 1 2%< 11% step 1 Year dummies 9%< 18% specific variables respectively in transaction and appraised cap rates 30% 23% 30% 19% regression step 2 > step 2 > Figure 8.10, (right) explanatory power of year dummies, location step 3 19%> 6% step 3 15%> 5% and property specific variables respectively in 2 2 transaction and R 51% 40% R 54% 40% appraised cap rates 20 21 regression 8.4 Hypothesis 3 | Structural vacancy as a Paradoxical phenomenon The result of the test shows a paradoxical phenomenon, which could not confirm the hypothesis 3. When the property is categorized as structural vacant, the differences between the appraised cap rates and those of transactions decreases (both directional and absolute differences), in comparison to the situation when a property has a market conformed vacancy level. This shows that when there is structural vacancy risk, both appraisers and investors weighted the vacancy risk roughly the same, but when it was market conformed vacancy ratio the appraisers put less emphasis on the vacancy and the differences becomes greater. Figure 8.11 illustrates the linear trend of the mean in directional differences and Figure 8.12 shows the linear trend of the mean in absolute differences in cap rates compared to the subgroups of vacancy risk variable. As mentioned in §8.3, this can be explained by the fact that, the base assumptions in determining the assessed value in the Netherlands is that the property should be valued as if vacant. An extra risk will only incorporate the calculation of the WOZ-value, when there is a high structural vacancy in a neighborhood. This can explain that when there is a structural vacancy level (since the appraisers should not follow the friction of appraising as if vacant), the differences between the appraised and transaction cap rates are reduced. 84 Valuation accuracy in vacant office properties In general, the result of this test is not statistically significant, due to the unbalanced distribution of the samples in each vacancy risk category. Neither the Post hoc test records any significant mean variances of cap rates differences among the different vacancy risk categories of market conformed, potential structural, and structural vacancy risks. Table 8.12 summarizes the mean differences in directional and absolute cap rate differences compared to different categories of vacancy risk. ,00 ,70 ,60 -,20 ,50 -,40 ,40 Mean of DifferencesAbsoluteCaps Mean of DifferencesDirectionalCaps -,60 ,30 Market conformed Potential structural structural Market conformed Potential structural structural VacancyVacancyRisk Risk VacancyVacancyRisk Risk Figure 8.11, the linear trend of the mean in cap rate directional Figure 8.12, the linear trend of the mean in cap rate absolute differences compared to vacancy risks differences compared to vacancy risks Directional differences vs. vacancy risks Table 8.12, the 95% Confidence mean differences Interval for Mean in directional and Vacancy Risks N Mean Std. Std. Error Lower Upper Minimum Maximum absolute differences Deviation Bound Bound compared to different categories Market conformed 115 -37,8% 44,2% 4,1% -46,0% -29,7% -96,8% 155,2% of vacancy risk Page 1 Potential structural 3 -64,5% 14,4% 8,3% -100,3% -28,8% -81,1% -55,6% Page 1 Structural 3 -9,6% 49,7% 28,7% -133,0% 113,9% -66,3% 26,5% Total 121 -37,8% 44,0% 4,0% -45,7% -29,9% -96,8% 155,2% Absolute differences vs. vacancy risks 95% Confidence Interval for Mean Vacancy Risks N Mean Std. Std. Error Lower Upper Minimum Maximum Deviation Bound Bound Market conformed 115 51,6% 26,6% 2,5% 46,7% 56,6% 2,7% 155,2% Potential structural 3 64,5% 14,4% 8,3% 28,8% 100,3% 55,6% 81,1% Structural 3 34,6% 28,5% 16,5% -36,2% 105,4% 11,0% 66,3% Total 121 51,5% 26,5% 2,4% 46,8% 56,3% 2,7% 155,2% Part IV: conclusions Chapter 9: Conclusion Chapter 10: recommendation for further research 9 Conclusion Chapter 9: Conclusion 87 Chapter 9: Conclusion This research examines the main cap rate determinants for the Amsterdam office market, for appraisers and investors respectively. Furthermore, it measures the differences between the appraised and transaction cap rates in order to gauge whether their differences are caused by variations in vacancy rate, or whether they are due to differences in the pricing mechanism between appraisers and investors. This chapter addresses the main findings of this research by answering the two main research questions: 1. To what extent do appraised cap rates correspond with transaction cap rates? 2. Can the differences between appraised cap rates and transaction cap ratesbe explained (partly) by structural vacancy risk? These questions are answered based on four major themes: cap rate determinants, valuation accuracy, the variation in pricing mechanism of appraisers and investors, and valuation accuracy of vacant office properties. 9.1 Cap rate determinants, the applicability of the new dynamic Cap rate model Literature on cap rate determinants show a trend from the dominancy of macro economic and time-series variations in cap rates, towards the state where micro-level and property-specific factors become more prominent in explaining the driving forces of cap rates. Due to an increase of the investors’ awareness and interest in the quality and characteristics of properties within investment funds, and also the development of ‘Big Data’ and availability of large volumes of information (structured and/or unstructured) regarding the property characteristics, this thesis introduces a more dynamic and applicable model specification to determine cap rates. This model decompounds the risk premium component achieved on investing in office market, to location, the property-itself and the user (office-user) attributes. Furthermore, it develops these components by categorizing them into background context, location, property, and office-users determinants of cap rates. This model includes not only macro-economic, time varies and cross sectional variation in cap rates, but also transforms a partly qualitative investment decision-making procedure and assessment of office properties to a more objective and quantitative method, by including variables pertaining the property itself (property-specific characteristics) and elements that are associated with the office- users (tenants). This provides a better specification of the risk premium achieved for office real estate which leads to more careful measuring of the risk associated with an investment, especially in the problematic situation of the Dutch office market. In addition, this research defines and measures the specific vacancy risk, as one of the major problems in the Dutch market, by considering the vacancy rate at the property level relative to its direct surroundings. This enables assessing the value of the vacant properties based on the different vacancy risk associated with the property introduced in this thesis, namely market conformed, potential structural and structural vacancy risk. This provides a comprehensive tool for investors as well as appraisers to determine and estimate cap rates, in a more objective and quantitative process, specifically regarding the estimation of the vacancy risk. This is contrary to the current qualitative assessment of the risk, to determine the 88 Valuation accuracy in vacant office properties property value which is prone to some degree of uncertainty, and leads to an inaccuracy in valuation. 9.2 valuation accuracy The findings from this research emphasize on consistently overstated and smoothed appraised cap rates in the Amsterdam office market from 2004 till 2011, compared to the transaction cap rates. The transaction cap rates are on average lower and more volatile compared to appraised cap rates. This indicates that appraised cap rates (WOZ-values), are understating the property values compared to their actual market value (transaction prices). An average deviation of 50% is the result of the differences between appraised cap rates and the transaction cap rates, which corresponds with the same deviation between appraisal value and transaction prices. These differences can be explained by the fact that the used data are the appraisal data for the tax purposes, and not for the commercial purposes (sale or finance). Even though this amount should correspond with the fair market value of the property, there are many restrictions (fictions) related to the tax appraisal such as the fiction of a property being appraised as if vacant, which is far from reality in many cases. Finally, there is also various evidence of a mismatch between the developments of transaction cap rates versus aggregated cap rates reported by real estate agencies. Even though the overall development of these cap rates are the same, transaction cap rates are more volatile while the aggregated cap rates reported by real estate agencies are smoothed. This emphasizes on the fact that appraisal indices do not completely record the true volatility of the office market through time. 9.3 appraised cap rates versus transaction cap rates By comparing the regression output of the transaction cap rates and appraised cap rates, it is clear that appraisers are more concerned with context (macroeconomic and financial risks), and time- series variation (year dummies) in cap rates. Whereas investors are more concerned with cross- sectional and micro-level and property related variations in cap rates. The empirical results of this research based on context, location and property indicate that location is a key factor in determining cap rates in the Amsterdam office market. Cap rates vary persistently across markets due to differences in fixed market characteristics which influence the perception of investors in predicting the rental growth and associated risk. Nevertheless, the magnitude and significance of the Amsterdam submarkets (city districts) on cap rates are higher for the investors, compared to appraisers. Regarding the property related variables, cap rates consist of components which are shaped by historical trends in rental growth in the Amsterdam submarkets. These relationships with historical trends indicate that appraisers strongly rely on past evidence in the market, rather than having a forward looking perspective. This phenomenon is consistent with the arguments regarding anchoring behavior of appraisers. On the other hand, investors consider the mean reversion of real rents in their rental growth expectation, since they use higher cap rates when compared to rental cyclical peaks. These all indicate that appraisers are prominently more backward looking, and more concerned with changes in macroeconomics and time varying aspects, whereas investors are more forward looking, and pay close attention to the submarket within the Amsterdam office market. Chapter 9: Conclusion 89 9.4 myth of vacancy and accuracy The differences between appraised cap rates and transaction cap rates have a negative correlation to its vacancy risks, namely market conformed, potential structural, and structural vacancy risk. The empirical results show that when there is structural vacancy level, both appraisers and investors weighted the vacancy risk similarly. Whereas, when there is a market conformed vacancy ratio, the appraisers put less emphasis on the vacancy risk and the differences becomes greater. The reliability of the statistical results are very low. Since less than 5% of the transactions studied, contain properties with a potential structural vacancy risk or structural vacancy risk. 9.5 overall conclusion The research findings indicate a transaction-valuation difference in cap rates as well as contributing factors to these differences. The transaction cap rates are determined by mostly the location and property related variables, whereas macroeconomic and context variables determine the appraised cap rates vastly in the Amsterdam Office market. It also shows that selling an office building, being structurally vacant, seems to be an exceptional situation in the Amsterdam office market. Since there are not that many of these being sold in Amsterdam. One can interpret this as a possibility of asking a higher value than an investor is willing to pay. Unfortunately, no concrete conclusion can be made due to the lack of market evidence and available data to further investigate this phenomenon. recommendation 10 for further research Chapter 10: recommendation for further research 91 Chapter 10: recommendation for further research Based upon the results of this study this chapter focuses on a couple of suggestions and recommendations for future research. In order to improve the degree of comparability between transaction and appraised cap rates, further research can be done while using appraised value for the commercial purposes (sale or finance), rather the WOZ values which are appraised for tax purposes. The use of transaction cap rates which are not calculated ex-post, can reduce the number of assumptions to estimate the transaction cap rates. This can lead to better research results, since it enhances the objectivity and reduces biases. 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Appendices Article 1 Article 2 author/authors Froland Ambrose and Nourse country U.S. U.S. publication year 1987 1993 ACLI dataset from 1970 to 1986 for apartments, retail, office, ACLI dataset for commercial and industrial properteis from dataset and industrial properties 1966 to 1988 Appendices 97 transaction-based or appraisal-based transaction-base transaction-base data methodology literature Seemingly Uncorrelated Regression and cross-sectional/time appendixresearch technique 1 - cap rate determinantsmultiple regression model per (stepwise reviewed regression appr articoach) le series (panel data) regression Article 1 Article 2 ● positive effect macroauthor/authors level variables Froland indicator/description time-seriesAmbrose cross-sectional and Nourse indicator/description time-series cross-sectional ● negative effect country U.S. U.S. the spread between long-term and short- the spread between long-term and short- ● tested and significant publication year 1987 1993 inflation expectation term government bond rates ● term government bond rates ● ○ tested but not significant ACLI dataset from 1970 to 1986 for apartments, retail, office, ACLI dataset for commercial and industrial properteis from mortgagedataset rate and industrial properties ● 1966 to 1988 the S&P 500 transaction-based or appraisal-based earnings/price ratio transaction-base ● transaction-base ● data methodology literature Seemingly Uncorrelated Regression and cross-sectional/time research technique multiple regression model (stepwise regression approach) series (panel data) regression GDP ● positive effect macro level variables indicator/description time-series cross-sectional indicator/description time-series cross-sectional ● negative effect the percentage change in real Gross ● tested and significant the spread between long-term and short- the spread between long-term and short- GNPinflation expectation ● ○ ● ○ tested but not significant term governmentNational bond Product rates term government bond rates capacitymortgage utilization rate ● ● national vacancy rate the S&P 500 vacancyearnings/price rate ratio ● ● ● average loan to value (LTV) debt-to-equityGDP ● property mortgage costs cost of debt the percentage change in real Gross ● ○ GNP National Product debt to GDP ratio capacity utilization ● national vacancy rate debtvacancy spread rate ● debt-to-equity average loan to value (LTV) ● laggedcost of debt spread property mortgage costs ● debt to GDP ratio equity spread debt spread laggedlagged debtequity spread spread expectedequity spread NOI growth rate market rent lagged equity spread rentexpected ratio NOI growth rate market rent rent ratio risk-free rate caprisk-free rate rate cap rate north- south- east location dummies ○ north- south- east location dummies ○ rating for the macro location rating for the macro location marketmarket risk/riskrisk/risk premium premium determinants rate cap of determinants rate cap of changechange inin financial financial employment employment micromicro level variables variables indicatorindicator time-series cross-sectionaltime-seriesindicatorcross-sectional indicator time-series cross-sectional time-series cross-sectional class A building class A building condition of the property conditionconstruction of quality the property constructionage of the building quality agenew of dummy the building newrenovation dummy dummy occupancy rate renovationbuilding size dummy occupancyparking dummy rate price per square meter building size date of sale parking dummy easement dummy price per square meter dateground of leasesale dummy easementrent ratio dummy ground lease dummy vacancy gap rentland ratioleverage auction dummy vacancy gap other off market dummy land leverage auctiontenant diversification dummy tenant risk illiquidity risk volume 1 other off market dummy illiquidity risk volume 2 rating for the micro location tenantoperating diversification costs remaining lease term tenant risk illiquidity risk volume 1 illiquidity risk volume 2 rating for the micro location operating costs remaining lease term Article 1 Article 2 author/authors Froland Ambrose and Nourse country U.S. U.S. publication year 1987 1993 ACLI dataset from 1970 to 1986 for apartments, retail, office, ACLI dataset for commercial and industrial properteis from dataset and industrial properties 1966 to 1988 98 Valuation accuracy in vacant office properties transaction-based or appraisal-based transaction-base transaction-base data methodology literature Seemingly Uncorrelated Regression and cross-sectional/time research technique multiple regression model (stepwise regression approach) series (panel data) regression Article 3 Article 4 ● positive effect author/authors Jud and Winkler Sivitanides, Southard, Torto, and Wheaton macro level variables indicator/description time-series cross-sectional indicator/description time-series cross-sectional country U.S. U.S. ● negative effect the spread between long-term and short- the spread between long-term and short- publication year 1995 2001 ● tested and significant inflation expectation term government bond rates ● term government bond rates ● National Real Estate Index (NREI) panel data for office, NCREIF Property Index for several property type ○ tested but not significant dataset warehouse/distribution, retail, and apartment properties mortgage rate ● the S&P 500 transaction-based or appraisal-based appraisal-based appraisal-based earnings/price ratio ● ● data methodology literature research technique multiple regression model Time-Series Cross-Section (TSCS) regression model GDP ● positive effect macro level variables indicator time-series cross-sectional indicator time-series cross-sectional ● negative effect the percentage change in real Gross ● tested and significant Annual percent change in consumer price inflation expectation ● GNP ○ ○ tested but not significant index (CPI) National Product mortgage rate capacity utilization ● national vacancy rate earnings/price ratio vacancy rate ● average loan to value (LTV) GDP debt-to-equity ● cost of debt property mortgage costs ● GNP debt to GDP ratio capacity utilization vacancy rate debt spread debt-to-equity cost of debt lagged debt spread debt to GDP ratio the return on BAA-rated debt minus the equity spread debt spread risk free rent ● the return on BAA-rated debt minus the lagged debt spread risk free rent, lagged respectively 1 and 2 ● ● lagged equity spread periods the total return on the S&P 500 Index ● equity spread minus risk free rent expected NOI growth rate the total return on the S&P 500 Index market rent lagged equity spread minus risk free rent lagged respectively 1 ● ● and 2 periods ● expected NOI growth rate rent ratio market rent in two forms: Metropolitan-specific real rent index and also Annual percent rent ratio change in the metropolitan- specific real ● ● rent index risk-free rate Government Bond Return Rate risk-free rate ● cap rate Logarithm of the annual capitalization cap rate rate calculated as the ratio of the NOI ● north- south- east over the ending value location dummies ○ MSA dummies - fixed effect for each ● ●● location dummies market rating for the macro location rating for the macro location market risk/risk premium market risk/risk premium determinants rate cap of determinants rate cap of change in financial employment change in financial employment micro level variables indicator time-series cross-sectional indicator time-series cross-sectional micro level variables indicator time-series cross-sectional indicator time-series cross-sectional class A building class A building condition of the property construction quality condition of the property age of the building construction quality new dummy age of the building renovation dummy occupancy rate new dummy building size renovation dummy parking dummy occupancy rate price per square meter date of sale building size parking dummy easement dummy price per square meter ground lease dummy date of sale rent ratio easement dummy ground lease dummy vacancy gap land leverage rent ratio auction dummy vacancy gap other off market dummy land leverage tenant diversification auction dummy tenant risk illiquidity risk volume 1 other off market dummy illiquidity risk volume 2 rating for the micro location operating costs tenant diversification remaining lease term tenant risk illiquidity risk volume 1 illiquidity risk volume 2 rating for the micro location operating costs remaining lease term Article 1 Article 2 author/authors Froland Ambrose and Nourse country U.S. U.S. publication year 1987 1993 ACLI dataset from 1970 to 1986 for apartments, retail, office, ACLI dataset for commercial and industrial properteis from dataset and industrial properties 1966 to 1988 Appendices 99 transaction-based or appraisal-based transaction-base transaction-base data methodology literature Seemingly Uncorrelated Regression and cross-sectional/time research technique multiple regression model (stepwise regression approach) series (panel data) regression Article 5 Article 5 ● positive effect macroauthor/authors level variables Verhaeghindicator/description time-seriesVan cross-sectionalNorren indicator/description time-series cross-sectional ● negative effect country The Netherlands The Netherlands ● tested and significant the spread between long-term and short- the spread between long-term and short- inflationpublication expectation year 2005 ● 2007 ● ○ tested but not significant ROZ / IPDterm Property government Index bond rates - term government bond rates mortgagedataset rate ● the S&P 500 transaction-based or appraisal-based earnings/price ratio appraisal-based ● ● data methodology literature multiple regression model with gross initial yield (GIY) as the research technique multiple regression model dependent variable ● positive effect GDPmacro level variables indicator time-series cross-sectional indicator time-series cross-sectional ● negative effect ● tested and significant the percentage change in real Gross GNPinflation expectation ○ ● ○ tested but not significant National Product capacitymortgage utilization rate ● national vacancy rate vacancyearnings/price rate ratio ● debt-to-equityGDP average loan to ●value (LTV) ● cost of debt property mortgage costs ● GNP debtcapacity to GDPutilization ratio in an absolute term debtvacancy spread rate ●● debt-to-equity laggedcost of debt spread debt to GDP ratio equitydebt spread spread laggedlagged debtequity spread spread expectedequity spread NOI growth rate market rent lagged equity spread expected NOI growth rate rentmarket ratio rent ● rent ratio ● ● risk-free rate risk-free rate ● cap rate cap rate north- south- east● location dummies ○ location dummies ●● rating for the macro location rating for the macro location marketmarket risk/riskrisk/risk premium premium determinants rate cap of determinants rate cap of changechange inin financial financial employment employment micromicro level variables variables indicatorindicator time-series cross-sectionaltime-seriesindicatorcross-sectional indicator time-series cross-sectional time-series cross-sectional class A building class A building condition of the property conditionconstruction of quality the property constructionage of the building quality ● agenew of dummy the building renovation dummy newoccupancy dummy rate renovationbuilding size dummy occupancyparking dummy rate price per square meter buildingdate of sale size parking dummy easement dummy price per square meter ground lease dummy date of sale rent ratio ● easement dummy ground lease dummy vacancy gap rentland ratioleverage auction dummy vacancy gap other off market dummy land leverage auctiontenant diversification dummy tenant risk illiquidity risk volume 1 otherilliquidity off riskmarket volume dummy 2 rating for the micro location tenantoperating diversification costs ● remaining lease term ● tenant risk illiquidity risk volume 1 illiquidity risk volume 2 rating for the micro location operating costs remaining lease term Article 1 Article 2 author/authors Froland Ambrose and Nourse country U.S. U.S. publication year 1987 1993 ACLI dataset from 1970 to 1986 for apartments, retail, office, ACLI dataset for commercial and industrial properteis from dataset and industrial properties 1966 to 1988 100 Valuation accuracy in vacant office properties transaction-based or appraisal-based transaction-base transaction-base data methodology literature Seemingly Uncorrelated Regression and cross-sectional/time research technique multiple regression model (stepwise regression approach) series (panel data) regression Article 6 Article 67 ● positive effect author/authors McDonald and Dermisi Netzell macro level variables indicator/description time-series cross-sectional indicator/description time-series cross-sectional country U.S. Sweden ● negative effect the spread between long-term and short- the spread between long-term and short- publication year 2008 2009 ● tested and significant inflation expectation term government bond rates ● term government bond rates ● 132 office sales in downtown Chicago from 1996 to 2007 3022 discounted cash flow market valuations of office ○ tested but not significant dataset properties in Stockholm, Gothenburg and Malmö during 1998- mortgage rate ● 2004 the S&P 500 transaction-based or appraisal-based transaction-based appraisal-based earnings/price ratio ● ● data methodology literature research technique multiple regression model ANOVA and Feasible Generalized Least Square (FGLS) estimator GDP ● positive effect macro level variables indicator time-series cross-sectional indicator time-series cross-sectional ● negative effect the percentage change in real Gross ● tested and significant inflation expectation GNP ○ ○ tested but not significant National Product mortgage rate ○ capacity utilization ● national vacancy rate earnings/price ratio vacancy rate ● average loan to value (LTV) ● GDP debt-to-equity cost of debt property mortgage costs ● GNP debt to GDP ratio capacity utilization ∆ Vacancy rate (the change in the vacancy gap - the deviation of current vacancy rate downtown Chicago vacancy rate) ●●vacancy and long-run vacancy per ●● debt spread segment and year debt-to-equity cost of debt lagged debt spread debt to GDP ratio equity spread debt spread lagged debt spread lagged equity spread equity spread expected NOI growth rate market rent lagged equity spread expected NOI growth rate rent ratio market rent the deviation of current rent from the market rent per segment and year rent ratio ● ● risk-free rate 3-month Treasury bill rate for the quarter The government bond real earnings on risk-free rate in which the building was sold ● stock index ● cap rate cap rate north- south- east location dummies ○ location dummies rating for the macro location 3 different cities rating for the macro location ●● expected rate of return for the entire The government bond rate earnings per market risk/risk premium market risk/risk premium capital market (S&P 500) - the risk-free ● share ● determinants rate cap of determinants rate cap of interest rate change in financial employment the growth in office employment ● change in financial employment micro level variables indicator time-series cross-sectional indicator time-series cross-sectional micro level variables indicator time-series cross-sectional indicator time-series cross-sectional A or B (e.g. the buildings with the most up- class A building to-date facilities is A, otherwise is B) ● class A building condition of the property construction quality condition of the property age of the building ● different effect on different submarkets ○/● construction quality new dummy age of the building renovation dummy (Age x renovated) ● new dummy occupancy rate occupancy rate with in the building ○ building size ○ renovation dummy parking dummy parking in building ○ occupancy rate price per square meter ○ building size date of sale ○ parking dummy easement dummy price per square meter ground lease dummy ● date of sale the difference between the rent ratio for rent ratio an individual property and the rent ratio ● easement dummy per segment and year the difference between the vacancy gap ground lease dummy vacancy gap for an individual property and the ● vacancy gap per segment and year rent ratio land leverage auction dummy vacancy gap other off market dummy land leverage auction dummy tenant diversification tenant risk illiquidity risk volume 1 other off market dummy illiquidity risk volume 2 three segments including CBD, central ● rating for the micro location and other operating costs tenant diversification remaining lease term tenant risk illiquidity risk volume 1 illiquidity risk volume 2 rating for the micro location operating costs remaining lease term Article 1 Article 2 author/authors Froland Ambrose and Nourse country U.S. U.S. publication year 1987 1993 ACLI dataset from 1970 to 1986 for apartments, retail, office, ACLI dataset for commercial and industrial properteis from dataset and industrial properties 1966 to 1988 Appendices 101 transaction-based or appraisal-based transaction-base transaction-base data methodology literature Seemingly Uncorrelated Regression and cross-sectional/time research technique multiple regression model (stepwise regression approach) series (panel data) regression Article 8 Article 9 ● positive effect macroauthor/authors level variables Chervachidzeindicator/description and Wheaton time-seriesHoesli cross-sectional and Chaney indicator/description time-series cross-sectional ● negative effect country U.S. Switzerland the spread between long-term and short- the spread between long-term and short- ● tested and significant publication year 2013 2014 inflation expectation term government bond rates ● term government bond rates ● ○ tested but not significant NCREIF Property Index IAZI database for the period between 1985 to 2010 mortgagedataset rate ● the S&P 500 transaction-based or appraisal-based earnings/price ratio appraisal-based ● both transaction-based and appraisal-based ● data methodology literature The fixed effects panel technique with ordinary least squares multiple regression considering the logarithm of cap rates as research technique (OLS) estimators dependent variable GDP ● positive effect macro level variables indicator time-series cross-sectional indicator time-series cross-sectional ● negative effect the percentage change in real Gross ● tested and significant GNPinflation expectation ○ ○ tested but not significant National Product capacitymortgage utilization rate ● national vacancy rate Shiller P/E-ratio of the S&P 500 defined as the current price to the average vacancyearnings/price rate ratio ● inflation-adjusted earnings from the past ● ten years. As a proxy for growth rate definedaverage as loan to value (LTV) debt-to-equity ● ● GDP Growth in nominal GDP cost of debt property mortgage costs ● GNP debt to GDP ratio capacity utilization Vacancy rate of the municipality in which debtvacancy spread rate the property is located ●● debt-to-equity laggedcost of debt spread the growth in the ● debt to GDP ratio debt as a fraction of GDP equity spread the spread between the Moody’s AAA debt spread yield and the 10 year Treasury bond ● laggedlagged debtequity spread spread expectedequity spread NOI growth rate market rent lagged equity spread rentexpected ratio NOI growth rate market rent Log(Real Rent ratio) calculated as a ratio Rent relative to median rent of real rent data from CBRE rent database rent ratio for a given MSA in a given quarter to the ● ● ● risk-free rate historical average of real rent for this MSA Real T-Bond yield calculated as nominal ten-year government bonds caprisk-free rate rate yield minus inflation rate ● ● Logarithm of the annual capitalization cap rate rate NCREIF database calculated from Net ● north- south- east location dummies Operating Income and asset values. ○ MSA dummies - fixed effect for each used to capture variation in α (fixed effect ●● ●● location dummies market per each market) rating for the macro location from Bad to Very Good as an indication rating for the macro location for risk premium and growth ● marketmarket risk/riskrisk/risk premium premium determinants rate cap of determinants rate cap of changechange inin financial financial employment employment micromicro level variables variables indicatorindicator time-series cross-sectionaltime-seriesindicatorcross-sectional indicator time-series cross-sectional time-series cross-sectional class A building class A building condition of the property 1: Bad to 4: Very Good ● conditionconstruction of quality the property 1: Bad to 4: Very Good ● constructionage of the building quality Ln (Age) ● new building consider when it is not older ● agenew of dummy the building than two years newrenovation dummy dummy when the property has been refurbished ● occupancy rate ● renovationbuilding size dummy occupancyparking dummy rate price per square meter buildingdate of sale size parking dummy a non-possessory right to use and/or easement dummy ● price per square meter enter onto the real property of another ground lease dummy ● date of sale Rent relative to median rent easementrent ratio dummy ● ground lease dummy vacancy gap rentland ratioleverage measured as Ln (volume/lot size) ● auction dummy a force sale ● whenever the transaction was vacancy gap neither an auction nor done at arm's other off market dummy length, i.e. when the sale was e.g. in ● relation with a related land leverage legal entity or to a family member Percentage of rents from commercial auction dummy ● tenant diversification tenants (Mixed used complex) tenant risk average tenant quality (residential) ● illiquidity risk volume 1 Ln (volume) ● other off market dummy Centered square of lVol to capture ● illiquidity risk volume 2 potential nonlinearity the location within the macro location - ● rating for the micro location Bad to Very Good tenantoperating diversification costs remaining lease term tenant risk illiquidity risk volume 1 illiquidity risk volume 2 rating for the micro location operating costs remaining lease term Where; = premium from participation in real estate, = premium on location attributes, = premium on property-itself attributes, = premium on property-user attributes. = + ∗ − + 1 − ∗ + → = + ∗ − + 1 − ∗ + + + = + + + (16) = – → = + ∗ − + 1 − ∗ + + + − = + ∗ − + 1 − ∗ + + + (17) Where; = risk free rate, = Loan-to-value ratio, = rate of return on debt, 102 ⁄ Valuation accuracy in vacant office properties = premium from participation in real estate, = premium on location attributes, appendix 2 - Transaction cap rate Calculating models = premium on property-itself attributes, = premium on property-user attributes, In total four model based on two main methods of pure cap rates (basic capitalization methods), = a constant expected rate of growth in the NOI. and cap rates with corrections (conventional method), are used to calculated the transaction cap rates. The first model (Model 1), is explained thoroughly in Chapter 7, § 7.2.2. Figure i shows the calculating model of pure cap rates. As mentioned in Chapter 7, § 7.2.2, this model uses the ERV (18) (Effective Rental Value) based on firstly, the availability of ERVs of a property, or it calculates it based on theWhere; average=+ effective∑ rents of+ ∑rental transactions +∑ in the radius of+ 500∑ m, 1000 m around + the = constant or intercept term, property, = the or coefficientaverage effectiveof variables rentsindicating per context, Amsterdam location, district property at and the office selling users time, factors, when no actual rental transactionsα = the error were term. present for specific properties. The second model (Model 2), uses the same pure cap rateε model where all the risk associated with the investment are reflected in the cap rate and are not imposed as secondary correction. However the differences between Model 1 and (19)Model 1 2 is related to differences in the input for the ERVs. Model 2 uses merely the average ERVs per Where; = Amsterdam= Appraised district cap at rate the (%), selling time to calculate the TRI (Total Rental Income). Both cap rates for = net income multiplier. Model 1 and Model 2 are based on the following equation: (20)(20) = Where; = overall capitalization rate (%), = property value (gross transaction price), = Net Operating Income in the first year. The third model (Model 3) and the fourth model (Model 4) are based on the conventional model that calculates the cap rates by considering corrections on the actual transaction price as shown in equation i (see also Figure ii): DIRECT INCOME CAPITALIZATION Figure i, the Property type: Office calculating model of pure cap rates (all risks included in cap rates) Gross rental value Effective Rent Value Market Rent Value SaleID# ObjectID# size (m² LFA) (ERV) (€/m² LFA) (€/m² LFA) 60 ## 1835 87 87 Total Rental Income (TRI) € 159.645 Net rental value Operating Expenses Ratio (OER) of TRI 10,0% Net Operating Income (NOI) € 143.681 Capitalization (Cap) rate (NIY) 1 Cap rate (NIY) 11,8% 2 Net Transaction Price to Gross Transaction Price Value including KK € 1.217.135 Transfer tax and legal fees (KK %) 6,3% Value excluding purchase costs € 1.145.000 Where; = overall capitalization rate (%), = property value (gross transaction price), Appendices = Net Operating Income in the first year. 103 (i) (i) = Where; = overall capitalization rate (%), = property value (gross transaction price), = Net Operating Income in the first year. In fact the realized transaction price is transformed by the following equation: (ii) Gross transaction price (TP) () = ∑ Where,Corrected Gross Transaction Price = (Net transaction price + Correction for KK%)+ ToMCorrection = time for a propertyfor difference to be let, between actual rent (ERV) and market rent + Corrections for n = the number of WOZ-objects in one neighborhood. vacancy and its related costs + Correction for overdue maintenance Correction for KK%: This correction, which is transferring the realized transaction price to the gross transaction price by 1 8 correcting for transfer tax and legal fees, is explained = thoroughly 3,1,4 = in §= 7.2.2. 2.6 3 3 Correction for the difference between actual rent (ERV) and market rent + Corrections for vacancy (iii) and its related costs These corrections = ( are ∗ categorized) ∗ ∗under 1.16 3 conditions: current building has no vacancy, is partially Where; vacant, or= overallis structurally cost of vacancy vacant. (€), The second one (partially vacant) is not valid for the used database, since all the= total transaction lettable floor sales area (mare2), those with a single tenant and a single owner (the tax units used by = effective rental value, the municipality = the length to of calculate the void period the (year).WOZ-values). Therefore, in this part the two conditions of whether the property is completely vacant or fully occupied are discussed as follows: Figure ii, main steps of calculating transaction cap rates for model 3 and 4 104 Valuation accuracy in vacant office properties - No vacancy In the case of a non-vacant object, three correction entries are made. The first one calculates the difference between present value of actual rent (ERV) and market rent (average ERVs in the 500m radius), of the remaining income till the end of the lease contract. The second one calculates the present value of income loss due to the vacancy, by considering first, the length of the void period in the direct neighborhood of the property and second the year in which the vacancy occurs. The third one corrects for additional vacancy costs which contain costs for marketing and letting commission. Based on the market evidence, the costs for marketing and letting commission are calculated as 16% of the total vacancy costs. Since in this thesis the total rental income is calculated using the effective rent, the incentives are already incorporated in the rent, and no incentive correction is needed. - Structurally vacant In the case of a structurally vacant object, two correction entries regarding vacancy are made. The first one calculates the present value of income loss due to the vacancy, by considering the length of the void period in the property’s direct neighborhood. The second one corrects for additional vacancy costs of marketing and letting commission (16%). To avoid complexity and subjectivity (bias) of using DCF to calculate the NPV of the remaining lease term (due to the lack of data regarding the investors discounted rate), a shortcut formula is used with an assumption of no growth in property rent and value (the concept of cash flow in perpetuity). Therefore, the correction for both the difference between actual rent (ERV) and market rent, and incomeWhere; loss due to the vacancy are not discounted to the NPV and assumed to occur in the first year. = overall capitalization rate (%), = property value (gross transaction price), However, = theNet Operatinglength of Income the void in the periods first year. are calculated precisely as explained in the next paragraphs. Calculating Void period In order to measure the potential income loss due to the vacancy, the average void period in the (i) direct neighborhood of the WOZ-objects are calculated at the selling time. The void period is the = expected period that a property remains vacant and generates no rental income. To measure that, the lengthWhere; of the average Time on Market (ToM) from the time that a property becomes vacant till = overall capitalization rate (%), it is let =again, property over value a (gross specific transaction period price), of 5 years, is calculated. This is estimated based on equation (ii), using = theNet Operatingregistered Income tax in vacant the first codes year. of the WOZ-objects per neighborhood, where no rental income for the WOZ-objects were registered to be taxed. (ii) (ii) () = ∑ Where, ToM = time for a property to be let, n = the number of WOZ-objects in one neighborhood. Table i, an example Object# 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 to explain how the 1 X X 0 0 0 X X X X X 0 X X void periods are 2 X X X 0 X X 1X X X8 X X X X calculated = 3,1,4 = = 2.6 3 X 0 0 0 0 X 3X X X3 X 0 0 0 X=Occupied, 0=vacant (iii) = ( ∗ ) ∗ ∗ 1.16 Where; = overall cost of vacancy (€), = total lettable floor area (m2), = effective rental value, = the length of the void period (year). Where; = overall capitalization rate (%), = property value (gross transaction price), = Net Operating Income in the first year. Where; = overall capitalization rate (%), = property value (gross transaction price), (i) = Net Operating Income in the first year. = Where; = overall capitalization rate (%), (i) = property value (gross transaction price), = Net Operating Income in the first year. = Where; = overall capitalization rate (%), Appendices= property value (gross transaction price), (ii) 105 = Net Operating Income in the first year. () = ∑ Where, ToM = time for a property to be let, For example when a property is sold in 2006, the average void period for that specific neighborhood n = the number of WOZ-objects in one neighborhood. (ii) (in the example in Table i, consists of three properties), is expected to be as follows: () = ∑ Where, ToM = time for a property to be let, n = the number of WOZ-objects in one neighborhood. 1 8 = 3,1,4 = = 2.6 3 3 Calculating Cost of vacancy (iii) After calculating the void periods, the income loss due1 to vacancy is8 calculated according to equation = ( ∗ ) ∗ ∗ 1.16 = 3,1,4 = = 2.6 (iii): 3 3 Where; = overall cost of vacancy (€), (iii) = total lettable floor area (m2), (iii) = effective rental value, = the length of the void period (year). = ( ∗ ) ∗ ∗ 1.16 Where; = overall cost of vacancy (€), = total lettable floor area (m2), = effective rental value, = the length of the void period (year). Correction for overdue maintenance This correction is done based on the available information from the GBA (the filled questionnaire by new buyers) over whether at the time of sale there was an overdue maintenance, and in case of such an overdue, the costs were specified in euro of these foreseen maintenances. The differences between Model 3 and Model 4 is the same as the differences between Model 1 and Model 2, regarding the input for the ERVs. Model 3 considers the sequence of available ERV in the property, the radius of 500 m, 1000 m, or if none of these ERVs are available it uses the average ERVs per Amsterdam district. Whereas Model 4 simply uses the average ERVs per Amsterdam district in the calculation model. The calculation model for the cap rates with correction is shown in Figure iii. Figure iv compares the outcome of these models (Model 1 to Model 4), also with the average appraised cap rates for both WOZ-values and market reports (based on C&W). For Model 1 and Model 2 the data from 2004 to 2011 is included in the model, while Model 3 and Model 4 included the cap rates from 2006 to 2011. The reason for omitting the years 2004 and 2005 for Models 3 and 4, is due to the calculation of the void periods, which the length of the average Time on Market (ToM) from the time that a property becomes vacant till it is let again, over a specific period of 5 years, is calculated. Since the tax vacancy database includes data merely since 2002, the first year that the transaction cap rates for Model 3 and 4 could be calculated, was 2006. For the purpose of this thesis, the outcome of Model 1 is selected due to the fact that the result are firstly representing the pure cap rates where all risk associated with the investments is reflected in the calculated cap rates. Secondly, the use of effective rents based on the sequence of the property itself, radius of 500 m, 1000 m and lastly if none of the previous ERVs are available, the average ERVs of the Amsterdam districts are considered. This is due to the fact that firstly these outcomes are more close to what real estate agenciesreport (with some exceptions in 2009). Secondly it is because of the significant impact of the location on the rental value and the provided incentives in the Amsterdam office market. Using the average ERVs per district seem to be far from the dynamics 106 Valuation accuracy in vacant office properties of the submarkets in Amsterdam. Finally, the most crucial reason to choose this model (Model 1), is to decrease the subjective assumptions and inputs to calculate the cap rates. This model has the leastDIRECT manipulation INCOME CAPITALIZATION in the data, therefore providing the most objectively calculated cap rates, and Property type: Office thus reduces the biases. Gross rental value Figure iii, the calculating model of cap rates with Effective Rent Value Market Rent Value SaleID# ObjectID# size (m² LFA) corrections (ERV) (€/m² LFA) (€/m² LFA) 60 ## 1835 87 87 Total Rental Income (TRI) € 159.645 Net rental value Operating Expenses Ratio (OER) of TRI 10,0% Net Operating Income (NOI) € 143.681 Capitalization (Cap) rate (NIY) 1 Cap rate (NIY) 11,4% Gross market value Before corrections 2 ERV -/- Market Rent € - Average Void Period (AVP) in year 0,2551 Marketing and letting commission 16,0% Cost of Vacancy (CoV) € 42.517 Overdue maintenance € - Total corrections € 1.259.652 Net Transaction Price to Gross Transaction Price Value including KK € 1.217.135 Transfer tax and legal fees (KK %) 6,3% Value excluding purchase costs € 1.145.000 Cap rates 12,00% Figure iv, a comparison among the outcomes 10,00% different models (Model 1 to Model 8,00% 4) 6,00% 4,00% 2,00% 0,00% 2004 2005 2006 2007 2008 2009 2010 2011 Model 1 Model 2 Model 3 Model 4 WOZ C&W Appendices 107 appendix 3 - regression model outcomes Transaction cap rate regression with context variables Descriptive Statistics Mean Std. Deviation N TP_CapRate ,060 ,044 121 OfficeJobs 105,492 3,344 121 OfficeInvest ,463 ,143 121 DD2 ,041 ,200 121 DD3 ,074 ,263 121 DD4 ,058 ,234 121 DD6 ,033 ,180 121 DD7 ,190 ,394 121 DD8 ,074 ,263 121 LnLFAm2 5,929 1,397 121 RentR ,926 ,421 121 LnAge 2,769 1,730 121 LnAfstDBZ_IC_Station 7,463 ,516 121 Asbest ,074 ,263 121 Variables Entered/Removeda Model Variables Entered Variables Removed Method 1 OfficeInvest, OfficeJobsb Enter 2 DD6, DD7, DD2, DD4, DD3, Enter DD8b 3 LnLFAm2, Asbest, RentR, Enter LnAge, LnAfstDBZ_IC_Stationb a. Dependent Variable: TP_CapRate b. All requested variables entered. Model Summaryd Durbin- Change Statistics Watson Model R R Adjusted Std. R Square F df1 df2 Sig. F Square R Square Error Change Change Change of the Estimate 1 ,135a ,018 ,002 ,044 ,018 1,099 2 118 ,337 2 ,564b ,318 ,270 ,038 ,300 8,216 6 112 ,000 3 ,716c ,513 ,454 ,033 ,195 8,567 5 107 ,000 1,972 a. Predictors: (Constant), OfficeInvest, OfficeJobs b. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8 c. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8, LnLFAm2, Asbest, RentR, LnAge, LnAfstDBZ_IC_Station d. Dependent Variable: TP_CapRate 108 Valuation accuracy in vacant office properties ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression ,004 2 ,002 1,099 ,337b Residual ,229 118 ,002 Total ,233 120 2 Regression ,074 8 ,009 6,537 ,000c Residual ,159 112 ,001 Total ,233 120 3 Regression ,120 13 ,009 8,677 ,000d Residual ,113 107 ,001 Total ,233 120 a. Dependent Variable: TP_CapRate b. Predictors: (Constant), OfficeInvest, OfficeJobs c. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8 d. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8, LnLFAm2, Asbest, RentR, LnAge, LnAfstDBZ_IC_Station Coefficientsa Unstandardized Standardized Collinearity Coefficients Coefficients Statistics Model B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) ,173 ,132 1,308 ,193 OfficeJobs -,001 ,001 -,068 -,731 ,466 ,963 1,038 OfficeInvest -,040 ,029 -,131 -1,406 ,162 ,963 1,038 2 (Constant) ,094 ,119 ,789 ,432 OfficeJobs ,000 ,001 -,020 -,243 ,809 ,870 1,150 OfficeInvest -,033 ,025 -,107 -1,320 ,190 ,931 1,074 DD2 ,027 ,018 ,121 1,513 ,133 ,948 1,055 DD3 ,071 ,014 ,424 5,247 ,000 ,930 1,075 DD4 ,011 ,015 ,058 ,723 ,471 ,938 1,066 DD6 ,080 ,019 ,325 4,106 ,000 ,969 1,032 DD7 -,009 ,009 -,078 -,948 ,345 ,896 1,116 DD8 ,023 ,014 ,140 1,695 ,093 ,896 1,117 3 (Constant) ,389 ,156 2,493 ,014 OfficeJobs -,002 ,001 -,175 -2,159 ,033 ,690 1,450 OfficeInvest -,053 ,022 -,173 -2,370 ,020 ,855 1,169 DD2 ,045 ,018 ,203 2,552 ,012 ,716 1,397 DD3 ,076 ,012 ,456 6,175 ,000 ,836 1,196 DD4 ,030 ,013 ,159 2,215 ,029 ,886 1,128 DD6 ,088 ,018 ,359 4,994 ,000 ,879 1,137 DD7 -,034 ,009 -,307 -3,706 ,000 ,663 1,509 DD8 ,040 ,018 ,240 2,184 ,031 ,378 2,648 LnLFAm2 ,006 ,002 ,197 2,721 ,008 ,870 1,150 RentR ,031 ,008 ,296 3,999 ,000 ,830 1,205 LnAge ,007 ,002 ,292 3,490 ,001 ,652 1,534 LnAfstDBZ_ -,021 ,010 -,247 -2,175 ,032 ,354 2,828 IC_Station Asbest ,024 ,012 ,145 1,989 ,049 ,851 1,175 a. Dependent Variable: TP_CapRate Appendices 109 Excluded Variablesa Collinearity Statistics Model Beta In t Sig. Partial Tolerance VIF Minimum Correlation Tolerance 1 DD2 ,083b ,900 ,370 ,083 ,980 1,020 ,946 DD3 ,400b 4,679 ,000 ,397 ,968 1,033 ,933 DD4 ,012b ,136 ,892 ,013 ,987 1,013 ,952 DD6 ,296b 3,376 ,001 ,298 ,995 1,005 ,958 DD7 -,201b -2,236 ,027 -,202 ,993 1,007 ,957 DD8 ,103b 1,106 ,271 ,102 ,952 1,050 ,917 LnLFAm2 ,206b 2,269 ,025 ,205 ,973 1,027 ,946 RentR ,208b 2,260 ,026 ,205 ,950 1,053 ,917 LnAge ,118b 1,279 ,203 ,117 ,968 1,033 ,933 LnAfstDBZ_ ,162b 1,777 ,078 ,162 ,985 1,015 ,949 IC_Station Asbest ,120b 1,315 ,191 ,121 ,992 1,008 ,958 2 LnLFAm2 ,226c 2,858 ,005 ,262 ,918 1,089 ,862 RentR ,296c 3,667 ,000 ,329 ,841 1,189 ,823 LnAge ,204c 2,342 ,021 ,217 ,774 1,293 ,749 LnAfstDBZ_ -,113c -,951 ,344 -,090 ,434 2,306 ,434 IC_Station Asbest ,178c 2,158 ,033 ,201 ,866 1,155 ,816 a. Dependent Variable: TP_CapRate b. Predictors in the Model: (Constant), OfficeInvest, OfficeJobs c. Predictors in the Model: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8 Transaction cap rate regression with year dummies Descriptive Statistics Mean Std. Deviation N TP_CapRate ,060 ,044 121 DY2004 ,124 ,331 121 DY2005 ,074 ,263 121 DY2006 ,124 ,331 121 DY2007 ,198 ,400 121 DY2009 ,157 ,365 121 DY2010 ,066 ,250 121 DY2011 ,091 ,289 121 DD2 ,041 ,200 121 DD3 ,074 ,263 121 DD4 ,058 ,234 121 DD6 ,033 ,180 121 DD7 ,190 ,394 121 DD8 ,074 ,263 121 LnLFAm2 5,929 1,397 121 RentR ,926 ,421 121 LnAge 2,769 1,730 121 LnAfstDBZ_IC_Station 7,463 ,516 121 Asbest ,074 ,263 121 110 Valuation accuracy in vacant office properties Variables Entered/Removeda Model Variables Entered Variables Removed Method 1 DY2011, DY2010, DY2005, Enter DY2006, DY2004, DY2009, DY2007b 2 DD2, DD6, DD7, DD3, DD4, Enter DD8b 3 LnLFAm2, Asbest, LnAge, Enter RentR, LnAfstDBZ_IC_Stationb a. Dependent Variable: TP_CapRate b. All requested variables entered. Model Summaryd Change Statistics Durbin- Watson Model R R Adjusted Std. Error R Square F Change df1 df2 Sig. F Square R Square of the Change Change Estimate 1 ,294a ,087 ,030 ,043390 ,087 1,533 7 113 ,163 2 ,626b ,392 ,318 ,036389 ,305 8,944 6 107 ,000 3 ,737c ,543 ,463 ,032294 ,152 6,772 5 102 ,000 1,946 a. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007 b. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8 c. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8, LnLFAm2, Asbest, LnAge, RentR, LnAfstDBZ_IC_Station d. Dependent Variable: TP_CapRate ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression ,020 7 ,003 1,533 ,163b Residual ,213 113 ,002 Total ,233 120 2 Regression ,091 13 ,007 5,302 ,000c Residual ,142 107 ,001 Total ,233 120 3 Regression ,127 18 ,007 6,743 ,000d Residual ,106 102 ,001 Total ,233 120 a. Dependent Variable: TP_CapRate b. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007 c. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8 d. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8, LnLFAm2, Asbest, LnAge, RentR, LnAfstDBZ_IC_Station Appendices 111 Coefficientsa Unstandardized Standardized Collinearity Coefficients Coefficients Statistics Model B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) ,068 ,010 6,998 ,000 DY2004 ,016 ,015 ,117 1,050 ,296 ,652 1,533 DY2005 -,012 ,017 -,074 -,715 ,476 ,745 1,342 DY2006 -,022 ,015 -,164 -1,473 ,143 ,652 1,533 DY2007 -,017 ,013 -,151 -1,261 ,210 ,567 1,764 DY2009 -,020 ,014 -,165 -1,428 ,156 ,608 1,644 DY2010 -,007 ,018 -,040 -,394 ,694 ,765 1,307 DY2011 ,009 ,016 ,058 ,542 ,589 ,710 1,409 2 (Constant) ,062 ,010 6,400 ,000 DY2004 ,001 ,013 ,008 ,083 ,934 ,578 1,729 DY2005 -,012 ,015 -,069 -,760 ,449 ,694 1,442 DY2006 -,025 ,013 -,185 -1,924 ,057 ,616 1,623 DY2007 -,013 ,012 -,118 -1,125 ,263 ,516 1,937 DY2009 -,026 ,012 -,213 -2,103 ,038 ,552 1,812 DY2010 -,014 ,016 -,081 -,915 ,362 ,725 1,380 DY2011 ,017 ,014 ,113 1,243 ,217 ,683 1,465 DD2 ,019 ,017 ,088 1,125 ,263 ,925 1,081 DD3 ,071 ,013 ,425 5,331 ,000 ,896 1,116 DD4 ,004 ,015 ,022 ,272 ,787 ,867 1,153 DD6 ,086 ,019 ,350 4,486 ,000 ,936 1,068 DD7 -,013 ,009 -,120 -1,473 ,144 ,850 1,176 DD8 ,017 ,014 ,099 1,205 ,231 ,847 1,181 3 (Constant) ,119 ,073 1,627 ,107 DY2004 ,025 ,013 ,191 1,918 ,058 ,454 2,205 DY2005 ,009 ,014 ,053 ,613 ,541 ,609 1,642 DY2006 -,011 ,012 -,082 -,911 ,364 ,551 1,813 DY2007 -,010 ,011 -,094 -,960 ,340 ,470 2,126 DY2009 -,008 ,012 -,069 -,720 ,473 ,487 2,053 DY2010 -,010 ,014 -,056 -,691 ,491 ,672 1,488 DY2011 ,008 ,013 ,051 ,612 ,542 ,638 1,568 DD2 ,038 ,018 ,173 2,132 ,035 ,678 1,475 DD3 ,074 ,013 ,442 5,844 ,000 ,781 1,280 DD4 ,025 ,014 ,133 1,772 ,079 ,798 1,254 DD6 ,088 ,018 ,358 4,942 ,000 ,852 1,173 DD7 -,035 ,009 -,314 -3,698 ,000 ,621 1,611 DD8 ,035 ,019 ,207 1,841 ,069 ,355 2,814 LnLFAm2 ,007 ,002 ,209 2,801 ,006 ,806 1,240 RentR ,028 ,008 ,272 3,367 ,001 ,687 1,455 LnAge ,007 ,002 ,273 3,247 ,002 ,631 1,584 LnAfstDBZ_ -,020 ,010 -,238 -2,024 ,046 ,322 3,102 IC_Station Asbest ,023 ,013 ,139 1,809 ,073 ,763 1,311 a. Dependent Variable: TP_CapRate 112 Valuation accuracy in vacant office properties Excluded Variablesa Collinearity Statistics Model Beta In t Sig. Partial Tolerance VIF Minimum Correlation Tolerance 1 DD2 ,053b ,581 ,563 ,055 ,965 1,036 ,562 DD3 ,403b 4,729 ,000 ,408 ,936 1,069 ,565 DD4 -,006b -,060 ,952 -,006 ,928 1,078 ,557 DD6 ,329b 3,772 ,000 ,336 ,952 1,051 ,564 DD7 -,218b -2,412 ,018 -,222 ,949 1,054 ,566 DD8 ,070b ,737 ,463 ,069 ,902 1,109 ,547 LnLFAm2 ,211b 2,284 ,024 ,211 ,912 1,097 ,566 RentR ,194b 1,941 ,055 ,180 ,790 1,266 ,552 LnAge ,087b ,929 ,355 ,087 ,925 1,082 ,567 LnAfstDBZ_ ,125b 1,329 ,186 ,125 ,902 1,108 ,567 IC_Station Asbest ,117b 1,239 ,218 ,116 ,906 1,103 ,559 2 LnLFAm2 ,217c 2,742 ,007 ,257 ,856 1,168 ,515 RentR ,251c 2,869 ,005 ,268 ,693 1,443 ,496 LnAge ,172c 1,978 ,050 ,189 ,736 1,359 ,516 LnAfstDBZ_ -,132c -1,088 ,279 -,105 ,384 2,606 ,384 IC_Station Asbest ,174c 2,070 ,041 ,197 ,782 1,279 ,513 a. Dependent Variable: TP_CapRate b. Predictors in the Model: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007 c. Predictors in the Model: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8 WOZ cap rate regression with context variables Descriptive Statistics Mean Std. Deviation N WOZ_CapRate ,093 ,012 121 OfficeJobs 105,492 3,344 121 OfficeInvest ,463 ,143 121 DD2 ,041 ,200 121 DD3 ,074 ,263 121 DD4 ,058 ,234 121 DD6 ,033 ,180 121 DD7 ,190 ,394 121 DD8 ,074 ,263 121 LnLFAm2 5,929 1,397 121 RentR ,926 ,421 121 LnAge 2,769 1,730 121 LnAfstDBZ_IC_Station 7,463 ,516 121 Asbest ,074 ,263 121 Appendices 113 Variables Entered/Removeda Model Variables Entered Variables Removed Method 1 OfficeInvest, OfficeJobsb Enter 2 DD6, DD7, DD2, DD4, DD3, Enter DD8b 3 LnLFAm2, Asbest, RentR, Enter LnAge, LnAfstDBZ_IC_Stationb a. Dependent Variable: WOZ_CapRate b. All requested variables entered. Model Summaryd Change Statistics Durbin- Watson Model R R Square Adjusted Std. Error R Square F df1 df2 Sig. F R Square of the Change Change Change Estimate 1 ,333a ,111 ,096 ,011835 ,111 7,383 2 118 ,001 2 ,583b ,340 ,293 ,010468 ,229 6,469 6 112 ,000 3 ,631c ,398 ,325 ,010227 ,058 2,072 5 107 ,075 2,069 a. Predictors: (Constant), OfficeInvest, OfficeJobs b. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8 c. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8, LnLFAm2, Asbest, RentR, LnAge, LnAfstDBZ_IC_Station d. Dependent Variable: WOZ_CapRate ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression ,002 2 ,001 7,383 ,001b Residual ,017 118 ,000 Total ,019 120 2 Regression ,006 8 ,001 7,211 ,000c Residual ,012 112 ,000 Total ,019 120 3 Regression ,007 13 ,001 5,447 ,000d Residual ,011 107 ,000 Total ,019 120 a. Dependent Variable: WOZ_CapRate b. Predictors: (Constant), OfficeInvest, OfficeJobs c. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8 d. Predictors: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8, LnLFAm2, Asbest, RentR, LnAge, LnAfstDBZ_IC_Station Coefficientsa Unstandardized Standardized Collinearity Coefficients Coefficients Statistics Model B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) ,018 ,036 ,501 ,618 OfficeJobs ,001 ,000 ,213 2,409 ,018 ,963 1,038 OfficeInvest -,019 ,008 -,219 -2,475 ,015 ,963 1,038 2 (Constant) ,015 ,033 ,453 ,651 114 Valuation accuracy in vacant office properties OfficeJobs ,001 ,000 ,214 2,604 ,010 ,870 1,150 OfficeInvest -,019 ,007 -,215 -2,699 ,008 ,931 1,074 DD2 ,005 ,005 ,075 ,949 ,345 ,948 1,055 DD3 ,015 ,004 ,315 3,952 ,000 ,930 1,075 DD4 ,012 ,004 ,222 2,807 ,006 ,938 1,066 DD6 ,011 ,005 ,158 2,027 ,045 ,969 1,032 DD7 -,005 ,003 -,146 -1,799 ,075 ,896 1,116 DD8 ,009 ,004 ,196 2,421 ,017 ,896 1,117 3 (Constant) ,067 ,049 1,359 ,177 OfficeJobs ,001 ,000 ,158 1,746 ,084 ,690 1,450 OfficeInvest -,016 ,007 -,183 -2,254 ,026 ,855 1,169 DD2 ,007 ,006 ,113 1,274 ,205 ,716 1,397 DD3 ,016 ,004 ,347 4,232 ,000 ,836 1,196 DD4 ,012 ,004 ,234 2,936 ,004 ,886 1,128 DD6 ,013 ,006 ,188 2,356 ,020 ,879 1,137 DD7 -,004 ,003 -,138 -1,493 ,138 ,663 1,509 DD8 ,014 ,006 ,302 2,472 ,015 ,378 2,648 LnLFAm2 ,000 ,001 ,035 ,437 ,663 ,870 1,150 RentR -,006 ,002 -,198 -2,407 ,018 ,830 1,205 LnAge ,001 ,001 ,170 1,830 ,070 ,652 1,534 LnAfstDBZ_ -,004 ,003 -,174 -1,377 ,171 ,354 2,828 IC_Station Asbest ,000 ,004 -,003 -,035 ,972 ,851 1,175 a. Dependent Variable: WOZ_CapRate Excluded Variablesa Collinearity Statistics Model Beta In t Sig. Partial Tolerance VIF Minimum Correlation Tolerance 1 DD2 ,043b ,492 ,624 ,045 ,980 1,020 ,946 DD3 ,300b 3,562 ,001 ,313 ,968 1,033 ,933 DD4 ,196b 2,280 ,024 ,206 ,987 1,013 ,952 DD6 ,132b 1,521 ,131 ,139 ,995 1,005 ,958 DD7 -,266b -3,170 ,002 -,281 ,993 1,007 ,957 DD8 ,171b 1,949 ,054 ,177 ,952 1,050 ,917 LnLFAm2 -,001b -,009 ,993 -,001 ,973 1,027 ,946 RentR -,279b -3,260 ,001 -,289 ,950 1,053 ,917 LnAge -,018b -,199 ,842 -,018 ,968 1,033 ,933 LnAfstDBZ_ ,138b 1,587 ,115 ,145 ,985 1,015 ,949 IC_Station Asbest -,022b -,254 ,800 -,023 ,992 1,008 ,958 2 LnLFAm2 ,033c ,406 ,686 ,038 ,918 1,089 ,862 RentR -,204c -2,491 ,014 -,230 ,841 1,189 ,823 LnAge ,107c 1,233 ,220 ,116 ,774 1,293 ,749 LnAfstDBZ_ -,121c -1,039 ,301 -,098 ,434 2,306 ,434 IC_Station Asbest ,004c ,049 ,961 ,005 ,866 1,155 ,816 a. Dependent Variable: WOZ_CapRate b. Predictors in the Model: (Constant), OfficeInvest, OfficeJobs c. Predictors in the Model: (Constant), OfficeInvest, OfficeJobs, DD6, DD7, DD2, DD4, DD3, DD8 Appendices 115 WOZ cap rate regression with year dummies Descriptive Statistics Mean Std. Deviation N WOZ_CapRate ,09 ,01 121 DY2004 ,12 ,33 121 DY2005 ,07 ,26 121 DY2006 ,12 ,33 121 DY2007 ,20 ,40 121 DY2009 ,16 ,37 121 DY2010 ,07 ,25 121 DY2011 ,09 ,29 121 DD2 ,04 ,20 121 DD3 ,07 ,26 121 DD4 ,06 ,23 121 DD6 ,03 ,18 121 DD7 ,19 ,39 121 DD8 ,07 ,26 121 LnLFAm2 5,93 1,40 121 RentR ,93 ,42 121 LnAge 2,77 1,73 121 LnAfstDBZ_IC_Station 7,46 ,52 121 Asbest ,07 ,26 121 Variables Entered/Removeda Model Variables Entered Variables Removed Method 1 DY2011, DY2010, DY2005, Enter DY2006, DY2004, DY2009, DY2007b 2 DD2, DD6, DD7, DD3, DD4, Enter DD8b 3 LnLFAm2, Asbest, LnAge, Enter RentR, LnAfstDBZ_IC_Stationb a. Dependent Variable: WOZ_CapRate b. All requested variables entered. Model Summaryd Change Statistics Durbin- Watson Model R R Adjusted Std. Error R Square F df1 df2 Sig. F Square R Square of the Change Change Change Estimate 1 ,423a ,179 ,128 ,011623 ,179 3,521 7 113 ,002 2 ,610b ,372 ,296 ,010445 ,193 5,485 6 107 ,000 3 ,648c ,420 ,317 ,010285 ,048 1,673 5 102 ,148 2,155 a. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007 b. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8 c. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8, LnLFAm2, Asbest, LnAge, RentR, LnAfstDBZ_IC_Station d. Dependent Variable: WOZ_CapRate 116 Valuation accuracy in vacant office properties ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression ,003 7 ,000 3,521 ,002b Residual ,015 113 ,000 Total ,019 120 2 Regression ,007 13 ,001 4,879 ,000c Residual ,012 107 ,000 Total ,019 120 3 Regression ,008 18 ,000 4,099 ,000d Residual ,011 102 ,000 Total ,019 120 a. Dependent Variable: WOZ_CapRate b. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007 c. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8 d. Predictors: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8, LnLFAm2, Asbest, LnAge, RentR, LnAfstDBZ_IC_Station Coefficientsa Unstandardized Standardized Collinearity Statistics Coefficients Coefficients Model B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) ,092 ,003 35,418 ,000 DY2004 ,000 ,004 ,004 ,038 ,970 ,652 1,533 DY2005 -,004 ,005 -,081 -,820 ,414 ,745 1,342 DY2006 -,002 ,004 -,062 -,584 ,561 ,652 1,533 DY2007 -,006 ,004 -,187 -1,648 ,102 ,567 1,764 DY2009 ,008 ,004 ,249 2,276 ,025 ,608 1,644 DY2010 ,010 ,005 ,204 2,098 ,038 ,765 1,307 DY2011 ,004 ,004 ,089 ,885 ,378 ,710 1,409 2 (Constant) ,089 ,003 31,852 ,000 DY2004 3,291E-05 ,004 ,001 ,009 ,993 ,578 1,729 DY2005 -,001 ,004 -,024 -,261 ,795 ,694 1,442 DY2006 -,002 ,004 -,052 -,534 ,594 ,616 1,623 DY2007 -,003 ,003 -,085 -,801 ,425 ,516 1,937 DY2009 ,010 ,004 ,280 2,716 ,008 ,552 1,812 DY2010 ,009 ,004 ,190 2,107 ,037 ,725 1,380 DY2011 ,006 ,004 ,129 1,387 ,168 ,683 1,465 DD2 ,005 ,005 ,081 1,019 ,310 ,925 1,081 DD3 ,014 ,004 ,292 3,605 ,000 ,896 1,116 DD4 ,012 ,004 ,228 2,769 ,007 ,867 1,153 DD6 ,010 ,005 ,144 1,817 ,072 ,936 1,068 DD7 -,004 ,003 -,119 -1,435 ,154 ,850 1,176 DD8 ,010 ,004 ,204 2,450 ,016 ,847 1,181 3 (Constant) ,122 ,023 5,218 ,000 DY2004 ,002 ,004 ,057 ,511 ,610 ,454 2,205 DY2005 3,319E-05 ,005 ,001 ,007 ,994 ,609 1,642 DY2006 -,002 ,004 -,044 -,429 ,669 ,551 1,813 DY2007 -,001 ,003 -,029 -,263 ,793 ,470 2,126 Appendices 117 DY2009 ,009 ,004 ,252 2,330 ,022 ,487 2,053 DY2010 ,009 ,005 ,177 1,924 ,057 ,672 1,488 DY2011 ,004 ,004 ,099 1,043 ,299 ,638 1,568 DD2 ,008 ,006 ,132 1,437 ,154 ,678 1,475 DD3 ,016 ,004 ,334 3,917 ,000 ,781 1,280 DD4 ,014 ,004 ,261 3,092 ,003 ,798 1,254 DD6 ,012 ,006 ,177 2,169 ,032 ,852 1,173 DD7 -,004 ,003 -,133 -1,385 ,169 ,621 1,611 DD8 ,015 ,006 ,324 2,564 ,012 ,355 2,814 LnLFAm2 ,000 ,001 ,043 ,517 ,607 ,806 1,240 RentR -,004 ,003 -,144 -1,583 ,117 ,687 1,455 LnAge ,001 ,001 ,192 2,022 ,046 ,631 1,584 LnAfstDBZ_ -,005 ,003 -,203 -1,531 ,129 ,322 3,102 IC_Station Asbest ,001 ,004 ,016 ,181 ,856 ,763 1,311 a. Dependent Variable: WOZ_CapRate Excluded Variablesa Collinearity Statistics Model Beta In t Sig. Partial Tolerance VIF Minimum Correlation Tolerance 1 DD2 ,041b ,467 ,641 ,044 ,965 1,036 ,562 DD3 ,263b 3,097 ,002 ,281 ,936 1,069 ,565 DD4 ,203b 2,344 ,021 ,216 ,928 1,078 ,557 DD6 ,123b 1,419 ,159 ,133 ,952 1,051 ,564 DD7 -,237b -2,794 ,006 -,255 ,949 1,054 ,566 DD8 ,171b 1,925 ,057 ,179 ,902 1,109 ,547 LnLFAm2 ,022b ,242 ,809 ,023 ,912 1,097 ,566 RentR -,222b -2,361 ,020 -,218 ,790 1,266 ,552 LnAge ,021b ,238 ,812 ,022 ,925 1,082 ,567 LnAfstDBZ_ ,144b 1,618 ,109 ,151 ,902 1,108 ,567 IC_Station Asbest -,009b -,095 ,925 -,009 ,906 1,103 ,559 2 LnLFAm2 ,050c ,598 ,551 ,058 ,856 1,168 ,515 RentR -,161c -1,763 ,081 -,169 ,693 1,443 ,496 LnAge ,140c 1,577 ,118 ,151 ,736 1,359 ,516 LnAfstDBZ_ -,125c -1,012 ,314 -,098 ,384 2,606 ,384 IC_Station Asbest ,013c ,153 ,879 ,015 ,782 1,279 ,513 a. Dependent Variable: WOZ_CapRate b. Predictors in the Model: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007 c. Predictors in the Model: (Constant), DY2011, DY2010, DY2005, DY2006, DY2004, DY2009, DY2007, DD2, DD6, DD7, DD3, DD4, DD8