The Other (Commercial) Real Estate Boom and Bust: The Effects of Risk Premia and Regulatory Capital Arbitrage
In the 2000 s, U.S. commercial real estate (CRE) prices experienced a boom and bust as dramatic as the more widely analyzed swings in house prices and contributed significantly to bank failures. We model short-run and long-run movements in capitalization rates (rent-to-price-ratio) and risk premia for office building and apartments. In the mid-2000s’ boom, CRE prices were mainly driven by declines in required risk premia that stemmed from a weakening of capital requirements. In the bust, CRE price declines were initially driven by a jump in general risk premia and later by a tightening of effective capital requirements on commercial mortgage-backed securities (CMBS) from the Dodd-Frank Act. The subsequent recovery in CRE prices was induced and sustained by unusually low real Treasury yields. We conclude that macro-prudential regulation of leverage may help limit asset price booms by preventing sharp declines in risk premia.
Duca, John V., and David C. Ling. 2020. “The Other (Commercial) Real Estate Boom and Bust: The Effects of Risk Premia and Regulatory Capital Arbitrage." Journal of Banking and Finance 112: 105317.
Journal of Banking & Finance
Asset pricing, Equity premiums, Bank deregulation, Institutional investors, Alternative asset classes, Commercial real estate