ERES Doctoral Session: Capitalization rates as risk indicator for (non-)efficient properties? Elaine Wilke Real Estate Management Institute EBS Universität für Wirtschaft und Recht Söhnleinstraße 8d Wiesbaden

Agenda: Capitalization rates as risk indicators for (non-) efficient properties? 2 1.0Introduction / Research objective 2.0Data and Research Method 3.0Results 4.0Conclusion Elaine Wilke REMI,

3 1.0 Introduction Risk of (non-)efficient properties so far only research and publications from the investors’ perspective But: most sustainability aspects influence the operating and occupancy costs of the occupier; these costs are not taken into consideration when calculating the NOI how are the results going to change if also the occupiers’ goals are considered? investors: higher net rents and/or higher returns occupiers: reduced operation and occupancy costs both perspectives interact in the valuation process:  sustainable (efficient) properties realize higher Capital Values than non-sustainable (efficient) properties, as sustainability (efficiency) reduces the property specific risk Hypothesis: The capitalization rate as all risks yield interacts as indicator for the risk of (non-) efficient properties  higher risk premiums for non-efficient properties! Elaine Wilke REMI,

Capitalization rates as risk indicators for (non-) efficient properties? 4 Elaine Wilke REMI, Introduction / Research objective 2.0Data and Research Method 3.0Results 4.0Conclusion

5 2.1 Data  Data from Investors and Occupiers:  IPD Investment Property Databank UK  IPD Occupiers Databank UK  Sample size n = 47 objects (in both databanks for 2007 and 2008) Elaine Wilke REMI,

6 2.2 Research Method  Partial Least Squares (PLS) – method (according to Wold)  causal relationships between (in)dependant (latent) variables  also available for smaller sample sizes  any measurement levels  separate calculation for 2007 and 2008  Illustration of the cause-effect relations (directions and sings) between the hypothesis and the latent variables. Elaine Wilke REMI,

7 2.3 Base Model Elaine Wilke REMI, Block 1 Block 2 Block 3 Block 4 Model latent exogenous variable Reflective Structure Model latent exogenous variable Reflective Structure Model latent exogenous variable Formative Structure Model latent endogenous variable Reflective Structure

8 2.4 Indicators Elaine Wilke REMI, IndicatorShortCalculation Lease contractIndividual conditions of the lease contract Net rent per sqm (NR) NR Net rent per sqm as relative difference to IPD mean at date of last rent review Remaining years of lease contract RL Remaining years of individual lease contract Property quality Overall quality of the property Age A Age of building at date of valuation Condition C 1 = very good condition 2 = good condition with minor improvements 3 = bad condition with major improvements Property efficiency Overall property efficiency as relative difference to the relevant IPD mean Location L 1 = London 2 = big cities (biggest 8 cities in the UK excl. London) 3 = small cities Total operating costs per sqm OC Total operating costs per sqm for the property as relative difference to the relevant IPD mean Rentable area SQM Total rentable area of the property Vacancy rate V Economic vacancy rate (in % of income) Property specific risk The property specific risk Capitalization rate CR relative difference between the "risk-free rate" (10 years UK gilts) and the calculated capitalization rate of the valuer for the individual property

9 2.4 Indicator - Total Operating Costs per sqm IPD International Total Occupancy Cost Code (ITOCC): Source: IPD ITOCC 4th edition Elaine Wilke REMI, Elements of the IPD Total Operating Costs per sqm:  consolidated service charge  insurance  internal repair and maintenance  M&A repair and maintenance  external/structural repair and maintenance  minor improvements  internal moves  reinstatement  security  cleaning  waste disposal  internal plants and flowers  ground maintenance  water, sewerage  energy

Capitalization rates as risk indicators for (non-) efficient properties? 10 Elaine Wilke REMI, Introduction / Research objective 2.0Data and Research Method 3.0Results 4.0Conclusion

3.1 Base Model (2007) 11 Elaine Wilke REMI, R²

3.1 Base Model (2007) 12 Model quality criteria:  AVE > 0.5  Composite Reliability > 0.7  Cronbach‘s Alpha > 0.7  Modification of the model! Elaine Wilke REMI,

Model – modified (2007)  AVE > 0.70  Composite Reliability > 0.7  Composite Reliability > Cronbach‘s Alpha  Cronbach‘s Alpha ~ 0.7 Elaine Wilke REMI, R²

Model – modified (2007) Discriminant Validity Outer Loadings > 0.7  support validation of reflective model Cross Loadings < Outer Loadings  no multicollinearity degree to which two measures designed to measure similar or conceptually related constructs: √AVE > Latent Variable Correlation  no relation Elaine Wilke REMI,

Model – modified (2007) - Bootstrapping  Estimating the distribution of the statistic by using the bootstrapping method  The calculation is based on 300 cases and 500 samples  standard errors with values < 0.04 suggest a low level of uncertainty  T Statistics indicate a good fit of the model explaining the degree of variability of the dependent variable Elaine Wilke REMI,

Model – modified (2007)  bigger role in explaining than in predicting as q² <f²  The effect size (f²) with a value of has to be interpreted according to Cohen as a low to medium effect with f² <0.15.  Q² with implies predictive relevance  The calculated GoF (.401) is higher than the marginal value of >.275 indicating that the model strongly fits the set of observations. R² = 27,53% GoF = 0,401 Elaine Wilke REMI,

Model – modified (2008)  AVE ~ 0.70  Composite Reliability > 0.7  Composite Reliability > Cronbach‘s Alpha  Cronbach‘s Alpha ~ 0.7 Elaine Wilke REMI, R²

Capitalization rates as risk indicators for (non-) efficient properties? 18 Elaine Wilke REMI, Introduction / Research objective 2.0Data and Research Method 3.0Results 4.0Conclusion

Conclusion Elaine Wilke REMI, Type of HypothesisSupportedNot supported Indicators -> latent variable H1: Property specific risk-> CR H10: A->Property quality H11: C->Property quality H15: V->Property efficiency H8: Lease contract-> RL H9: Lease contract-> NR H12: L->Property efficiency H13: OC->Property efficiency H14: SQM->Property efficiency Exogenous -> exogenous variable H7: Property quality->Property efficiency H5: Property quality->Lease contract H6: Property efficiency-> Lease contract Exogenous -> endogenous variable H3: Property quality-> Property specific risk H4: Property efficiency-> Property specific risk H2: Lease contract-> Property specific risk

Base Model Elaine Wilke REMI, Block 1 Block 2 Block 3 Block 4 Model latent exogenous variable Reflective Structure Model latent exogenous variable Reflective Structure Model latent exogenous variable Formative Structure Model latent endogenous variable Reflective Structure

Conclusion  so far only minor consideration of property characteristics in the derivation of the cap rate  changes in the (economic) environment dominate the choice of the risk premium  no integration of use efficiency  occupiers’ perspectives are ignored  future consideration of (non-)efficiency ?  review of the interrelations with bigger sample sizes Elaine Wilke REMI,

Capitalization rates as risk indicators for (non-) efficient properties? 22 Thank you! Elaine Wilke REMI,