Investor Sentiment and Commercial Real Estate Valuation

This paper investigates the role of fundamentals and investor sentiment in commercial real estate valuation. In real estate markets, heterogeneous properties trade in illiquid, highly segmented and informationally inefficient local markets. Moreover, the inability to short sell private real estate restricts the ability of sophisticated traders to enter the market and eliminate mispricing. These characteristics would seem to render private real estate markets highly susceptible to sentiment-induced mispricing. Using error correction models to carefully model potential lags in the adjustment process, this paper extends previous work on cap rate dynamics by examining the extent to which fundamentals and investor sentiment help to explain the timeseries variation in national-level cap rates. We find evidence that investor sentiment impacts pricing, even after controlling for changes in expected rental growth, equity risk premiums, T-bond yields, and lagged adjustments from long run equilibrium. We thank the Real Estate Research Institute (RERI) for providing partial funding for this project. *Pension Real Estate Association, 100 Pearl Street, 13 Floor, Hartford, CT 06103, phone: (860) 692-6341, email: [email protected]; **Department of Finance, Insurance, and Real Estate, Hough Graduate School of Business, University of Florida, Gainesville, FL 32611-7168, phone: (352) 273-0313, email: [email protected]; ***Department of Finance, Insurance, and Real Estate, Hough Graduate School of Business, University of Florida, Gainesville, FL 32611-7168, phone: (352) 392-3781, email: [email protected]