The Impact of Capital Expenditures on Property Performance in Commercial Real Estate

Using a sample of 56,144 annual property observations during 2000 – 2011 we analyze the determinants of capital expenditures and their sub-components at the property level when accounting for uncertainty. We argue that uncertainty impacts the relationships between interest rates, profitability and capital expenditures and that these relationships may differ not only by property type, but also by cap-ex categories. We find that interest rates, credit spread and standard deviation of cap rates are all strongly negatively associated with capital expenditures. Interestingly, both lagged income return and lagged appreciation return are negatively associated with property investment. In addition, in the presence of uncertainty the effect of appreciation return is even more negative, which suggests that owners exercise their option to delay investment. Since increased returns may be correlated with the quality of property capital components, we use property fixed effects to control for endogeneity of returns and observe that the negative effect of property returns on capital expenditures disappears. Finally, we analyze the relationship between capital expenditures and performance and find persistently strong positive relationship between capital expenditures and cumulative returns. The observed positive relationship between capital expenditures over the holding period and cumulative returns is even more significant when controlling for the endogeneity of capital expenditures and using 2SLS model.