IPF: Reconciling the Predictability of Returns from Commercial Real Estate Yields

Awarded an IPF Research grant in autumn 2024, this 12-month study considers whether commercial real estate yields are predictors of excess returns and if not, why not?

The research was predicated on real estate returns being driven by the commercial real estate yield at the start of the holding period and changes in the cap rate and income during the holding period. Cap rates vary over time and these changes can be attributed to changes in expected cash flow growth, risk free rates, or risk premia.

A high cap rate implies either a high property expected return, or low expected rental growth, or a combination of both. One implication is that a higher cap rate should predict higher ex-post returns and/or lower ex-post rental growth.

From stock market literature, most of the variation in dividend yields is attributed to changing forecasts of expected returns. Analogously, if most of the variation in cap rate is driven by changes in expected return, the cap rate should be able to forecast future excess returns.