For those who missed it, Columbia University finance and real estate professor Stijn Van Nieuwerburgh gave a tutorial on commercial real estate (CRE) assets in the context of evolving market dynamics during the Inquire Europe Autumn Seminar 2024 in Valencia.
The Context
“We are witnessing a great rotation away from public markets with the number of publicly listed companies in the United States having halved in the last 25 years,” contrasted with substantial growth in private investment sectors, such as buyouts, venture capital (VC), and real estate. Valuing CRE is challenging for several reasons : “Commercial real estate assets get transacted once every 10 years or so, as opposed to stocks which get traded multiple times per second. It’s a completely different frequency of observing prices.”
This infrequent nature of transactions in the private market lends itself to valuation based on cash flows rather than market prices, a method that risks underestimating volatility. Limited data on private transactions may obscure the true volatility of CRE, which “impacts the broader financial stability of the sector but may make portfolio managers happy to not have to market these assets very frequently.”
Shifting focus to the distinct nature of private assets, Van Nieuwerburgh pointed out that buildings are very heterogeneous assets: “Every share of Apple stock is the same. Every building is different, because of its location, its unique features, and its mix of tenants.”
The Pandemic’s Impact on Valuations
“After 2020, we had a proverbial meteorite hitting the office market, which was that people started working from home. All of a sudden, offices were mostly empty. Even today, the United States offices are only about 50% occupied relative to pre-COVID levels […] and the New York City office stock is worth 46% less today than it was before COVID.”
Van Nieuwerburgh explained that this decrease has implications for financial stability, as office buildings are often financed through debt, creating vulnerability to loan defaults amid declining asset values. This situation is particularly concerning for regional banks with substantial CRE loan exposure.
New Theory
Van Nieuwerburgh revealed a new framework he has developed for valuing private assets, which is written up in his new research paper ‘The Commercial Real Estate Eco-System’. It integrates investor characteristics and trade interactions to enhance asset pricing analysis, thereby emphasizing the role of investor diversity in understanding CRE prices amid varying market liquidity. By analyzing two decades of transaction data from 475,000 properties valued at $10 trillion, the framework reveals key valuation dynamics.
By analysing the universe of institutional CRE transactions from MSCI Real Capital Analytics (RCA) it is possible to see that different investor types approach real estate with distinct strategies. Private equity firms, for example, target high-value properties and follow investment horizons that influence predictable cycles of acquisitions and divestitures. Meanwhile, institutional investors, like pension funds, focus on long-term holding strategies, while Real Estate Investment Trusts (REITs) are influenced by public market valuations, affecting their buying power during market downturns. Foreign investors, such as sovereign wealth funds, prefer prime office properties in major markets like Manhattan, and their investment activities may depend on the geopolitical climate.
Shifts in the demand for specific asset types have also impacted CRE valuations. “For example, the e-commerce revolution […] It decimated shopping malls and was a huge boon for warehouse space.”
The Importance of Investor Heterogeneity
Van Nieuwerburgh emphasized that investor heterogeneity, and consequently identifying the investor categorization, plays a huge role in shaping the CRE market. “Real estate private equity investors are buying about 12% of the buildings by volume. Then we have a large group of institutional investors, which includes pension funds, endowments, open-ended funds, banks, finance companies, insurance companies, investment managers, and CMBS. They are buying about 14% of the buildings. There is also a large group of owner, operator, developer, local, which are smaller players. Most importantly, we need to consider how likely these various investors are to trade with each other and the effects of those interactions on valuations.”
In summary
Van Nieuwerburgh’s new framework features a valuation segment that assesses investor preferences and asset attributes, highlighting variability in how different investors value properties, and a transaction segment that analyzes deal likelihood based on buyer-seller valuation alignment. He emphasized that RCA’s data-driven approach provides insights into economic factors and investor behavior, supporting hypothetical analyses of foreign investment and monetary policy changes. His research underscores the importance of understanding private market dynamics as global assets increasingly shift away from public markets, offering investors and policymakers enhanced tools for assessing risks and pricing distributions in private asset valuation.
View the research in full via : https://www.inquire-europe.org/event/autumn-seminar-2024-valancia-spain/