Ex post to ex ante: using some lessons from the global financial crisis to prepare for future risk

Published date04 September 2017
Pages541-555
DOIhttps://doi.org/10.1108/JPIF-10-2016-0082
Date04 September 2017
AuthorHugh F. Kelly
Subject MatterProperty management & built environment,Real estate & property,Property valuation & finance
Ex post to ex ante: using some
lessons from the global financial
crisis to prepare for future risk
Hugh F. Kelly
Board of Regents, Realtor University, New York, New York, USA
Abstract
Purpose The purpose of this paper is to develop benchmarking standards for risk premiums in
capitalization rates and commercial mortgage rates, to examine the impact of investor choice of property type
and geographic markets on those risk premiums, and to supplement the quantitative analysis with historical
and behavioral decision-making factors.
Design/methodology/approach Using data sets extending from 1Q 1995 to 2Q 2016, a range of risk
premiums is calculated and norms established at the 65th and 35th percentiles by property type and
investment position. Relative levels of the risk premiums are compared to three defined categories of urban
markets, to discover potential risks in yield-seeking market selection. A historical context is discussed to
illustrate that prudential judgment is needed to supplement statistical measures of risk.
Findings A stable range of risk premiums is identified for the pre-financial crisis period 1995-2003, the
dislocations of risk pricing 2004-2007 leads to an extreme reaction 2009-2012. A period of renormalizationis
hypothesized thereafter. An important distinction is made between the transaction peak of 2007, and the
numerically similar peak of 2015. Taxonomy of urban property markets is adduced.
Practical implications Investment analyses and portfolio allocation decisions can benefit from a
longitudinal examination of risk premiums hitherto unavailable. The proposed taxonomy of markets has
been shown (elsewhere) to correlate to investment performance. City planners may wish to capture increased
real estate value stemming from investor preferences among cities.
Originality/value The risk premium benchmarking is not previouslyavailable in the scholarly literature.
The historicalcontext as a prudentialelement in evaluatingrisk is not often emphasizedin the finance literature.
Keywords Benchmarking, Capital flows, Global financial crisis, Risk premiums,
US commercial real estate, Urban taxonomy
Paper type Conceptual paper
It seems that whenever a major disruptive event strikes, it is quickly asserted that this
changes everything.We heard this after the 9/11 attacks, in the wake of Hurricane Katrina,
and again when the global financial crisis dislocated the world economy. Although it makes
for a great sound bite, this changes everythingis one of the most deeply untruthful claims
foisted upon the public. Revolutionarychange is extremely rare in world history[1]. Linnaeus
and Darwin posited the maxim, Natura non facit saltum Nature does not make leaps, and
Alfred Marshall made this statement the epigraph of his Principles of Economics[2].
The reason why the claim of changing everythingshould be viewed skeptically is not only
because of the overwhelming evidence of the laws of conservation in natural and social science.
The concept of a discontinuity that requires an entirely fresh startisprofoundlyunsettlingnot
only epistemologically (what can we know?), but also pedagogically (what can we learn?).
Thus the question of continuity and disruption in the global financial crisis bears examination
both for those who are charged with finance and investment decisions today, and those who are
charged with educating the next generation of decision-makers in the real estate field.
This paper outlines three major topics:
(1) A longitudinal analysis of risk premiums (1995-2016) demonstrates the aberrations in
US commercial property cap rates and mortgage rates in the years leading up to
the global financial crisis, and the over-reaction in the years immediately after the
catastrophe of 2008-2009. This analysis provides a useful measure of conditions as
Journal of Property Investment &
Finance
Vol. 35 No. 6, 2017
pp. 541-555
© Emerald PublishingLimited
1463-578X
DOI 10.1108/JPIF-10-2016-0082
Received 26 October 2016
Revised 24 December 2016
Accepted 31 December 2016
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
541
Global
financial crisis

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