Pricing risk and its use in modelling real estate market yields

Date12 December 2020
Publication Date12 December 2020
AuthorTony McGough,Jim Berry
SubjectProperty management & built environment,Real estate & property,Property valuation & finance
Pricing risk and its use in
modelling real estate
market yields
Tony McGough
School of Property Construction and Project Management,
College of Design and Social Context, RMIT University, Melbourne, Australia, and
Jim Berry
Built Environment Research Institute, University of Ulster, Belfast, UK
Purpose In the light of past financial and economic turmoil, there has been a marked increase in the
volatility in real estate markets. This has impacted on the pricing of property assets, partly through market
sentiment and particularly concerning risk. It also limits modelling accuracy model accuracy. The purpose of
this paper is to create a new variable and model to enhance analysis of what drives real estate yields
incorporating market sentiment to risk.
Design/methodology/approach This paper specifically considers the modelling of property pricing
within a volatile economic environment. The theoretical context begins by analysing the relationship between
property yields and government bonds. The analytical context then moves on to specifically include a
measurement of risk which stresses its role and importance in investment markets since the Global Financial
Crisis. The model thus incorporates macroeconomic and real estate data, together with an international risk
multiplier, which is calculated within the paper.
Findings The paper finds the use of measurements of market sentiment and risk are more powerful tools
for modelling yields than previous techniques alone.
Research limitations/implications This is an initial paper outlining the creation of sentiment and risk
measurements in the financial market and showing an example of its application to a commercial real estate
market. The implication is that this could add a major new explanatory variable to modelling of yields.
Practical implications The paper highlights the importance of risk in the pricing of commercial real
estate, over and above normal variables. It highlights how this can help explain over and undershooting of
yields within commercial real estate which would be of great importance in the investment world.
Originality/value This paper attempts to explicitly measure market sentiment, pricing of risk and how
this impacts real estate pricing.
Keywords Commercial real estate, Real estate pricing, Risk pricing, Risk sentiment indicator,
Yield modelling, Yield spreads
Paper type Research paper
1. Introduction
Property investment and total returns have been profoundly influenced by the economic
turmoil that has impacted on the worlds financial markets since 2007. The crisis, which
started in a seemingly niche part of the residential lending market turned out to be one of the
most severe economic shocks experienced in decades from which no economies in Europe or
indeed the world were immune. Furthermore, the Global Financial Crisis (GFC) has served to
emphasise the inter-relationship that exists between property markets, financial markets
and the economic performance of countries.
With real estate becoming more intertwined within international capital markets, low
interest rates have increasingly put downward pressure on yields and thus encouraged
asset price inflation (see, e.g. Playton, 2009; Tsolacos et al., 2009, and further discussion in
the literature review section of this paper). Fiscal and monitory policies are therefore
Received 16 August 2019
Revised 12 November 2019
Accepted 13 November 2019
The current issue and full text archive of this journal is available on Emerald Insight at:
A previous presentation of this work was carried out with the support of Ben Burston (now at Knight
Frank) and Fergus Hicks (now at UBS) whose advice on this work we would like to acknowledge.
Modelling real
estate market
JournalofProperty Investment&
Vol.38 No. 5, 2020

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