Commercial real estate investors differ in their sentiment due to factors such as market expertise, investment strategies and expectations about future market conditions. Focusing on the office market, we investigate whether investors with a multiasset investment focus such as pension funds or insurance companies rely on the sentiment of specialized real estate investors such as public REITs or private developers/owners as source of information in their investment decision-making. Using disaggregated sentiment measures and vector autoregression (VAR) we find evidence that changes in REIT and private real estate investor sentiment lead to changes in institutional investor sentiment in the suburban office and office REIT market. Our findings suggest that institutional investors rely on the sentiment of specialized real estate investors to make real estate investment decisions. Our study contributes to the existing literature on sentiment in commercial real estate markets by emphasizing the heterogeneity of investor sentiment and introducing a disaggregated sentiment measure. We also contribute to the institutional herding literature.

This study introduces the cap rate spread as a novel metric for underwriting commercial mortgages. Cap rate spread is the difference between the cap rate and the fixed coupon rate. The spread predicts performance risk in a sample of 24,951 commercial mortgage-backed securities loans during 1993-2011. We demonstrate that the cap rate spread includes crucial information about performance risk. The results arise from the role of the cap rate spread in generating positive or negative leveraged returns to equity in situations where additional equity is required. Incorporating simplistic cap rate spread requirements in commercial underwriting is expected to reduce loan performance risk.Standard underwriting models for approving and pricing debt on commercial loans rely upon classic measures such as the size of the loan relative to the value of the property (loan-to-value ratio [LTV]) and the ratio of net income from the property to the annual debt payment obligation (debt service coverage ratio [DSCR]). Yet, the 30-day delinquency rate on commercial mortgages has recently skyrocketed, including on commercial mortgage-backed securities (CMBS) loans that rose from less than 0.5% in June 2008 to consistently greater than 8% since June 2010. 1 Although a portion of these CMBS delinquencies were originated with excessive leverage and thin debt coverage, many distressed commercial loans would have otherwise passed traditionally conservative underwriting standards. This suggests that conventional underwriting methods should be given a critical evaluation. In this study, we propose the cap rate spread as a new metric for underwriting that introduces information that is available at the time of origination, but not fully reflected in stand-alone LTV or DSCR measures.LTV is widely used to determine loan risk and one of the most commonly cited indicators that are used to characterize individual loans and the broader lending environment. As the loan amount approaches or exceeds the value of the underlying asset, equity vanishes and default risk increases. DSCR is another important measure that provides a basic assessment of the borrower's ability to remain current on debt payments in the event that operating cash flows from the underlying property are impaired. With a higher DSCR at origination, the debt service has a greater cushion against the impact from reduced rental income or increased expenses. The key limitation to LTV and DSCR criteria, when considered in isolation, is their failure to relate cash flows to asset values. This is true, even though incentives for equity investors are driven by yields that are defined by cash flows relative to asset values.LTV is a ratio of asset values only, and includes the loan amount (i.e., the lender's asset) in the numerator and the property value in the denominator. DSCR is a ratio of cash flows only, and includes net operating cash flows from the property in the numerator and debt cash flows in the denominator. Recognizable measures already exist that relate cash flows to asset values...

No abstract

No abstract