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Cornell Real Estate Review

Abstract

One of the original premises for investing in the real estate asset class was to achieve strong, consistent yields from contractual cash flows, with a secondary objective of earnings growth and capital appreciation. During this past cycle, these secondary objectives rose to the top as unprecedented levels of cap rate compression caused investors to accept aggressive appreciation and NOI growth assumptions. Now that the market has bottomed, investors finding their way back into the market are asking: 1) are today’s pro forma returns good enough to support buying and, 2) is now the right time in the market cycle to buy? While effective market timing is much easier said than done, this paper shows that the ability to tactically acquire commercial real estate at the “bottom” of a cycle can help achieve one of the primary goals, i.e. beating the benchmark. This paper focuses on the impact of investment timing on long-term investment performance. It defines the optimal time frame of “buying at the bottom” and demonstrates how buying near the bottom and several years after the bottom provides a higher probability of outperforming the benchmark; the NCREIF property index (NPI)2 due to expected relatively higher dividend yields and the recovery of net operating income (NOI), if other investment factors remain constant.

Note: While the first three quarters of data is available for 2010 as of this update, most analysis in this paper only incorporates year-end 2009 data for two reasons: 1) the analysis is based on full-year data series; 2) the recent three quarters of NCREIF performance were strongly driven by the short-term capital market effect, which is exactly one of the key message that this paper is attempted to address. For investors with a long-term perspective, recent capital market effect has a small contribution to total returns.

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