The Risk and Return of Commercial Real Estate: A Property Level Analysis

This paper develops a novel empirical method that uses property level cash flow information to estimate the risk and return characteristics of private commercial real estate. Monte Carlo simulations suggest that this method is more accurate than the conventional index-based approach. Applying this method to 3,125 commercial properties (with estimated total value of $147 billion in 2009) invested by institutional investors between 1978 and 2009, this paper finds that the commercial real estate risk premium is positively related to the GDP growth rate and the change in the credit spread, and negatively related to the inflation rate, the stock market risk premium, and the change in the term spread. The sensitivities vary across property types and time. This paper also finds that the risk characteristics of commercial real estate vary across property types. While apartments have small positive loadings on all three Fama French factors, offices, industrial, and retail properties have insignificant loadings on the stock market risk premium, large positive loadings on SMB, and negative loadings on HML. The factor loadings also vary across time.