California Dreamin’ Rational and Irrational Exuberance in Property Markets
-
Upload
api-25984133 -
Category
Documents
-
view
223 -
download
0
Transcript of California Dreamin’ Rational and Irrational Exuberance in Property Markets
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
1/44
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
2/44
California DreaminRational and Irrational Exuberancein Property Markets
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
3/44
Bubbles and the Winners CurseSnap, Crackle and Pop:
How to Win in a Bubble Economy
Randall ZislerManaging Director and Chief Investment Officer
Griffin & Company, LLCA Real Estate Investment Bank
Beverly Hills
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
4/44
Outline
What is a bubble?
What causes bubbles?
How can investors minimize the likelihood of
overpaying during a bubblewinners curse? What are the warning signs a bubble exists?
How can investors profit during a bubble?
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
5/44
Thank You! to Our Contributors
Irrational Exuberance
HeitmanA Real Estate Investment Management Firm
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
6/44
Popular Bubble Definitions Irrational exuberance
Speculative mania Self fulfilling
prophecy
Vicious cycles
Speculative orgy
Markets out of line Analytic approach
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
7/44
What is a Bubble?
A psychological state of irrational exuberance
and investor enthusiasm
Spreads like contagion
A cascade of amplifying stories Price and volume increases
Doubts about fundamentals crumble in theface of investor envy
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
8/44
Famous Bubbles
Japanese stock market in the 1980sPalm stock and the NASDAQ run-up
U.S. real estate in the 1980s
Stock market and DOT COM 1994 through 2000
Real estate 2004 - ?
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
9/44
South Sea Bubble
0
100
200
300
400
500
600
700
800
900
1000
1720.0 1720.5 1721.
perfullyp
aidshare
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
10/44
South Sea Bubble
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
11/44
TulipmaniaOne of the early experiments in
financial engineering
0
10
20
30
40
50
60
70
1634 1635 1636 1637
PriceofG
oudatulipbu
lbs,
Guilders
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
12/44
Teapot Dome Scandal
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
13/44
Bubbles are easier todetect with the benefit of
20/20 hindsight!
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
14/44
What is Not a Bubble? A rapid price increase
Relative prices can change due to
regulatory or tax changes, cartel-inducedoil price hikes
Have fundamentals changed?
Are expectations of future price increasessustaining the market?
Are these expectations creating anxieties? Is there sufficient confidence in diverse
expectations to generate trades
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
15/44
Housing and Apartments are the
Most Bubbly
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
16/44
Single Family Homes and
Condominiums are Bubbly
Disentangling bubbles from fundamentals is difficult.
One comparable period of home price increases isthe period just following WW II.
Smart money does not typically speculate in homes
Real, quality-adjusted, housing prices have notappreciated significantly over the decades.
Stock and housing market booms have a two yearlagged correlation.
Booms are contagious across asset classes.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
17/44
BubblesMacro Correlates
Prices are significantlyabove trend
High prices in relationto incomecap rateshave fallen rapidly
High price volatility Trading volume is high
and rising
Increase in frequencyof portfolio and megadeals
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
18/44
Bubbles-Micro Correlates
Winners curse and participant irrationality
More bidders increase probability ofoverestimating the value of an asset
Increased bid dispersion Bubbles do not typically crash if there is a lot of
market noise and investors are not
synchronized Many positive feedback channels, not all
evident to investors
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
19/44
Positive Feedback
Difficult to identify precipitating factors orspecify causality; feedback can last for
years Feedback occurs in response not to a
sudden price increase but a consistentpattern of price increases
Price-to-GDP-to-price
Price-to-price Wealth-to-price
Price-to-corporate earnings-to-price
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
20/44
Not all bubbles are bad!
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
21/44
Stock Market Interlinkages
Stock markets can play a significant stabilizing ordestabilizing role
Where countries have different financial risk,interlinkage reduces dispersion of asset prices.
Where countries differ to asset payoff risk, linkagecan increase price dispersionhigh prices arehigher and low prices are lower
Financial liberalization, short-run inelastic supply ofassets, and absence of short sales.
Central bank must make difficult choices: Stabilizeexchange rates? Consumer prices? or assetprices?
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
22/44
Agency Problems
Intermediaries with agency problems buymost real estate.
Leverage accentuates the agency problem.
Borrowers increase payoffs in good times
by shifting risk to lenders in bad times. In the aggregate, this risk shifting can bid
up prices.
The riskier the asset, the more risk to beshifted and the larger the bubble.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
23/44
And now for some fun
technical stuff!
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
24/44
Our Bubble Model 1
Assumptions
High trading costs
Short sales not allowed or practically too costly
Heterogeneous and asymmetric information Investors differ in assessment of fundamentals
Inelastic supply of real estate assets
Many risk neutral agents
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
25/44
Our Bubble Model 2
Preliminaries and predictions
Coexistence of high prices, high trading volume, and highvolatility
Asset prices may exceed fundamental value when agentsdisagree or when short selling is not possible
Agents disagree regarding probability distribution ofexpected income
Information signaled through noisy indicators; each classof bidders has a special indicator
Agents are overconfident in the accuracy of their indicators.
Thus, there are different forecasts.
The noisier the information, the more trades.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
26/44
Our Bubble Model 3
The Bubble
Asset owners have an option to sell the asset in thefuture to agents in other bidding groups
Determining the option value is an optimal stoppingproblem
Value of option (the bubble) is difference betweendemand price and fundamental value
Fluctuations in bubble value contributes to priced
volatility Bubble is consequence of divergence of opinions by
overestimation of informativeness of distinct indicators
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
27/44
Our Bubble Model 4
When to sell?
The critical amount, K, is the amount by which the pricemust exceed the agents valuation
K determines turnover and sales volume
K is zero when there are no trading costs, C
Low C increases the size of the bubble and volatility
As C increases, K increases and the expected profit fromeach trade increases.
Forecasts oscillate and information flows, thusgenerating trades
The greater the overconfidence of heterogeneous beliefs,
the greater is the size of the bubble
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
28/44
Lets check the evidence!
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
29/44
REIT Trading Volume is Up
0
500
1000
1500
2000
2500
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
AllREITs
,averagedailytradingvo
lume,
millionsofdollars
Volume
Predicted
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
30/44
NCREIF Cap Rates Have Fallen
4%
5%
6%
7%
8%
9%
10%
11%
923 943 963 983 003 023 043
Year-Quarter
C
apRates
Cap Rates - All Sold Props
Current Value (Appraisal) Cap Rates
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
31/44
Total and Apartment
REIT and Returns
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Returns
tandarddeviatio
n,
monthly,
% all stdev
apt stdev
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Returnm
ovingaverage,monthly,
% all mov
apt mov
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
32/44
NCREIF Regional Cap Rates
5%
6%
7%
8%
9%
10%
11%
12%
91 93 95 97 99 01 03Year-Quarter
Cap
Rates
East West
South Midwest
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
33/44
Total Private NCREIF Sales
0
100
200
300
400
500
600
700
78 82 86 90 94 98 02
Year
Prop
erties
0
5,000
10,000
15,000
20,000
25,000
MarketValue(millions)
# of Properties
Market Value
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
34/44
If you win the bid, are
you losing the game!
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
35/44
Winners CurseWhat is it? People often overestimate the precision of their
knowledge; Illusion of knowledge; experts estimateswill vary substantially
Asymmetric bargaining and incomplete information Winning the bidding is a Pyrrhic victory Each player estimates the value of the asset. If bidders estimates are unbiased, then the highest
bidder almost certainly overestimates the value,and, on average, overpays
Perceptive, rationale bidders place a bid below theirestimate of value
The greater the winners curse, the greater thenumber of bidders, the uncertainty of the price of theasset, and the dispersion between the highest and
lowest bid.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
36/44
Avoiding the Winners Curse Rationality is an assumption, not a demonstrated
fact!
The curse is about cognitive illusion and systematicerror, especially in bubble economies
Hubris hypothesis and takeovers
Collusion (which is probably illegal) or sharingknowledge with competitors to reduce their bids
Bidding lower than ones estimate of value, and being
prepared to lose more auctions and to avoid loses. Avoiding auctions and focusing on off-market
transactions.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
37/44
Focus on California
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
38/44
California Apartment and Total
Cap Rates and Trading Volume
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
2001 2002 2003 2004 2005
Averagecapr
ate,
%
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
$8.0
$9.0
Totalvolumesales,
$billions
CA apartment average cap rate
CA apartment volume, $
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
2001 2002 2003 2004 2005
Averagecapr
ate,
%
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
$8.0
$9.0
Totalvolumesales,
$billions
CA office average cap rate
CA off ice volume, $
2005 Real Capital Analytics, Inc. All rights reserved.2005 Real Capital Analytics, Inc. All rights reserved.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
39/44
U.S. Apartment and Total
Cap Rates and Trading Volume
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
2001 2002 2003 2004 2005
Averagecaprate,%
$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
$30.0
Totalvolumesales,$billions
US apartment average cap
rate
US apartment volume, $
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
2001 2002 2003 2004 2005
Averagecapr
ate,%
$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
$30.0
Totalvolumesales,$billions
US office average cap rate
US office volume, $
2005 Real Capital Analytics, Inc. All rights reserved. 2005 Real Capital Analytics, Inc. All rights reserved.
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
40/44
Is Real Estate in a Bubble?
Probably, we observe high prices, increased
volatility, high trading volume, and increaseddispersion of bids
Maybe we are witnessing a massive institutionalportfolio shift toward real estate
The bubble component varies by market, assettype, and location
Single family homes and apartments/condos are the
most bubbly How will the bubble break? What are the likely mechanisms of a burst bubble?
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
41/44
Will the bubble break?
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
42/44
Profiting During Bubbles 1 Brokers (paid based on trading volume):
Punctured bubbles are Darwinian herd-thinners Agents benefit from volatility and heterogeneity
Break up portfolio if assets have low correlation
Otherwise, reap potential portfolio premium
Research as story telling generates trades andreinforces environment of heterogeneous views
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
43/44
Profiting During Bubbles 2
Agents (paid based on asset performance)
Big question: Bubble or change in fundamentals?
Answer suggests different strategies
Avoid auctions
Focus on non-bubble markets
Build strengths that permit preemptive moves
Specialize in controlling certain kinds of systematic risks
Pursue economies of scale
Pay for value-added research that is not a sophisticated
front end for the sales or marketing department
-
8/14/2019 California Dreamin Rational and Irrational Exuberance in Property Markets
44/44
My beach has the BEST bubbles!