Commercial Real Estate Rental Index: A Dynamic Panel Data Model Estimation

Abstract

Using the actual quarterly rental income generated in the years between 2001 and 2010 by over 9,000 NCREIF commercial properties, we construct a commercial real estate rental index and estimate the time series properties (e.g., mean-reversion speed and volatility) of market-wide rental growth using a dynamic panel data model. The dynamic panel data model has several advantages over a standard hedonic regression. In addition, we incorporate age effects into our panel data model, and by doing so we correct the age-bias in the repeated sales method and in the simple average method. Our estimates show that rental growth is cyclical but it generally lags behind broader economic growth. Surprisingly, the long-term average rental growth is significantly lower than what is usually perceived, and the volatility of rental growth can be significantly under-estimated when the conventional methods are adopted. We also find significant cross-property type and cross-region variations in the rental adjustment process. In contrast to the existing literature, we find a strong negative relation between rental growth and cap rate, and that this relation is significantly stronger than that between NOI growth and cap rate. Finally, we establish an empirical relation between price return and rental growth in the commercial real estate market.

Keywords: rental index, cap rate, commercial real estate, dynamic panel data model