Valuation Estimates and Return Smoothing: Evidence from Private Equity Real Estate Assets

48 Pages Posted: 17 Jan 2024

See all articles by Spencer J. Couts

Spencer J. Couts

University of Southern California - Sol Price School of Public Policy; USC Lusk Center of Real Estate

Date Written: January 5, 2024

Abstract

Illiquid assets have stale prices and spurious return autocorrelation. It is important to understand what drives this autocorrelation. I provide evidence that the fundamental driver of this phenomenon is the difficulty in valuing illiquid assets and not managerial manipulation. Specifically, I find that autocorrelations, risk factor loadings, beta's and risk-adjusted returns alpha's, are all statistically and economically equivalent, regardless of whether valuations are completed internally or externally. I do find, however, that market pricing information is incorporated at a slower rate when managers complete the valuation updates, but this does not increase return smoothing. In fact, it decreases the smoothing effect because the rate at which they incorporate market pricing information is time-varying. Specifically, I find that internal valuations have a significantly larger percentage of lame valuations and significantly smaller valuation updates and that because the percentage of lame valuations varies over time, the loadings on lagged factors are actually smaller for internal valuations. However, the difference in the valuation update and the loadings on lagged factors are due to the greater percentage of lame internal valuations. After controlling for lame valuations, the loadings on lagged factors increase for both external and internal valuations. However, they increase the most for internal valuations such that they become economically and statistically equivalent. Additionally, the size of valuation updates becomes economically equivalent after controlling for lame valuations as well. Lastly, I find that managers and third-party appraisers both put forth the greatest valuation effort when market returns are the most extreme.

Keywords: Commercial Real Estate, Illiquid Assets, Return Smoothing

JEL Classification: G11, G12, G13, G14, G23, R33

Suggested Citation

Couts, Spencer J., Valuation Estimates and Return Smoothing: Evidence from Private Equity Real Estate Assets (January 5, 2024). Available at SSRN: https://ssrn.com/abstract=4684665 or http://dx.doi.org/10.2139/ssrn.4684665

Spencer J. Couts (Contact Author)

University of Southern California - Sol Price School of Public Policy ( email )

Los Angeles, CA 90089-0626
United States

USC Lusk Center of Real Estate ( email )

650 Childs Way
Los Angeles, CA 90089
United States

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