Capitalization rate and control variables

Capitalization rates are calculated from the Strabo commercial real estate database of commercial real estate transactions, which tracks rental and asset transactions for individual properties at the time of purchase. This dataset allows us to construct property level capitalization rates as both asset and rental transaction values at the time of purchase are available. The data used cover the period from January 1990 to March 2011 and include periods of both boom and bust in the commercial real estate market. For each property sold in the sample period, we compute the capitalization rate as the asset price per square metre divided by the rent (cash-flow income) per square metre at the time of purchase. We also have limited information about a property’s structural characteristics such as the total square metres of office space in the asset transaction.⁵⁶ We are also able to distinguish between new and existing properties.⁵⁷ For the risk-free interest rate, we use the rate on ten-year Dutch government bonds.

In our analysis, we only calculate capitalization rates for properties that have asset and rental transactions at the time of purchase. The removal of those transactions for which we do not have this information reduces the sample to 2,649 observations. We further excluded transactions where we had insufficient information on the property characteristics, reducing the sample to 2,646. Finally, we excluded transactions lacking a complete postal address, leaving us with 2,065 observations.

The main descriptive statistics are given in Table 5.1. In the table, we can see that the mean capitalization rate over the 1990-2011 period was 8.81 per cent, with a median

56 We do not have detailed information on characteristics such as building year, property quality and the condition of the property. We take this into account by seeing the rent as a proxy for quality.

57 The size is based on the useable office space in the asset transaction and not on the property size. This is because some transactions are within-property transactions.

capitalization rate of 8.40 per cent. So investors pay on average 12 times the annual rent at the time of purchase. The property-specific capitalization rates show substantial variation, ranging from a low of 3.48 per cent to a high of 33.1 per cent.

Notes: This table shows the descriptive statistics for the variables of interest. Panel (A) shows the summary statistics for the capitalization rate (asset price/rent), rent per square metre, asset price per square metre, contract size, new office property (dummy), and interest rate. Panel (B) shows the distribution over time, between the provinces in the Netherlands, and also in specific metropolitan areas. * The 2011 data only include transactions in the first three months.

While variation in property specific capitalization rates reflect different risk-return levels over time, it reflects heterogeneity across properties as well and underlines the great benefit of using transaction-based data. The mean real rent per m² ranges from €36 to

€367 with an average of €127 per square metre over the period studied, and a median of

€123 per square metre. The mean contract size was 3,707 m², with a median size of 1,847 m². On average, 7 per cent of the transactions involved new properties, relative to existing properties. We can also observe that transactions peaked in 2007, with approximately 11 per cent of all the transactions in our period.

Table 5.2 - Correlation matrix

Variable Cap rate Rent Size New property Interest rate

Cap rate 1 -0.31 *** -0.15 *** -0.13 *** 0.28 ***

Rent -0.31 *** 1 0.23 *** 0.08 *** -0.33 ***

Size -0.15 *** 0.23 *** 1 0.15 *** -0.08 ***

New property -0.13 *** 0.08 *** 0.15 *** 1 0.06 ***

Interest rate 0.28 *** -0.33 *** -0.08 *** 0.06 *** 1

Notes: This table presents the correlation matrix between the variables included in Table 5.1 and indicates dependencies between the variables of interest. Significant relationships at the 1 per cent levels are indicated by ***.

Table 5.2 shows the correlations among the variables of interest used in the analysis. The results reveal that the capitalization rate is negatively correlated with the rent (cash-flow generated), the office size, as well as to new properties. This univariate evidence indicates that higher cash-flows are associated with lower capitalization rates, and that larger transactions and new properties have lower capitalization rates. In addition, we find that the interest rate is positively correlated with the capitalization rate.

To further explore temporal and cross-sectional variation in capitalization rates, it is informative to examine the bivariate relationship of capitalization rates with interest rate, and of asset prices with rents. Figure 5.1 depicts the capitalization rate and the interest rate by year (upper panel) and the rent by asset price (lower panel). From the upper panel, one observes that the interest rate ranged from a high of 8.92 per cent in 1990 to a low of 2.98 per cent in 2010. The first observation is of a rising mean capitalization rate and a declining interest rate in the period up to 1995. Furthermore, we observe a strongly declining pattern for both the capitalization rate and the interest rate from 1995 up to 2004. After 2004, the capitalization rate and interest rate tended to move in opposing directions. So, while capitalization rates reflect interest rate variation to a certain extent is does not fully mimic temporal variation in interest rates. The cross -sectional variation in capitalization rates is reflected in the bivariate relationship of asset prices with rents. While one observes a linear relationship between asset prices and rents,

considerable variation can be observed in the lower panel of Figure 5.1. In this chapter we consider to what degree property-specific variation in capitalization rates relates to agglomeration economies.

Figure 5.1 Capitalization rates and interest rate by year (upper panel) and rent against asset price (lower panel)

Notes: The upper panel shows the mean capitalization rate and the interest rate over the 1990-2011 period. In the lower panel, we plot the asset prices against rents for individual transactions.