CAIA - 15 - Real Estate Indices and Unsmoothing Techniques

Question 1

___ ___exists when real estate transaction prices contain errors, rendering the prices less reliable.

Answer 1

Transaction noise exists when real estate transaction prices contain errors, rendering the prices less reliable.

Question 2

The two primary approaches to real estate indexation are ___-based and ___-based techniques.

Answer 2

The two primary approaches to real estate indexation are appraisal-based and transaction-based techniques.

Question 3

Reported asset prices may have a delayed reaction to changes in economic conditions, which results in a ___ ___.

Answer 3

Reported asset prices may have a delayed reaction to changes in economic conditions, which results in a smoothed series.

Question 4

The unsmoothing process removes the effects of smoothing by reducing the level of ___ in the data.

Answer 4

The unsmoothing process removes the effects of smoothing by reducing the level of autocorrelation in the data.

Question 5

A smoothed return series has lower ___ ___, lower ___and lower ___.

Answer 5

A smoothed return series has lower standard deviations, lower correlations and lower betas.

Question 6

In perfect markets with low or no transaction costs, ___ can unsmooth prices.

Answer 6

In perfect markets with low or no transaction costs, arbitrageurs can unsmooth prices.

Question 7

Two key impediments prevent arbitrageurs from unsmoothing a smoothed return series:

1. No real ___ ___
2. ___ ___and other ___

Answer 7

Two key impediments prevent arbitrageurs from unsmoothing a smoothed return series:

1. No real trading opportunities
2. Transaction costs and other barriers

Question 8

Key consequences for understating volatility of assets with smoothed prices are inflated ___ ___ and ___ to the assets by standard portfolio optimization models.

Answer 8

Key consequences for understating volatility of assets with smoothed prices are inflated Sharpe ratios and overallocation to the assets by standard portfolio optimization models.

Question 9

Smoothing model equation in terms of beta

Answer 9

Question 10

Smoothing model equation in terms of alpha (rate of decay)

Answer 10

Question 11

A ___ α indicates that the current reported price is driven more by the current true price than by true prices in previous time periods.

Answer 11

A larger α indicates that the current reported price is driven more by the current true price than by true prices in previous time periods.

Question 12

Fisher estimates α to be ___ for private, unleveraged annual real estate returns.

Answer 12

Fisher estimates α to be 0.4 for private, unleveraged annual real estate returns.

Question 13

What is the true price in terms of first-order autocorrelation. (equation)

Answer 13

Question 14

There are 4 key reasons for first-order autocorrelation

1. A price index is based on ___ ___and ___ ___.
2. ___may generate smoothed prices and exhibit ___
3. Even efficient markets may signal ___ ___responses
4. There is often a ___ ___between setting the price and reporting the transaction.

Answer 14

There are 4 key reasons for first-order autocorrelation

1. A price index is based on recent transactions and stale components.
2. Appraisers may generate smoothed prices and exhibit anchoring
3. Even efficient markets may signal lagged price responses
4. There is often a time delay between setting the price and reporting the transaction.

Question 15

What is the correlation coefficient between 2 variables?

Answer 15

Question 16

What is the true variance of smoothed returns (equation)

Answer 16

Question 17

What is the Beta of true returns (equation)

Answer 17

Question 18

___ ___ ___or ___occurs because real estate market transactions involve negotiations between parties and the final transaction price is one of value from a range of prices that could have resulted from the negotiations.

Answer 18

Purely random error or noise occurs because real estate market transactions involve negotiations between parties and the final transaction price is one of value from a range of prices that could have resulted from the negotiations.

Question 19

___ ___ ___occurs when transaction prices are related to historical prices because of the structure of the real estate market.

Answer 19

Temporal lag bias occurs when transaction prices are related to historical prices because of the structure of the real estate market.

Question 20

Noisy pricing can be explained by the fact that the transaction price is selected from a range of ___ ___.

Answer 20

Noisy pricing can be explained by the fact that the transaction price is selected from a range of reservation prices.

Question 21

The difference between an observed price and the unobservable true market value is referred to as ___ ___ ___or ___ ___ ___.

Answer 21

The difference between an observed price and the unobservable true market value is referred to as transaction price noise or transaction price error.

Question 22

The difference between an appraised value and the unobservable true market value is referred to as ___ ___.

Answer 22

The difference between an appraised value and the unobservable true market value is referred to as appraisal error.

Question 23

The random appraisal estimation error can be reduced by using more ___ ___. However, using data from earlier periods increases ___ ___. Similarly, reducing ___ ___increases the ___. This ___-___trade-off has a ___form: it ___but at a ___rate.

Answer 23

The random appraisal estimation error can be reduced by using more transaction data. However, using data from earlier periods increases temporal lag. Similarly, reducing temporal lag increases the noise. This noise-lag trade-off has a concave form: it increases but at a decreasing rate.

Question 24

The accuracy of an estimated appraisal is ___ proportional to the ___ ___of the number of transactions

Answer 24

The accuracy of an estimated appraisal is inversely proportional to the square root of the number of transactions

Question 25

There are 3 primary approaches to appraising real estate:

1. ___ ___ approach
2. ___ approach
3. ___ approach

Answer 25

There are 3 primary approaches to appraising real estate:

1. Sales comparison approach
2. Cost approach
3. Income approach

Question 26

The ___ appraisal approach estimates a property’s value by adding the depreciated value of any improvements to the land value.

Answer 26

The cost appraisal approach estimates a property’s value by adding the depreciated value of any improvements to the land value.

Question 27

The ___ appraisal approach is a discounted cash flow approach that values a property by discounting the property’s projected net operating income by an appropriate discount rate.

Answer 27

The income appraisal approach is a discounted cash flow approach that values a property by discounting the property’s projected net operating income by an appropriate discount rate.

Question 28

There are 2 primary advantages of appraisal-based models:

1. They do not suffer from a ___ ___ ___bias
2. All properties can be ___ ___.

Answer 28

There are 2 primary advantages of appraisal-based models:

1. They do not suffer from a small sample size bias
2. All properties can be appraised frequently.

Question 29

There are three disadvantages to appraisal-based models:

1. Appraisals are ___ and ___-___.
2. Values of appraisal-based indices are ___
3. Appraisal techniques depend on ___of ___ ___

Answer 29

There are three disadvantages to appraisal-based models:

1. Appraisals are subjective and backward-looking.
2. Values of appraisal-based indices are smoothed
3. Appraisal techniques depend on availability of quality data

Question 30

The change in value of each property in the NPI is calculated on an “___ ___” basis. If a property was bought or sold during the quarter, its ___ ___is used.

Answer 30

The change in value of each property in the NPI is calculated on an “as if” basis. If a property was bought or sold during the quarter, its transaction price is used.

Question 31

NPI returns are calculated on a (pre/post)-tax basis.

Answer 31

NPI returns are calculated on a pre-tax basis.

Question 32

Appraisers typically use the ___/___ ___ ___analysis approach.

Answer 32

Appraisers typically use the income/discounted cash flow analysis approach.

Question 33

A drawback of the income/discounted cash flow analysis method is that its results are subject to ___ ___.

Answer 33

A drawback of the income/discounted cash flow analysis method is that its results are subject to forecasting errors.

Question 34

The index that tracks commercial real estate properties in the UK is called the ___ ___ ___.

Answer 34

The index that tracks commercial real estate properties in the UK is called the Investment Property Databank.

Question 35

The characteristics of transaction based real estate indices are:

1. They are based on ___ ___and ___ ___
2. Differences in properties are ___ ___
3. ___ ___is minimized

Answer 35

The characteristics of transaction based real estate indices are:

1. They are based on ample data and econometric methods
2. Differences in properties are controlled for
3. Statistical noise is minimized

Question 36

The ___-___ ___regresses the percentage price changes observed in properties onto a sequence of time dummy-variables representing the historical periods in the index

Answer 36

The repeat-sales method regresses the percentage price changes observed in properties onto a sequence of time dummy-variables representing the historical periods in the index

Question 37

There are 2 primary advantages of the repeat sales method:

1. Does not need detailed information on ___ ___
2. Fairly robust to ___ ___

Answer 37

There are 2 primary advantages of the repeat sales method:

1. Does not need detailed information on property characteristics
2. Fairly robust to specification error

Question 38

There are 3 key disadvantages to the repeat sales model:

1. It likely suffers from ___ ___ ___
2. It assumes the property ___ ___ ___
3. It results in ___ ___

Answer 38

There are 3 key disadvantages to the repeat sales model:

1. It likely suffers from sample selection bias
2. It assumes the property did not change
3. It results in backward adjustments

Question 39

The ___ ___ ___attempts to value properties as a function of the properties’ specific attributes.

Answer 39

The hedonic pricing method attempts to value properties as a function of the properties’ specific attributes.

Question 40

Advantages of the hedonic pricing method:

1. It uses ___ ___
2. It is ___
3. It does not make ___ ___
4. It analyzes a property’s ___ ___
5. It can be used to estimate the ___ ___to property prices

Answer 40

Advantages of the hedonic pricing method:

1. It uses all observations
2. It is versatile
3. It does not make backward adjustments
4. It analyzes a property’s value attributes
5. It can be used to estimate the marginal contribution to property prices

Question 41

There are 6 disadvantages to the hedonic pricing model:

1. It needs a ___ ___ ___
2. It may suffer from ___ ___ ___
3. It is subject to ___ ___
4. It assumes ___are known
5. It assumes buyers will be able to ___ ___ ___ they want
6. It is subject to ___

Answer 41

There are 6 disadvantages to the hedonic pricing model:

1. It needs a large data set
2. It may suffer from sample selection bias
3. It is subject to specification error
4. It assumes externalities are known
5. It assumes buyers will be able to select the attributes they want
6. It is subject to multicollinearity

Question 42

___ occurs when there are high correlations between two or more predictor variables.

Answer 42

Multicollinearity occurs when there are high correlations between two or more predictor variables.

Question 43

___ ___in regression are the errors that occur because of a mistake in one of the variables or other assumptions of the model

Answer 43

Specification errors in regression are the errors that occur because of a mistake in one of the variables or other assumptions of the model

Question 44

The ___ ___ ___is a hedonic index that uses transaction data from NCREIF.

Answer 44

The transaction based index is a hedonic index that uses transaction data from NCREIF.

Question 45

Sample selection bias has a ___ effect on commercial property than residential because its sample size is ___.

Answer 45

Sample selection bias has a greater effect on commercial property than residential because its sample size is small.

Question 46

The transaction based TBI has been (more/less) volatile than the appraisal based NPI

Answer 46

The transaction based TBI has been more volatile than the appraisal based NPI

Question 47

Compared to stocks and bonds, mortgage REITs have generated (higher/lower) returns with (higher/lower) risk.

Answer 47

Compared to stocks and bonds, mortgage REITs have generated higher returns with higher risk.

Question 48

Mortgage REITs Sharpe and Sortino ratios are (higher/lower) than world equities and commodities and (higher/lower) than those of global bonds and U.S. high yield.

Answer 48

Mortgage REITs Sharpe and Sortino ratios are higher than world equities and commodities and lower than those of global bonds and U.S. high yield.

Question 49

Net Operating Income (Equation)

Answer 49

NOI = Effective Gross Income - Operating expense

Question 50

Effective gross income (equation)

Answer 50

Effective Gross Income = Potential Gross Income (1 - Vacancy Loss Rate)

Question 51

True Return derived from smoothed returns (Equation)

Answer 51

R_T2 = (R_R2 - pR_R1) / (1 - p)