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The German Open-End Fund Crisis – A Valuation Problem?

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Abstract

Using a unique dataset of appraised values and transaction prices, this paper investigates whether systematic over-appraisals could have been at the heart of the 2005/2006 German open-end fund crisis. Because sold properties are valued more closely to market values than unsold properties, we develop a hedonic pricing model that controls for sample selectivity. The resulting estimates of prices achievable in the market are then compared to appraised values. Our results show that the properties held by open-end real estate funds were likely to have been overvalued prior to the crisis. This supports the view that a fundamentally justified run was at the heart of the 2005/2006 crisis, and it challenges the effectiveness of current valuation practices.

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Notes

  1. German investment law explicitly provides for the possibility to close a fund due to liquidity problems. However, since the introduction of OEREFs in 1959, this rule had been not been tested prior to the 2005/2006 crisis.

  2. Of course, the two views presented here are not mutually exclusive. In fact, bad fundamentals and a speculative momentum may well have interacted during the crisis.

  3. By the end of 2009 only two German REITs were issuing shares, i.e. Alstria Office and Fair Value.

  4. Until the end of 2007 sale prices were allowed to “marginally” fall short of valuations.

  5. Of course, one could follow (1981) in arguing that the volatility of market prices may actually be too high relative to the volatility of the underlying income stream. Appraisals would then be merely trying to eliminate excess volatility.

  6. Note that there can be a valuation mismatch either with or without smoothing and lagging being present.

  7. By excluding observations of appraised values shortly before a transaction took place, we are able to rule out the “information spill-over” hypothesis. Excluding observations prior to sales furthermore reduces the likelihood of dealing with appraised values that are influenced by clients.

  8. By the end of 2007, the IPD database contained about 3,800 properties, with a total market value of EUR 44.5bn. Thereof, office properties (47%) accounted for the largest fraction in volume terms, followed by other properties (22%), retail (19%) and residential properties (11%). In terms of investor coverage, properties of the IPD database were held by open-end funds (42%), insurance and pension funds (39%), asset managers (13%), and special real estate funds (6%).

  9. RICS/IPD (2008) exclude appraisal based values three months prior to a sale.

  10. For a review of the literature on hedonic pricing models see Malpezzi (2002)

  11. Frankfurt hosts the largest fraction of properties in our sample. The dummy variable is omitted from our regression equation.

  12. Here we depart from Fisher et al. (2003, 2007), who do not explicitly model the factors that determine the probability of a sale other than the hedonic factors.

  13. Fisher et al (2003, 2007) use the midpoint assumption to identify the seller’s and buyer’s reservation price equation, respectively. Since our primary goal is to compensate for sample selection bias, rather than to identify the reservation price equation on either side of the market, any alternative assumption about bargaining power would be suitable.

  14. Actually, we only need the inverse Mills ratio for the sold properties.

  15. In normal times, property valuations tend to be conservative. That is, on average there will be a slight undervaluation compared to what can be expected in the market.

  16. This equals the predicted error from our hedonic regression for the combined sample.

  17. The sample size is reduced compared to the naive specifications, as we consider only valuation reserves within the boundaries of +/-25%

  18. For instance, the Swiss model confines share redemptions to the end of the calender year, in addition to having a one year notice period.

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Authors and Affiliations

  1. European Central Bank, Sonnemannstraβe 20, 60314, Frankfurt am Main, Germany

    Christian Weistroffer

  2. IREBS International Real Estate Business School, University of Regensburg, Universitaetsstr. 31, 93040, Regensburg, Germany

    Steffen Sebastian

Authors
  1. Christian Weistroffer
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  2. Steffen Sebastian
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Correspondence to Steffen Sebastian.

Additional information

We thank the IPD Investment Property Databank for generous access to their database; especially Alexander Bauer, Lars Dierkes, Björn-Martin Kurzrock, Daniel Piazolo, Julius Stinauer and Matthias Thomas for excellent support and great hospitality at IPD. We are grateful to Neil Crosby, Andreas Hackethal, Jan Pieter Krahnen, David Nicolaus and the anonymous referees for valuable comments and suggestions; and especially to René-Ojas Woltering for outstanding research assistance. The views expressed in this article are those of the authors only and do not necessarily reflect the views of the European Central Bank. Any errors or omissions are the responsibility of the authors.

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Weistroffer, C., Sebastian, S. The German Open-End Fund Crisis – A Valuation Problem?. J Real Estate Finan Econ 50, 517–548 (2015). https://doi.org/10.1007/s11146-014-9485-9

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