Abstract
The real estate literature recognizes the real option to invest in capital expenditures (CAPEX) or sell a property but treats these options as independent. We show that these real options are interconnected. We provide empirical evidence that, consistent with the real option framework, CAPEX increases in income growth expectations but declines in their volatility; that CAPEX are partially capitalized into property market values; and that CAPEX significantly reduce the subsequent likelihood of sale. We also present evidence that, controlling for market timing, past property performance influences CAPEX but not disposition choices, consistent with a value-add investment strategy.
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Notes
We assume that leases are reviewed or renewed so that rents can be reset to the prevailing market level.
Those represent accounting anomalies where excess reserves for CAPEX projects were booked and then reversed when the actual cost of the projects was revealed.
It is important to note that we do not consider routine repairs and maintenance, which would fall under operating expenses, nor tenant incentives and lease commissions.
It is possible for a property to be bought and subsequently sold quickly, potentially within the same year. There are no instances of “flipping” properties in our final sample.
These results are robust to the inclusion of a variable that measures the time since acquisition. However, the homogeneous and low baseline likelihood of sale in the NCREIF data works against us establishing empirical evidence for a significant relationship between CAPEX and subsequent disposition; as a result our estimates can be regarded as conservative.
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Acknowledgments
We are thankful for comments from James Conklin, Robert Connolly, David Geltner, David Ling, Crocker Liu, Joseph Ooi, Tim Riddiough, Jacob Sagi, Stijn Van Nieuwerburgh, and Susan Wachter, as well as an anonymous referee, seminar participants at the RERI Research Conference 2017, the AREUEA National Meeting 2017, the ASSA Annual Meeting 2018, and the University of Florida–Cambridge–National University of Singapore Real Estate Symposium 2018. We gratefully acknowledge financial support from the Real Estate Research Institute (RERI). We are also grateful to the National Council of Real Estate Investment Fiduciaries for providing data.
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Ambrose, B.W., Steiner, E. Economic Fundamentals, Capital Expenditures and Asset Dispositions. J Real Estate Finan Econ 64, 361–378 (2022). https://doi.org/10.1007/s11146-019-09698-9
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DOI: https://doi.org/10.1007/s11146-019-09698-9