Real Estate Finance: REITs, Commercial Mortgages, and Housing Market Dynamics

Abstract

Real estate—residential and commercial property—is the world’s largest asset class, with global real estate value estimated at approximately $326 trillion in 2020, representing 43% of global wealth. Real estate markets exhibit distinctive characteristics that differentiate them from securities markets: illiquidity, high transaction costs, heterogeneity (no two properties are identical), and local market segmentation. This paper reviews real estate finance theory and evidence across three major segments: residential real estate markets and mortgage finance; commercial real estate finance and capitalization rate determination; and Real Estate Investment Trusts (REITs), which provide liquid stock-market exposure to real estate economics. We examine housing cycle dynamics, the role of credit in amplifying housing booms and busts, commercial real estate valuation through the income approach, and the performance characteristics of REITs as an asset class in diversified portfolios.