S hort -T erm and L ong -T erm D iscount R ates For Real Estate Investment Trusts

How should we discount cash flows generated by real estate projects up to 30 years in the future? In this paper, we develop a methodology to estimate the term structure of discount rates. We provide empirical estimates of the yield curve for the REIT market, and three subsectors: Equity, Mortgage, and Hybrids. We explore three empirical hypotheses related to the behavior of the yield curve: First, we examine whether the term structure for REITs should be upward or downward sloping. Second, because REIT betas tend to be counter-cyclical, we examine the hypothesis that discount rates implied by our term structure model should be higher than those implied by the traditional CAPM. Third, in the spirit of Campbell 1991, we decompose the variance of REIT prices into variation due to the cost of capital and variation due to expected cash flows and find some unexpected results.