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Applied Quantitative
Analysis for Real Estate

To fully function in today’s global real estate industry, students and professionals increasingly
need to understand how to implement essential and cutting-edge quantitative techniques.
This book presents an easy-to-read guide to applying quantitative analysis in real estate aimed
at non-cognate undergraduate and masters students, and meets the requirements of modern
professional practice. Through case studies and examples illustrating applications using data
sourced from dedicated real estate information providers and major firms in the industry, the
book provides an introduction to the foundations underlying statistical data analysis, common
data manipulations and understanding descriptive statistics, before gradually building up to
more advanced quantitative analysis, modelling and forecasting of real estate markets.
Our examples and case studies within the chapters have been specifically compiled for
this book and explicitly designed to help the reader acquire a better understanding of the
quantitative methods addressed in each chapter. Our objective is to equip readers with the
skills needed to confidently carry out their own quantitative analysis and be able to interpret
empirical results from academic work and practitioner studies in the field of real estate and
in other asset classes.
Both undergraduate and masters level students, as well as real estate analysts in the
professions, will find this book to be essential reading.

Sotiris Tsolacos is Professor of Real Estate Investment at Cass Business School and the
Programme Director for the MSc Real Estate Investment. Previously he was with Henley
Business School. He earned his PhD in economics at the University of Reading. He has over
25 years of experience in the quantitative analysis of real estate markets. He has over 40
publications in this field and is the co-author of the book Real Estate Modelling and Forecasting.
He has long industry experience. He was with JLL in London and the Director of European
Research in Property & Portfolio Research/CoStar. He is the co-founder of KappaSigma
Partners, a regional property consultancy firm. He works closely with the industry on a range
of topical themes in real estate. His industry experience and continual engagement with the
profession has greatly inspired the content of this book.

Mark Andrew is Senior Lecturer in Real Estate Finance and Investment and Programme
Director for the MSc Real Estate at Cass Business School, City, University of London.
He received his PhD from the University of Reading in 2001 and has taught non-cognate
and cognate real estate students for over 15 years. He has published in highly ranked real
estate and non-real estate journals, such as Real Estate Economics, Urban Studies and Environment
and Planning A. He has undertaken a number of government commissioned reports on his
research specialty in residential markets. He currently acts as a referee for a number of leading
academic real estate journals and is a serving member on the IPF Research Steering Group.
Applied Quantitative
Analysis for Real Estate

Sotiris Tsolacos and Mark Andrew

First published 2021
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
52 Vanderbilt Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2021 Sotiris Tsolacos and Mark Andrew
The right of Sotiris Tsolacos and Mark Andrew to be identified as authors of
this work has been asserted by them in accordance with sections 77 and 78 of the
Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or
utilised in any form or by any electronic, mechanical, or other means, now
known or hereafter invented, including photocopying and recording, or in any
information storage or retrieval system, without permission in writing from the
publishers.
Trademark notice: Product or corporate names may be trademarks or registered
trademarks, and are used only for identification and explanation without intent to
infringe.
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
Names: Tsolacos, Sotiris, author. | Andrew, Mark, author.
Title: Applied quantitative analysis for real estate / Sotiris Tsolacos and
Mark Andrew.
Description: Abingdon, Oxon ; New York, NY : Routledge, 2020. | Includes
bibliographical references and index.
Identifiers: LCCN 2020013923 (print) | LCCN 2020013924 (ebook) |
ISBN 9781138561328 (hbk) | ISBN 9781138561335 (pbk) |
ISBN 9780203710876 (ebk) | ISBN 9781351359016 (adobe pdf) |
ISBN 9781351358996 (mobi) | ISBN 9781351359009 (epub)
Subjects: LCSH: Real estate investment—Statistical methods. | Real property—
Statistical methods. | Quantitative analysis.
Classification: LCC HD1382.5 .T79 2020 (print) | LCC HD1382.5 (ebook) |
DDC 332.63/240721—dc23
LC record available at https://lccn.loc.gov/2020013923
LC ebook record available at https://lccn.loc.gov/2020013924
ISBN: 978-1-138-56132-8 (hbk)
ISBN: 978-1-138-56133-5 (pbk)
ISBN: 978-0-203-71087-6 (ebk)
Typeset in Baskerville
by Apex CoVantage, LLC
Visit the eResources: www.routledge.com/9781138561335
Contents

List of figures ix
List of tables xi
Preface xiv
Acknowledgements xvi

1 Introduction 1
1.1 Motivation and rationale for this book 1
1.2 Broad themes covered in the book 2
1.3 Book online resource 4

2 Real estate data 5

2.1 Introduction 5
2.2 Segments of the real estate market 5
2.3 User/occupier market data 6
2.4 Investment market 15
2.5 Indirect investment – property funds 21
2.6 Final remarks 24

3 Data, common manipulations and descriptive statistics

in analysis 25
3.1 Introduction 25
3.2 Data representations 25
3.3 Data structures 27
3.4 Mathematical symbols, operations and rules 28
3.5 Indices/indexes 34
3.6 Applications: preparing data for analysing investment performance 43
3.7 Descriptive statistics 56
3.8 Applications: analysing investment performance 69
3.9 Concluding remarks 70
vi Contents
4 Random variables, correlation, estimation and
hypothesis testing 71
4.1 Introduction 71
4.2 Random variables and probability distributions 72
4.3 The normal and standard normal probability distributions 76
4.4 Measures of association: covariance and correlation 86
4.5 Samples and sampling distributions 92
4.6 Estimation 98
4.7 Hypothesis testing 106
4.8 Concluding remarks 120

5 Simple regression analysis 121

5.1 Introduction 121
5.2 Regression versus correlation – the difference 122
5.3 Population regression function (PRF): key concepts 123
5.4 The sample regression function (SRF): key concepts 126
5.5 The ordinary least squares estimator (OLSE) 128
5.6 Sampling variability of OLS estimators 130
5.7 Significance of regression coefficients 131
5.8 Analysis of variance (ANOVA) 133
5.9 Overall performance of the model – goodness of fit 133
5.10 Assumptions of the classical linear regression model (CLRM) 135
5.11 The issue of bias and efficiency – properties of CLRM 138
5.12 A simple regression model of US commercial prices 140
5.13 Forecasting 150
5.14 Concluding remarks 151

6 Multiple regression 153

6.1 Introduction 153
6.2 Multiple regression model: an overview 153
6.3 Coefficient interpretation in multiple regression 157
6.4 Coefficient of determination: the adjusted R-squared 157
6.5 The F-test of multiple restrictions in the model 158
6.6 Model specification – dynamics and lags in the real estate market 162
6.7 Attributes of a good model 164
6.8 Example: building a multiple regression model for Hong Kong office rents 164
6.9 Using the F-test to test for restrictions 176
6.10 Omitted variables 177
6.11 Standardised coefficients 178
6.12 Concluding remarks 179
Appendix 6A: F distributions 180
 Contents vii
7 Regression diagnostics 181
7.1 Introduction 181
7.2 E(ui ) = 0 182
7.3 Homoscedastic errors 182
7.4 Uncorrelated error terms: E(ui,uj ) = 0 191
7.5 Regressors not correlated with disturbances: E(ui, xi ) = 0 201
7.6 Inappropriate functional form (non-linearities) 202
7.7 Residuals are normally distributed: ui ~ N(0, σ2) 207
7.8 Multicollinearity 209
7.9 Structural breaks and parameter stability 213
7.10 Concluding remarks 221

8 Stationarity 222
8.1 Introduction 222
8.2 Stationarity 222
8.3 Random walks 225
8.4 Implications of non-stationarity 229
8.5 Inducing stationarity 230
8.6 Unit root and stationarity tests 232
8.7 Practical considerations in real estate analysis 238
8.8 Concluding remarks 239

9 Forecast evaluation 241

9.1 Introduction 241
9.2 Objectives in real estate forecasting 242
9.3 Forecast approaches 243
9.4 Sources of error in real estate forecasting 243
9.5 Forecast evaluation tests 244
9.6 Application of forecast evaluation tests – ex post forecasts 249
9.7 Dynamic ex ante forecasts and further testing – US property prices 254
9.8 Directional forecast evaluation 260
9.9 Qualitative forecasts and real estate forecasting in practice 262
9.10 Concluding remarks 262

10 ARMA models 265

10.1 Introduction 265
10.2 AR and MA processes 266
10.3 ARMA specification 268
10.4 Example 269
10.5 Concluding remarks 272
viii Contents
11 Vector autoregressions 273
11.1 Introduction 273
11.2 VAR specification 274
11.3 Specifying a VAR: an application to City of London office market 276
11.4 VAR diagnostics 280
11.5 Impulse response functions – City of London office market VAR 280
11.6 Variance decompositions 284
11.7 Granger causality tests 286
11.8 VAR forecasting – London office market 288
11.9 VAR advantages and limitations 293
11.10 Concluding remarks 294

12 Epilogue 295

Appendix A: statistical tables 298

References 302
Index 307
Figures

2.1 Segments of the real estate market 6

2.2 European logistics take up 8
2.3 Components of total returns 18
2.4 Transaction-based capital values in Asia-Pacific 19
2.5 Capital growth and yield impact 20
2.6 Total return components series for European unlisted property funds 22
2.7 Volume of transactions in Asia-Pacific (offices) 23
3.1 US REIT total return index 34
3.2 Nominal return indices and nominal percentage returns 51
3.3 Simulated distributions of percentage total returns 56
3.4 Graphical illustration of skewness 65
3.5 Graphical illustration of kurtosis 66
4.1 A continuous probability density function 73
4.2 Normal probability distribution 77
4.3 Standard normal and the normal probability distribution 78
4.4 Finding probabilities from the standard normal table 79
4.5 Finding probabilities from the standard normal table in example 3 81
4.6 Finding probabilities from the standard normal table in example 5 82
4.7 Finding the interval value for a probability 83
4.8 Return of capital 85
4.9 Scale for correlation coefficient 86
4.10 Scatter plots 88
4.11 Distribution of prices of all dwellings in a location (population) 94
4.12 Sampling distribution of sample mean values of prices of dwellings 95
4.13 Distribution of prices of flats in a location (population) and the sampling
distribution of sample means of prices of flats 96
4.14 Distribution of prices of dwellings from a non-normal population
and its sampling distribution of sample means 97
4.15 Standard normal and Student’s t distribution 100
4.16 Chi-square distributions with various degrees of freedom 104
4.17 Stylised hypothesis testing procedure 107
4.18 The null and alternative hypothesised distributions in a two-tailed z-test 110
4.19 Decision rule: significance level and critical values 110
4.20 One-tailed test: testing for a reduction in the risk premium 113
4.21 A diagrammatical representation of the result testing the risk premium
using a one-tailed t-test 114
x Figures
4.22 The p-value approach to testing the risk premium using a
one-tailed test 116
4.23 JB test for normality 118
5.1 The concept of the population regression function (PRF) 124
5.2 The population regression function 125
5.3 The sample regression function 126
5.4 The population and sample regression function 127
5.5 Sample regression function: the ordinary least squares estimator 129
5.6 Extreme R-squared values 134
5.7 Bias and efficiency in estimation 139
5.8 Regression line for equation (5.31) 141
5.9 Actual, fitted and residual values of equation (5.31) 147
5.10 Actual and fitted values in relation to the average of the dependent
variable 148
6.1 The F distribution 160
6.2 A conceptual framework for the determination of rents 165
6.3 Hong Kong office market data 168
6.4 Actual and fitted values for Hong Kong office rents 176
6A.1 F distributions 180
7.1 Homoscedasticity – finite error variance 183
7.2 A known form of heteroscedasticity 184
7.3 Graphical illustration of serial correlation (first order) 193
7.4 Decision rules for the DW statistic 197
7.5 Non-linearity and outliers 203
7.6 Illustration of non-linearities in real estate 204
7.7 Graphical illustrations of a structural break 214
8.1 Stationary series 224
8.2 A white noise series 225
8.3 Random walks – stochastic trends 227
8.4 Random walks – deterministic trend 227
8.5 Central London headline retail rents (index, nominal) 231
8.6 Making the retail rent series stationary 231
8.7 All property total returns (real) in the US 231
9.1 Summary of forecasting approaches 243
11.1 Graphs of impulse responses 283
Tables

2.1 Net absorption calculations (City of London offices) 9

2.2 Four quadrant framework I 16
2.3 Four quadrant framework II 16
3.1 Common mathematical symbols 29
3.2 Lags in data 30
3.3 Properties of natural logarithms 32
3.4 Percentage and logarithmic changes in office prices 33
3.5 Prices of items and expenditure 35
3.6 Monthly Laspeyres return indices 40
3.7 Chain-linked index 42
3.8 A commercial property record 45
3.9 Commercial property portfolio total returns 46
3.10 Constructing weights: commercial property portfolio returns 47
3.11 Nominal percentage returns 48
3.12 Nominal return indexes 49
3.13 Consumer price index and annual inflation rate 52
3.14 Real return indices 54
3.15 Real percentage returns 55
3.16 Nominal and real de-smoothed commercial property percentage
returns 58
3.17 Finding the median, semi-interquartile range and standard
deviation 61
3.18 Investment performance – key summary statistics 69
4.1 Random variable discrete probabilities 75
4.2 Random variable discrete variance 76
4.3 Correlation bonds and property 90
4.4 Variance-covariance matrix 91
4.5 Correlation matrix 91
4.6 Portfolio expected investment performance 92
4.7 Guide to using the standard normal or t distribution to construct
confidence intervals 102
4.8 Descriptive statistics percentage nominal returns 103
4.9 Type 1 and type 2 errors 108
4.10 Sample data 112
4.11 Critical values of z and t sampling distributions 115
4.12 Descriptive statistics percentage nominal returns 117
xii Tables
4.13 Investment performance measures 118
5.1 Terminology for variables in a regression model 122
5.2 Calculation of OLS coefficients for equation (5.30) 143
5.3 Calculation of standard errors 144
5.4 Finding the t-critical values 145
5.5 Construction of confidence intervals 146
5.6 Fitted values and errors (equation (5.31)) 147
5.7 Estimation of TSS, ESS and RSS 149
5.8 Forecast interval for comg 151
6.1 Hypothesis testing using the F-test 160
6.2 Autocorrelation pattern of variables 169
6.3 Cross-correlations of real rent growth with causal variables 169
6.4 Estimation of standardised coefficients 179
7.1 CLRM assumptions and diagnostic tests 181
7.2 Comparison of OLS and White estimation for heteroscedasticity 190
7.3 Forms of serial correlation in time series 192
7.4 Form of autocorrelation and DW d-statistic values 197
7.5 Durbin Watson critical values (5% level of significance) 197
7.6 Correlation between regressors and residuals 202
7.7 Possible transformations to induce linearity 207
8.1 Random walk models (forms of non-stationarity) 226
8.2 The Dickey-Fuller test 234
8.3 Critical values for the Dickey-Fuller test 235
8.4 Hypotheses for ADF, PP and KPSS tests 237
8.5 Outcomes of ADF, PP and KPSS tests 237
9.1 Forecasts for Hong Kong office rent growth 251
9.2 Forecast evaluation – full sample coefficients 252
9.3 Model forecast versus naïve forecast 253
9.4 Sensitivity of forecast evaluation to forecast period 254
9.5 Correlation patterns for all property price growth and TED spread 255
9.6 Forecast evaluation for one-quarter-ahead forecasts for US all
property price growth 257
9.7 Forecast evaluation for three-quarter-ahead forecasts for US all
property price growth 258
9.8 Three-step ahead forecast evaluation post Lehman’s event 260
9.9 Evaluation of directional forecasts 261
9.10 Evaluation of directional forecasts for rate of growth 262
10.1 Autocorrelation pattern of real NPI returns (dlnpir) 270
10.2 Determining the ARMA specification for real NPI returns (dlnpir) 271
11.1 Lag order selection 278
11.2 Defining the lag order of the VAR in EViews 278
11.3 VAR output for City office market 279
11.4 Impulse responses 281
11.5 Forecast error variance decomposition for London City office VAR 285
11.6 Sensitivity of variance decomposition results to re-ordering 285
11.7 Pairwise causality tests at different lags – City of London offices 288
11.8 Unconditional out-of-sample VAR forecasts 289
11.9 VAR forecasts conditional on predetermined GDPg 290
 Tables xiii
11.10 Calculating the VAR in-sample forecasts 291
11.11 VAR in-sample dynamic forecasts 291
11.12 Forecast evaluation: take up 292
11.13 Forecast evaluation: real rent growth 292
Preface

Motivation
This book aims to support and accompany the teaching of quantitative education in the real
estate field. Over the last few years, the quantitative analysis of real estate markets has grown
in importance. Real estate is a truly multidisciplinary field reflecting the characteristics of the
built environment, which itself is a factor of production, a component of fixed capital invest­
ment, a means of accumulating and holding wealth and an investment asset class. Within
this wide-ranging realm there are important everyday tasks performed in the industry, such
as valuations, cash flow predictions, loan underwriting and asset allocations to mention a
few. The greater sophistication of the industry has generated education demands on students
and analysts. Graduates and apprentices joining valuation teams, capital market, investment
research and debt teams would need to carry out basic and more sophisticated quantitative
analysis. The industry now requires a more analytical skill set.
Both undergraduate and postgraduate courses in real estate, real estate finance and invest­
ment include basic and advanced quantitative analysis in their curriculum. In our experi­
ence, real estate students come from a variety of disciplines. Some may not have studied
mathematics or statistics since leaving school, while others may have studied quantitative
techniques but applied in different contexts and therefore are unfamiliar with real estate data
and theories. There are numerous econometrics textbooks with good applications in the field
of economics and finance. Our motivation for this book was to cover topics, essential and
advanced, that are most in demand by employers in the real estate market. The idea was
to produce a book containing extensive examples of applications in real estate, so that the
reader becomes familiar with real estate data, and the issues and peculiarities encountered
when applying quantitative methods in its analysis, yet at the same time ensure that the level
is accessible readers from a non-numerical and statistical background. Empirical and prac­
tical applications in this book are based on extensive use of real estate data, which should
additionally aid the understanding of the theoretical concepts underlying the explanations of
phenomena and outcomes in the market. We further illustrate the analyses using Excel and
EViews, commonly used software in the real estate industry.
The origin of this book is derived from the content of lectures delivered in modules taught
on the MSc Real Estate and MSc Real Estate Investment degree programmes at Cass Busi­
ness School, and our frustration at the lack of an appropriate textbook to cater for our stu­
dents’ needs. Introductory textbooks are appropriate for students with limited backgrounds
in mathematics and statistics but seldom contain any content related to real estate. They
also tend to focus too much on the derivations of formulae of estimators along with proofs
of their desirable and undesirable properties. On the other hand, the more advanced text­
books require a significant step up in mathematical and statistical ability to comprehend their
 Preface xv
content, and are geared more toward courses lasting more than one or two terms. Many
introductory and advanced textbooks very often provide little guidance on how to actually
execute a quantitative analysis. We believe that our book will help real estate students acquire
the skills to work confidently and independently and provide the basis to carry out further
statistical work addressing real estate issues.
Both authors of this book have had several years of experience of teaching quantitative
methods to real estate students in the classroom and have published research in highly repu­
table real estate journals. Sotiris Tsolacos has over 16 years of experience working in various
real estate research environments in the industry. Mark Andrew has been involved in housing
research projects funded by the UK government and also undertaken private consultancy
work. Our experience of working with the industry and government helped to shape the
content of the book, emphasising elements that are often not be flagged in more mainstream
econometrics textbooks. We feel that between us we have the sufficient expertise and experi­
ence to achieve our objectives.

Intended audience
The intended audience is undergraduate and postgraduate students in real estate and disci­
plines incorporating real estate who require a broad knowledge of modern applied statistical
techniques employed in analysing its markets, and professionals in the industry who would like
to refresh or extend their knowledge. An important feature of this book is its aim to address the
needs of the industry and make the book a reference book for post-education. Although the
applications and motivations for modelling in this book are drawn from real estate, the empiri­
cal procedures adopted in testing of theories are relevant to other disciplines, such as econom­
ics, business studies, finance and management, and should prove useful to these students.

Online resource
The content of the book is supported by online material. It contains accompanying notes
for each chapter with further examples and data files in Excel and EViews so that the reader
can replicate the empirical analysis undertaken throughout the book. Further, the online
resource includes additional chapters:

Chapter I: building empirical regression models

Chapter II: regression analysis: a cross-section model
Chapter III: cointegration
Chapter IV: panel analysis

There is also an instructor’s section that comprises a suite of lecture slides.

Prerequisites for understanding the material in this book

We assume little knowledge of quantitative techniques, although the reader should have
basic knowledge mathematics and statistics at secondary (high) school. To refresh memory,
we devote a chapter to cover these prerequisites. The focus of our book is on the application
of the most commonly used techniques to analyse real estate data and markets. Throughout
the book we refer to the theories commonly applied in real estate analyses since many read­
ers may not have this background. The emphasis in our book is on an application of various
methods to analyse real estate data and to deal with common issues related to it.
Acknowledgements

We made use of several databases provided by the private sector. We would like to express
our appreciation to the CoStar Group, JLL, RCA, Knight Frank, MSCI and GPR for data
provision. We have also used websites and data publicly available on the internet in our
examples.
We would like to acknowledge the input of a number of individuals for their involvement
in various tasks with this book. We are grateful to Nigel Almond, Mark Stansfield, Sophia
Roberts and Nicole Lux for their assistance and Ervi Liusman for help with Hong Kong
data. In particular, we would like to thank Cleo Flokes and Fergus Hicks for their comments
and suggestions in Chapters 2 and 11.
1 Introduction

The focus of this book is the application of quantitative techniques to real estate. The
material presented takes the reader from basic statistical analysis to more advanced topics
addressing a range of quantitative methods employed both in real estate education and the
workplace. The themes in this book are presented in an applied manner. Throughout the
book we provide examples to illustrate the statistical concepts in the context of the real estate
market. The online resource for this book contains further applications. The aim of the book
is to make the reader confident with the application of quantitative techniques to real estate.

1.1 Motivation and rationale for this book

We highlight four inter-related trends in the real estate field that necessitate the existence of
a textbook on the applied quantitative analysis of real estate markets.

(i) The application of statistical tools to analyse data is a much-sought skill in the real estate
business. It is increasingly becoming an integral part of real estate education. Students
in real estate degree programmes are expected to have at least a fair knowledge of
basic statistical techniques. A good grasp of statistical analysis is helpful for the study
of other subjects such as real estate investment, appraisals and portfolio management.
(ii) It is recognised that the real estate market interacts with the economic and broader
investment environments. Quantitative analysis will assist us to quantify relationships
and test them empirically. Such analysis varies from simple descriptions of features
of the data, examining correlations to constructing a variety of econometric models.
It opens up a greater range of options in the empirical investigation of real estate
markets.
(iii) The recognition of real estate as a mainstream asset class poses challenges to how
analysis in real estate markets is conducted. Investors in other asset classes are accus­
tomed to the application of quantitative analysis and would expect similar practices
in the real estate market.
(iv) The availability of data is growing. Databases are getting larger and becoming more
readily available. Universities are increasingly gaining access to more databases, includ­
ing proprietary data from firms and organisations. A good background of quantitative
analysis enables students, researchers, analysts and others to utilise the growing avail­
ability of data.

Universities have incorporated quantitative research techniques into their real estate pro­
grammes. Modules covering simple data analysis and statistical modelling are part of the
2 Introduction
curricula, depending of course on the nature of the programme. Real estate investment and
finance programmes will incorporate more advanced analysis whereas the more traditional
real estate programmes will contain essential quantitative techniques. This book is motivated
by the needs of both groups of students either at the undergraduate or postgraduate levels. A
number of these programmes are conversion courses, usually taken by non-cognate students
who may come from a subject area with little statistical background. This book is intended
to bring these students up to speed with the application of quantitative techniques to real
estate data analysis. The book aims to facilitate the development of these skills. Students
will become familiar with the most commonly used techniques in practice and will be well
equipped to directly carry out empirical work.
The work in this book is also inspired by the quantitative needs of real estate analysts in
the industry. Analysts have access to large datasets. Some of them may have to brush up their
quantitative knowledge. A quantitative background gives them flexibility to undertake their
own work and investigate relationships using the wealth of data available. Ability to make
sense of the data and carry out empirical analyses is a valuable skill for a professional in the
real estate field.

1.2 Broad themes covered in the book

Quantitative analysis comprises a large set of mathematical and statistical procedures and
tools for factual analysis. This book is not intended to present any branch of quantitative
analysis that is potentially relevant to real estate. This would be an onerous task. The book
focuses on themes most prevalent in real estate and presents them in detail and in a practi­
cal way. The book helps the reader build the necessary background for further quantitative
analysis. In this section we give a short outline of four themes covered in this book. They are
data manipulation, probability and inferential statistics in real estate, applied econometric
modelling and forecasting.

1.2.1 Data manipulation and summarising information

Understanding and summarising data to reveal systematic patterns is informative. Informa­
tion in its raw form may not be appropriate to conduct analysis or make comparisons and can
be difficult to comprehend. Consider, for example, rents recorded in different units (e.g. local
currency per square metre per year vis-à-vis in local currency per square foot per month). Or
for that matter, rents obtained from countries with low and high inflation. Data transforma­
tions help us to understand the information they contain about the market. Rents should
be expressed in similar units, or one should produce an index or adjust them for inflation.
It is valuable to understand the distribution of the data, obtain statistics such as the mean
and standard deviation and use techniques such as correlation analysis to study relationships
between data series. Think of a situation in which we find that rents in market A are more
strongly associated with the economy than in market B. What are the reasons behind this?

1.2.2 Probability analysis, inferential statistics and applications

Analysing the market entails dealing with uncertainty that arises from the complex nature
of the real world. Real estate is subject to uncertainty of the same nature and intensity, as
for instance in the stock market. Following data transformations and rudimentary statistical
analysis, we introduce the concepts of probability, expected values and hypothesis testing.
 Introduction 3
They enable the analyst to draw conclusions reflecting the most probable outcomes. Proba­
bility distributions are the basic statistical framework for undertaking such analyses. Suppose
when we study house price growth we observe that the most common growth rate values lie
between 4% and 6% per annum. There are occasions, however, when house price growth
can be negative, say −10%, or strongly positive, +20%. These are rare occasions, but they
still occur reflecting major economic events in the market. By studying the distributional
properties of the data, we are able to make useful inferences about expected values and prob­
abilities of them occurring.
Related to this topic is sampling. Usually we work with samples from a larger and often
unknown population or have a preconceived idea about the data generating process (DGP).
This concept is not easy to grasp at first, a fact we acknowledge. Results reported from
calculations are sample-based results with which we infer conclusions for the unknown or
unmeasurable population. For example, when we work with 40 observations of rent data,
we assume that this is either a subset of the unknown population of rents or the unknown
DGP. If our objective is to estimate, for example, the mean value of house price growth out
of sample estimates, we can utilise the concepts of a sampling distribution to determine
the likelihood of the sample estimates reflecting the population or DGP value. Again, any
inferences will involve the language of probability. These concepts are additionally used in
hypothesis testing and modelling relationships.

1.2.3 Model building and applied econometric analysis

The book proceeds to employ and present formal techniques to study relationships within
the real estate market and between the real estate market and the economy and investment
environment. The complexity of the real estate market, its linkages to the economy and the
importance of real estate in credit and investment markets have necessitated closer study of
the dynamics of the real estate market. This market has taken a major part in causing eco­
nomic and financial crises; an example is the global financial crisis in 2008–2009. As a result,
we have seen an explosion in the use of quantitative analysis to explore how adjustments take
place within the real estate market and measure its linkages to the external environment.
The relationships can be complex. We try to establish the factor or factors that influence a
real estate variable. Housing construction can be influenced not just by economic growth but
also by other influences including interest rates, construction costs and other. The empirical
investigation of relationships will give evidence about prevailing theories and a priori argu­
ments. It will be based on what happened in the past, will identify systematic influences and
will use it to explain the relationship and forecast as we will discuss. These systematic influ­
ences are best uncovered by statistical techniques, as the human brain cannot work out exact
systematic relationships. We will address a range of questions, for example, if interest rates
rise by a percentage point, what is the expected impact on mortgage rates and eventually
house prices? Such questions can be answered by regression analysis. We discuss the diagnos­
tics tests to run to confirm the validity of the model. This background is used to extend the
analysis to study relationships with more advanced tools.

1.2.4 Forecasting
Finally, we recognise that a definitive goal in the quantitative analysis of real estate is to make
predictions and forecasts about the market. Explicitly addressing real estate forecasting is
necessitated by the growing need for forecasts in the industry. The book exposes the reader to
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