Are Commercial Property Values Rising or Falling?

This might seem like a simple question. But it is not.

The Moodys/REAL Commercial Property Price Index (CPPI), produced at MIT, says they are still falling:

Green Street’s Commerical Property Price Index says they are rising:

Which one is correct matters. If Green Street is right, and prices are only 12.6 percent off peak, then commercial properties by-and-large have equity (loan-to-value ratios rarely exceeded 80 percent on commericial properties). If MIT is right, we are still in deep trouble.

Both sources do a good job explaining their methods. For MIT:

The Moodys/REAL commercial property index (CPPI) is a periodic same-property round-trip investment price change index of the U.S. commercial investment property market based on data from MIT Center for Real Estate industry partner Real Capital Analytics, Inc (RCA). The methodology for index construction has been developed by the MIT/CRE through a project undertaken in cooperation with a consortium of firms including RCA and Real Estate Analytics, LLC (REAL). The index has been developed with the objective of supporting the trading of commercial property price derivatives. The index is designed to track same-property realized round-trip price changes based purely on the documented prices in completed, contemporary property transactions. The index uses no appraisal valuations. The methodology employed to construct the index is a repeat-sales regression (RSR), as described in detail in Geltner & Pollakowski (2007). The data source for the index is described in detail in a white paper available from RCA.

The set of indices developed so far includes a national all-property index at the monthly frequency, national quarterly indices for each of the four major property type sectors (office, apartment, industrial, retail), selected annual-frequency indices for specific property sectors in specific metropolitan areas, and primary markets quarterly indices for the top 10 metropolitan areas in the major property types. The annual indices are produced in four versions, beginning in January, April, July, and October of each year. These are respectively named the calendar year (CY) index, the fiscal year ending March (FYM) index, the fiscal year ending June (FYJ) index and the fiscal year ending September (FYS) index.

The RCA Database

The commercial property index is based on the RCA database which attempts to collect, on a timely basis, price information for every commercial property transaction in the U.S. over $2,500,000 in value. This represents one of the most extensive and intensively documented national databases of commercial property prices ever developed in the U.S.

The Moodys/REAL CPPI and the TBI

The Moodys/REAL CPPI index is a complementary information product to the transaction based index (TBI) also published on the MIT/CRE web site. Both the CPPI and the TBI are based purely on transaction price data. The TBI is based on NCREIF property sales prices data, while the CPPI is based on RCA sales prices data. Thus, the TBI is based on a smaller population of more purely institutionally held properties. The TBI is based on a hedonic regression methodology whereas the CPPI is constructed with a repeat-sales methodology. The TBI is published with history going back to 1984 but only at the quarterly frequency, and only at the national level (for the four major property types), whereas the CPPI includes monthly and annual frequencies and more geographic regional break outs. The CPPI is a variable-liquidity price-change (appreciation return) index, while the TBI includes total return and demand and supply-side indexes.

For Green Street:

Green Street’s Commercial Property Price Index is a time series of unleveraged U.S. commercial property values that captures the prices at which commercial real estate transactions are currently being negotiated and contracted.

Two features that differentiate this index are its timeliness and its ability to capture changes in the aggregate value of the commercial property sector.

• Timeliness: Other indices are based on closed transactions, and therefore convey info about market prices from several months earlier. Also, the Green Street index value for a given month is released within days of monthend, whereas other indices have a sizeable lag. As shown below, the Green Street index spots inflection points earlier than other indices.

• Weighting: This index is weighted by asset value within each property sector, and therefore it provides a gauge of changes in aggregate values. Most other indices are equally weighted.

So the big differences are: (1) MIT looks only at transactions, whereas Green Street looks at current negotiations; (2) MIT’s valuation model gives equal weight to all properties, while Green Street’s valuation gives greater weight to expensive properties than to cheaper properties; and (3) MIT has a much broader sample, because REITs would rarely buy properties as inexpensive as $2.5 million.

So which index is correct? It all depends on context. While I would be a little leary of using “negotiated price” as an indicator of value (as opposed to closed transactions), the timeliness of Green Street’s data does give it an advantage. For REIT’s trying to determine strategy, the Green Street index is probably better. For banks making loans to smaller properties–or for individual investors thinking of buying small office buildings–the MIT index is more relevant.

About Richard K. Green 102 Articles

Affiliation: University of Southern California

Richard K. Green, Ph.D., is the Director of the USC Lusk Center for Real Estate. He holds the Lusk Chair in Real Estate and is Professor in the School of Policy, Planning, and Development and the Marshall School of Business at the University of Southern California.

Prior to joining the USC faculty, Dr. Green spent four years as the Oliver T. Carr, Jr., Chair of Real Estate Finance at The George Washington University School of Business. He was Director of the Center for Washington Area Studies and the Center for Real Estate and Urban Studies at that institution. Dr. Green also taught real estate finance and economics courses for 12 years at the University of Wisconsin-Madison, where he was Wangard Faculty Scholar and Chair of Real Estate and Urban Land Economics. He also has been principal economist and director of financial strategy and policy analysis at Freddie Mac.

His research addresses housing markets, housing policy, tax policy, transportation, mortgage finance and urban growth. He is a member of two academic journal editorial boards, and a reviewer for several others.

His work is published in a number of journals including the American Economic Review, Journal of Economic Perspectives, Journal of Real Estate Finance and Economics, Journal of Urban Economics, Land Economics, Regional Science and Urban Economics, Real Estate Economics, Housing Policy Debate, Journal of Housing Economics, and Urban Studies.

His book with Stephen Malpezzi, A Primer on U.S. Housing Markets and Housing Policy, is used at universities throughout the country. His work has been cited or he has been quoted in the New York Times, The Wall Street Journal, The Washington Post, the Christian Science Monitor, the Los Angeles Times, Newsweek and the Economist, as well as other outlets.

Dr. Green earned his Ph.D. and M.S. in economics from the University of Wisconsin-Madison. He earned his A.B. in economics from Harvard University.

Visit: Real Estate and Urban Economics Blog

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