David Geltner

Smoothing in Appraisal-Based Returns

This article presents a conceptual analysis of smoothing in the second moments of appraisal-based returns series in commercial real estate. The intent of the article is to lay the groundwork necessary for the more scientific use of appraisal-based returns time series for the purpose of inferring the true second moments. Formal smoothing models are presented together with their theoretical implications for smoothing in various second moments of interest to investment analysts. Empirical estimators for inferring true moments from appraisal-based data are described. Limited empirical findings from previous literature are also briefly discussed in the light of the theoretical findings of this study. The overall conclusion is that appraisal-based returns can be very useful in studying the risk characteristics of commercial real estate assets, provided that this type of data is corrected for smoothing as discussed in the article.

Value indices of commercial real estate: A comparison of index construction methods

The purpose of this paper is to shed light on the history of commercial property values over the past decade, and to compare different methods of constructing commercial property value indices and returns series. We examine three types of indices: (i) Indices that attempt to reconstructproperty market values by “unsmoothing” the appraisal-based Russell-NCREIF Index; (ii) Indices that trace average ex posttransaction prices of commercial property over time; and (iii) an index based onunlevering REIT share prices. By comparing the different historical pictures that result from the various index construction methodologies, one gains insight into the nature of commercial property price and valuation behavior. The REIT-based values lead the other indices in time but display greater short-run volatility. The transactions-based indices lag behind the other series in time, and are consistent with the idea that institutional investors attempt to hold onto properties until they can sell them for a price at least equal to the current appraised value, in effect trading off liquidity for reduced volatility.

Price Discovery in American and British Property Markets

This paper examines the securitized (public) and unsecuritized (private) commercial property markets in the United States and the United Kingdom for evidence of price discovery. Appraisal-based returns are corrected for smoothing, without presupposing the true returns to be uncorrelated or unpredictable across time. Real Estate Investment Trusts (REITS) and property company returns are corrected for leverage. We find evidence that price discovery occurs in the securitized market structure in both countries, and that this price information does not fully transmit to the unsecuritized markets for a year or more. In Britain, the unsecuritized market appears to be more closely and immediately linked to the securitized market than is the case in the U.S.

Estimating Real Estate's Systematic Risk from Aggregate Level Appraisal-Based Returns

This paper estimates the systematic risk (or “beta”) of unsecuritized investment grade commercial real estate, as represented by the FRC and PRISA indices of institutional real estate holdings. Systematic risk defined with respect to national consumption is compared to systematic risk defined with respect to the stock market. Also, the risk estimates are explicitly adjusted to account for “smoothing” in appraisal‐based aggregate level returns data. The systematic risk of these real estate indices appears to be virtually zero with respect to the stock market, even after correcting for smoothing, but substantially positive with respect to national consumption.

Bias in Appraisal‐Based Returns

This note quantifies and extends Gilibertos [AREUEA Journal 16(1)] analysis of bias in appraisal-based returns. An important clarification and distinction is made, defining two different perspectives from which one may view appraisal return bias. The Giliberto analysis addressed bias in the holding period return only. Here, after reviewing and extending Gilibertos analysis in this regard, bias is considered from another perspective, that of the arithmetic mean of a time-series of appraisal-based returns. The two types of bias are likely to be of opposite sign, thereby possibly offsetting one another, so that we may often observe very little bias in the means of empirical appraisal-based returns time-series. Copyright American Real Estate and Urban Economics Association.

Unsmoothing British valuation‐based returns without assuming an efficient market

Summary The United Kingdom is well endowed with property indices, most of which are valuation based. Because valuers have incomplete information they tend to be influenced by past valuations of the subject property or past transaction prices of comparable properties. One result of this is that contemporaneous valuations may contain components of past market values, which induces a lagging and smoothing within an aggregate index. This paper demonstrates how the underlying market values may be recovered from a smoothed index, without assuming that the underlying property market is informationally efficient. The methodology is applied to the Jones Lang Wootton Index of capital values. The characteristics of the smoothed and unsmoothed indices are compared and some resulting implications about the optimal weighting of property in a multi‐asset portfolio are discussed. Our results support the hypothesis that British commercial property markets are ‘weak‐form’ efficient. Implications for optimal valuation proce...

Two Decades of Commercial Property Returns: A Repeated-Measures Regression-Based Version of the NCREIF Index

This article documents 20 years of performance of commercial real estate in the United States using a portfolio of properties that comprise the widely followed NCREIF Property Index (NPI). We develop an extension of the repeated-measures regression (RMR) to produce an improved version of the NCREIF Index that eliminates the “stale appraisal” and seasonality problems. We use this RMR version of the index to examine the magnitude and duration of the of the crash in property values in the early 1990s. The RMR Index is also compared with the NAREIT Index, and property-type subindices are developed using a Bayesian estimator. Finally, it is also shown how the RMR can be used to estimate the average magnitude of random valuation error in commercial property valuation.

Loss Aversion and Anchoring in Commercial Real Estate Pricing: Empirical Evidence and Price Index Implications

Loss aversion behavior plays a major role in the pricing of commercial properties, and it varies both across the type of market participants and across the cycle. We find that sophisticated and more experienced investors are at least as loss averse as their counterparts and that loss aversion operated most strongly during the cycle peak in 2007. We also document a possible anchoring effect of the asking price in influencing buyer valuation and subsequent transaction price. We demonstrate the importance of behavioral phenomena in constructing hedonic price indices, and we find that the impact of loss aversion is attenuated at the aggregate market level. This suggests that the pricing and volume cycle during 2001–2009 was little affected by loss aversion.

The present value model with time-varying discount rates: Implications for commercial property valuation and investment decisions

A vector autoregressive model is developed for predicting cash flow and returns in the private (unsecuritized) commercial property markets. The model predicts both of these variables quite well during the sample period. The forecasting model is then used to develop a simple “buy/sell” rule for identifying property market value peaks and troughs. An improved present value model, taking account of the predictability of property returns, is described and found to track historical market values much more closely than does either the appraisal-based index or the traditional present value model with constant expected returns. Analysis in this paper suggests that most of the change in commercial property market values has been due to changes in expected returns, rather than to changes in expected future operating cash flows.

Pricing and Index Considerations in Commercial Real Estate Derivatives

It is important for participants in the nascent commercial real estate derivatives market to understand the fundamentals and the subtleties of the appraisal and transaction based indexes that underpin derivatives, as well as the proper pricing of derivatives taking into account the risk and return characteristics of the index. The authors review these considerations including the implications that appraisal lag in the index has for the equilibrium pricing of derivatives such as index swaps, and the use of such vehicles for hedging real estate risk. An important conclusion is that even if the underlying index does not represent the current equilibrium in the property market or if the property market itself is not in equilibrium, we can still use equilibrium analysis in the derivatives market to derive a fair price for an appraisal index based derivative including consideration of the effect of any lagging and smoothing in the index. The analysis highlights informational issues about indexes and property markets that present both danger and opportunity for the facilitation of a well-functioning property derivatives market in the United States and shows how usage of derivatives needs to consider the effect of possible lag in the index.