A Note on Commercial Property Markets

An old habit of mine from my stint in the “real world” is to keep an eye on the NCREIF Property Index (NPI). The NPI is an appraisal-based index measuring the total rate of return for a very large (6,349 in the 2nd quarter, to be exact) pool of commercial properties acquired for investment purposes only.  Most of those properties were acquired on behalf of tax-exempt investors like pension funds and are thus held in a fiduciary environment.

New 2nd quarter NPI data were just released and continue to show improvement with a quarterly return of 3.94 percent.  That’s the best performance in the index since the start of the “Great Recession” with the exception of the 4.62 percent return in the 4th quarter of last year.  There are, however, some pesky data issues to consider with an appraisal-based index like the NPI; most importantly, the NPI suffers from artificial smoothing or appraisal lag-bias.  As MIT’s David Geltner, who developed a complementary transactions-based index, has written,

…the property-level appraisal process that underlies appraisal-based indices tends to be more conservative about recognizing value changes, and more “backward-looking” for price discovery and documentation, than are the principal parties engaging in actual transactions. Also, in some cases the appraisals (or valuation reports) used in the index are effectively not updated for all properties as of the end of each period (i.e., the appraisals in the index are staggered or rolling in time). The overall result is that appraisal-based indices tend to exhibit dampened market cycle amplitude and/or lagged turning points in the cycle, as well as lower return volatility, compared to transactions- based indices.

NPI Transaction-Based Index

The NPI transaction-based index gives us a less rosy picture of the market, with a second quarter return of -0.24 percent, following only a 1.05 percent 1st quarter return.

The NPI transactions-based index will, by definition, reflect the actual prices paid in market transactions so, as much as you may read about the high prices of big commercial real estate deals in the news, those may be limited to a few “trophy” properties; at the very least, those high prices are not signficant enough to be reflected in recent transactions index data.  Distressed commercial property sales seem to remain in the pipeline despite some of the headlines. These data probably also reflect the fact that distressed commercial properties take a while to actually be executed (anywhere from 12 to 24 months), so we may well be seeing that lag playing out in the transactions price data now.