A simplified constant-liquidity price index for U.S. commercial property based on the RCA database

Abstract

This thesis builds on the endogenous relationship between transaction price and volume in commercial real estate markets in order to construct a simple "constant-liquidity price index" (SCLI) applicable to general transaction databases such as that of Real Capital Analytics Inc (a MIT/CRE member firm). By recognizing the fact that current commercial property indices do not capture the demand-side of the market (potential property buyers), which is the source of liquidity in the market, the type of index developed in this thesis fills a gap in the need for commercial property investment information. The ease of selling a property at the price indicated by an index of average realized prices (in closed deals) is variable and highly correlated with market cycles. And investors care not only for the price but also want to know how easy it is to sell property at those prices. This thesis is an extension of the formal study of constant-liquidity indexing (Transaction based supply and demand index) developed by Fisher, Gatzlaff, Geltner and Haurin (2003) based on the NCREIF (National Council of Real Estate Investment Fiduciaries) Property Index (NPI) transaction data base (hereafter referred to as "FGGH"). Compared with the underlying more rigorous econometric model of FGGH, this thesis presents a simplified approach to construct a constant liquidity price index (hereafter referred to as "Simplified Constant-Liquidity Price Index/ SCLI") suitable for a more typical type of commercial property transaction database, one that contains data only on sold properties (the NCREIF database used by FGGH contains data on both sold and unsold properties).

(cont.) In this thesis, monthly SCLIs are compared with the corresponding realized price indices and the results suggest that the SCLIs tend to lead the price indices and display a greater volatility. The SCLI developed here behaves similarly to the more econometrically rigorous FGGH-based demand-side indexes, therefore tends to validate the construction method of the SCLI, suggesting that this could be a useful information product and possibly a valuable tool for investment allocation and derivatives trading.