Watching the Watchers: The Metrics of the Real Estate Recovery
Here in Manhattan, the consensus at mid-year holds that commercial real estate investment and credit market conditions have improved markedly since last summer. There’s a lot of support for this assessment: clear evidence of rising transaction volume; an increasing diversity of lenders extending credit in support of property sales and the refinancing of maturing mortgages; and an uptick in the gross absorption of available space. Along each of these dimensions, the commercial real estate market has recorded significant progress.
The generally consistent headline investment, credit and fundamentals trends nonetheless mask a substantial and increasing divergence between several of the market’s most oft-cited pricing metrics. As The Wall Street Journal highlighted last month in a comparative report on the Green Street Advisors Commercial Property Price Index (GSA CPPI) and its counterpart from Moody’s/REAL, “… two closely watched indexes on commercial real estate continue to draw much different pictures of the market recovery.”
In its most recent report, released last week, CoStar’s General Commercial Index fell to a new cyclical low. Meanwhile, Green Street’s CPPI extended its advance, closing to within 10 percent of the market’s 2007 peak.
Why the Split
Indices are diverging, but it has not always been so. During the market’s upswing and through midyear 2009, several key market metrics were generally well correlated in their movements. While each index employed a well-differentiated methodology and relied upon an independent data source, consistent results often reflected that the market’s momentum was largely undifferentiated across dimensions such as price tier, asset quality and geography.
During the more recent period of uneven recovery, however, the observable bifurcation in the indices corresponds with very real differences across segments of the market—such as distress sales, lower quality property sales and lower price tiers—that are captured asymmetrically across indices.
The magnitude and durability of the divergence in the index trends highlight that the summary statistics necessarily abstract away from the underlying variation in the marketplace to produce a single tractable measure. The greater the variation in those underlying trends and the more fragmented the market, the more important the index methodology and data become for the interpretation of the results. This is not to say that the index with the broadest coverage is necessarily better. Rather, each index offers a distinct perspective on the market that will make it more or less relevant depending upon each investor’s objective.
A View of a Rising Market
The updated GSA index on June 6 showed that values increased by 3 percent between April and May and are within striking distance of their all-time highs. While the GSA index methodology is less tractable than one relying solely upon discrete property sales, the exceptional rebound captured by GSA reflects that it is based on the private-market valuation of REIT portfolios and that the index is weighted by asset value.
In effect, these two features result in the index’s being weighted heavily toward the market’s coveted trophy assets, where value recovery has clearly been most significant.
A Market Reaching for Bottom
In stark contrast with the GSA index, CoStar’s Commercial Repeat Sales Indices reflect a much weaker set of market conditions. CoStar’s national index, updated last week, shows a 1.7 percent decline in its national price metric between March and April. Down 38 percent from its peak in August 2007, the CoStar index has shown no signs of a sustainable recovery in prices.
Distinct from the GSA index, the CoStar index captures a very broad range of the market, encompassing even very small transactions and sales out of distress on a repeat-sales basis. This inclusiveness results in the index’s showing continued declines in value, a function in part of downward pressure from the rising outflow of investment-grade property distress and the weaker investment and credit conditions for smaller and lower quality properties.
Key Developments in the Latest Findings
The latest results suggest that the market’s overarching focus on large-scale, well-managed assets in primary markets continues to dominate the recovery. The GSA index results are consistent with the upward pressure being exerted by inflows of capital to this segment, often in advance of fundamentals.
Given the share of investment-grade sales related to distress cited in the CoStar result, we can also infer that contagion across segments of the market has been limited. In spite of the fact that distressed assets are trading in increasing absolute and relative numbers, the price trajectory for the high end of the market appears unaffected thus far.
That bodes well for investors atop the quality spectrum concerned about the impact of larger distress outflows as the recovery matures. While distress may drag on the broad index measure of the market, it appears to be having little impact on the current value of these investors’ portfolios.
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.