CPPI is now at Long Run Equilibrium

In his December edition of Professor’s Comments, Dr. David Geltner analyzed where the current Moodys/REAL Commercial Property Price Index (CPPI) was relative to the long run price equilibrium.

The chart [below] updates an analysis I have shown in previous commentaries. It presents an extension of the CPPI back to 1969 based on other indices similar in “spirit” in that they reflect same property transaction pricing (rather than appraisals).

Overlaid on this “extended CPPI” is a simplistic model of long-run equilibrium for same-property pricing, based on the hypothesis that 2000 prices were in such equilibrium, and that same-property long-run sustainable prices evolve with the Consumer Price Index less 1% to 2% per year (to reflect real depreciation of the property).

We see that the CPPI is now squarely in the middle of the modeled “long-run equilibrium” property price range, with the CPPI now at 108 and the range now between 104 and 114. This is another reason to have hope that we are now very near the pricing bottom in the current downturn.

To compare the current downturn with the two previous ones depicted in the chart, in real terms (net of inflation) the 1971-75 price drop was 39% (of the prior peak price), the 1986-92 drop was 43%, and the current drop (so far) is 46%. Thus, we now have a bigger drop in the U.S. commercial property market, and one that has happened much faster, than the two previous cycles going back four decades.

But, similar to most stock market corrections, will the market over-correct, pushing property prices below the equilibrium line, creating a negative bubble?

Of course, the chart makes it painfully obvious that the peak preceding the current drop also was higher and sharper. “The higher they fly, the farther they fall.” The greater speed of the correction this time probably reflects the greater efficiency in the commercial property market of the 21st century, including better information and the larger role of public securities markets and certain forms of derivatives trading.

Of course it may also have to do with the relative height of the preceding peak, as well as the severity of the accompanying economic recession.”

[REALIndices.com]