MIT’s Center for Real Estate just released their year end findings for 2009. Their Transaction-Based Index (TBI) is down 22.5% from 2008. A drop of 4.9% during the fourth quarter erased all hope for back-to-back quarters of positive price movement.
On the positive side, transaction volume increased in the fourth quarter, suggesting improved liquidity in the market, although the increase in volume was only modest considering that the fourth quarter is traditionally a very active season in the commercial property markets. The TBI now stands 39.5 percent below its mid-2007 peak.
“It is a bit disappointing that we couldn’t put together two back-to-back positive quarters, but in the big picture, I regard the index as suggesting that the market has essentially flattened out since the end of the first half of the year, which is a lot better than continuing the drastic fall that had happened the previous year,” said Professor David Geltner, director of research at MIT/CRE.
“Our latest results relate interestingly to recent results posted by another commercial property price index whose methodology was developed at the MIT/CRE: the Moody’s/REAL Commercial Property Price Index – or CPPI – produced monthly by Moody’s Investors Service,” Geltner noted. “That index’s November result, reported in January, turned positive for the first time in over a year, possibly also hinting at a flattening out of commercial property pricing.
While the overall CPPI was down 43 percent from its peak, analysis of that index shows that relatively healthy properties, those that are not in distress, have only dropped in price about 39 percent from the 2007 peak, a similar drop to the TBI, while distressed properties in the CPPI have fallen 58 percent. The types of properties and owners tracked by the TBI would generally be less subject to distress than those tracked by the CPPI,” Geltner noted.
One measure the TBI tracks, which Moodys/REAL CPPI does not, is demand and supply levels. The gap between the TBI Demand (the red area on the chart) and TBI Supply (the yellow area on the chart) has continued to narrow over the last 4 quarters. The blue area represents what is estimated to be market equilibrium.
“The supply-side index which gauges the prices property owners are willing to accept also was down in the fourth quarter, by 5.3 percent, to a level now 35.5 percent below its peak,” said MIT/CRE Research Technician Holly Horrigan. “The continued drop in the willing-to-accept pricing among property owners, for five quarters in a row now, could be viewed as a good thing, in that it is helping to re-liquify the market, making more trading possible,” said Horrigan. “However, there remains a gap in pricing perception between the two sides of the market, which is keeping trading volume low by historical standards,” added Horrigan.
We voiced our concern of continued pricing disconnection between buyers and sellers in 2010 in our recent post covering NREI’s 2010 Investment Outlook. But the TBI results indicate that there is continued bid-ask price spread compression between buyers and sellers. As the chart below illustrates, the bid-ask spread has never been wider than it was in early 2009.
But it has bounced off of its’ floor, established during the first half of 2009, and matching a spread differential not registered since 2007.
The liquidity measure that we construct from the TBI demand and supply side indices improved only slightly in the fourth quarter, to negative 10%. Still, this is the highest this measure has been since the end of 2007. This metric implies that some combination of sellers’ reduction in their reservation prices and/or buyers’ increase in their reservation prices totaling about 10% of the fourth quarter’s average transaction price would bring the market back to full normal liquidity.
One thing to keep in mind is that the TBI uses econometric techniques to estimate quarterly market price changes based on the verifiable sales prices of all and only properties sold from the NCREIF Property Index (NPI) database.
The NPI database is comprised of a smaller population of purely institutionally-held properties, typically owned by pension funds, insurance companies and publicly-traded REITs. For this reason, this index may not directly mirror conditions in lower valued (say $5mm to $20mm) properties.
A more applicable price index for this subset of the industry would be the Moodys/REAL CPPI, which is based on monthly Real Capital Analytics sales data. This index considers asset sales of $2.5 million and above.