Two Indexes, Two Views On Commercial Real Estate

Trying to determine turning points in the real-estate market has never been simple. But now that two influential research firms are pushing very different views of the market, some investors are scratching their heads.

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Green Street Advisors, a Newport Beach, Calif., firm that closely tracks real-estate investment trusts, says prices of commercial real estate hit bottom in mid 2009 and have been slowly rising ever since. Not so, says Moody’s Investors Service, which is telling clients that it is still too early to call a bottom and advises caution. Both firms are digging in their heels and saying their approach most accurately reflects the state of the market.

“We’re surprised by such the wide discrepancy” in valuations, said Jeung Hyung, a portfolio manager at Adelante Capital Management based in Oakland, Calif.

Such divergence has perplexed investors who are looking for a guide to identify when to start buying office, retail and apartment buildings again. Investment sales are picking up this year as shown by the recent sale of the John Hancock Tower in Boston to Boston Properties Inc. for about $900 million, but agreement on how to evaluate the market remains tricky.

Both Green Street and Moody’s base their forecasts largely on price indexes they developed internally. Green Street’s Commercial Property Price Index was up 30% in September when compared to last year. Moody’s/Real Commercial Property Price Index was up 0.9% in September, an indication that prices have stabilized but aren’t recovering.

Economists say each index is good at looking at particular segments of the market, but neither one does a good job of providing a broad overview.

The source of the discrepancy appears to be the different approaches the two firms take in measuring price changes. Moody’s tracks all property sales of $2.5 million and more, looking only at transactions that have closed. In addition, the index is equally weighted and focused on so-called repeat sales, where the sale price of a building is compared to the price it fetched from the previous buyer.

In contrast, Green Street’s index tracks 47 real-estate investment trusts with roughly $400 billion in assets. The index reflects the valuations assigned to the REIT portfolios formed by input from brokers, economists and company executives. The index relies less on repeat sales but does take into account most property deals, and more weight is given to large trades.

Mike Kirby, director of research for Green Street, acknowledges that his firm’s index isn’t scientifically precise. “Yes, it’s subjective,” Mr. Kirby says, borrowing from an oft-quoted phrase from famed economist John Maynard Keynes.

“We believe it is better to be roughly right rather than precisely wrong,” Mr. Kirby says. “Commercial real-estate prices have clearly and unambiguously gone up in the last year. The fact that some indexes [don’t reflect this] doesn’t change the truth.”

There is no dispute that commercial real-estate valuations aren’t continuing to slide, but whether they are improving or have merely hit bottom appears to be in question.

Neither index is perfect. Some argue that Moody’s CPPI gives equal weight to small deals, which tend to sell more frequently at distressed prices and therefore brings down the index. Green Street’s index gives more weight to big deals, which offer a better indication about major markets.

“Big deals deserve more weight for the same reason that most stock market indices…are market-cap-weighted,” Mr. Kirby says.

For its part, Moody’s says large individual transactions can skew results. “We are trying to capture the entire market, not just a subset of institutional quality assets,” says Michael Gerdes, head of Moody’s commercial-mortgage-backed securities monitoring group.

Mr. Gerdes says his firm isn’t concerned by any lagging effect from focusing on closed transactions because not all deals make it to closing. He says closing prices give investors concrete numbers to use as a measure, as opposed to valuations that are more theoretical.

“Prices reflect reality. Valuations reflect the projections and estimates from market participants,” Mr. Gerdes says. “They are fundamentally  different products. ( credit a.pruitt-wsj)

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