The value of U.S. commercial real estate owned by big pension funds fell another 5 percent in the fourth quarter of 2007, according to an index produced by the MIT Center for Real Estate.
The drop in the quarterly transaction-based index (TBI), which tracks the price at which big pension funds buy and sell properties like shopping malls, apartment complexes and office towers, was the second straight quarterly decline. It was deeper than the 2.5 percent drop in the third quarter, and it means the cumulative fall since last year's midsummer peak is now more than 7 percent.
"This is evidence that the commercial property market continued to fall, and at an accelerated rate, through the last quarter of 2007, no doubt due to the effects of the credit crunch," said MIT Center for Real Estate Director David Geltner.
The TBI, based on properties sold from the National Council of Real Estate Investment Fiduciaries (NCREIF) data base, grew 64 percent from 2004 through 2006, then had another 8 percent spurt in the first half of 2007. The decline in the second half of 2007 still leaves commercial property prices at their level of a year ago, a level that was considered historically high at the time.
"If this is as far as it goes, the price decline we see so far in commercial property as reflected in the TBI may simply represent a correction of the froth that occurred in early 2007 as a result of very aggressive commercial mortgage underwriting practices," said Geltner.
The TBI measure of total returns for the year 2007 was 3.7 percent, which simply reflected operating income, with prices basically unchanged. Despite the upsurge in the first half of the year, this was the poorest calendar year annual performance for the index since 1992, when commercial property experienced its worst crash since the Great Depression. Index Co-Director Henry Pollakowski was quick to point out, however, that fundamentals in the commercial property market are much stronger now than they were in 1992.
"We don't have the kind of over-building we had then, and building occupancies and rents are much stronger. Commercial mortgage default rates are much lower than in the early 1990s," Pollakowski said.
The MIT Center's TBI is based on prices of NCREIF properties sold each quarter from the property database that underlies the NCREIF Property Index (NPI), and also makes use of the appraisal information for all of the more than 5,000 NCREIF properties. Such an index--national, quarterly, transaction-based, and by property type--had not been previously constructed prior to MIT's development of it in 2006. NCREIF supported development of the index as a useful tool for research and decision-making in the industry.
While the NCREIF properties well represent institutional investments such as pension funds, a second index based on a broader population of properties was subsequently developed at the MIT Center for Real Estate. That index, now published by Moody's Investor Services as the Moody's/REAL Commercial Property Price Index, will release its 4th-quarter results later this month. While the TBI represents pension funds' sales, the Moody's/REAL Index represents the broader commercial property market and includes a monthly national commercial property index.
A version of this article appeared in MIT Tech Talk on February 6, 2008 (download PDF).