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MIT price index for commercial properties declines in Q2

Office properties show biggest decline
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Transaction sale prices of commercial property sold by major institutional investors declined 2.7 percent overall in the second quarter of 2008 with prices for office properties declining 5.5 percent, according to an index produced by the MIT Center for Real Estate.

The office sector encountered the largest drop in the quarterly transaction-based index (TBI) in a single quarter since 1994, following minor declines in the past two quarters. The decline reduces office property prices to their early 2007 level.

The 2.7 percent decline in the overall quarterly TBI means that prices for properties such as shopping malls, apartment complexes, office buildings and warehouses are now more than 9 percent below peak values attained in mid-2007.

"The down movement this quarter in the overall prices represents the third down quarter out of the last four quarters in the index. This represents a continuation of the correction in commercial property market prices that began last fall -- a correction triggered by the credit crunch caused by the subprime housing mortgage crisis and fueled by concerns about a recession," said Professor David Geltner, research director of the MIT/CRE.

Geltner said, however, that commercial properties, which produce regular income and serve as a major investment asset class, are generally in much better shape than housing. They are still experiencing good fundamental performance in terms of strong income, good occupancy, low commercial mortgage delinquency, and substantial equity capital interested in buying such property.

Geltner noted, nevertheless, that the generally positive fundamentals that currently shore up commercial property are still subject to the threat of a severe economic downturn.

"The biggest threat would be a major recession," he said.

The current declines are consistent with a previously reported widening disconnect between buyers and sellers. The MIT/CRE publishes not only the price index based on closed deals, which declined 2.7 percent, but also compiles indices that separately track movements on the demand side and the supply side of the property market.

The demand-side index tracks the changes in prices that potential buyers are willing to pay (sometimes called a "constant-liquidity" index of the market, because it tracks how much prices would have to change to keep a constant ability to sell as many properties at the same rate of trading volume). That index has now fallen steadily for all of the past four quarters, falling again in the second quarter by the same 2.7 percent as the realized price index. During the past four quarters, the cumulative decline in potential buyers' prices is more than 17 percent versus their mid-2007 peak.

The supply side of the market -- the property owners who are the potential sellers --matched the demand-side movement in the second quarter, also revising their willingness-to-sell prices downward by 2.7 percent, and this lock-step movement kept the overall sales volume tracked by the index nearly constant, at the historically low levels reached earlier in 2008.

Henry Pollakowski, MIT/CRE senior economist and co-director of the Center's Commercial Real Estate Data Laboratory (CREDL), noted that the gap represents "a second consecutive quarter of historically low trading volume."

"This quarter at least shows a pause in any further pulling away of supply from demand such as we had seen in the first quarter," Pollakowski said. "The result of this continuation of the relationship between supply and demand is that the volume of closed transactions tracked by the index remained low this quarter after falling drastically by 47 percent from the last quarter of 2007 to the first quarter of 2008."

Geltner noted that: "The results posted by our index are corroborated by recent evidence from another commercial property price index whose methodology was developed at the MIT/CRE, the Moody's/REAL Index produced by Moody's Investors Service, which showed a decline of 3.5 percent in its latest monthly report, for May, placing that broader index of realized commercial property prices at about 9 percent below its 2007 peak, very similar to the NCREIF-based index reported here."

The TBI tracks the prices that institutions such as pension funds pay or receive when transacting properties such as shopping malls, apartment complexes and office towers. The MIT Center's TBI is based on prices of National Council of Real Estate Investment Fiduciaries (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 currently 6,000 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.

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