Commonalities in Private Commercial Real Estate Market Liquidity and Price Index Returns

Dorinth W Van Dijk,Marc K Francke

doi:10.1007/s11146-021-09839-z

Abstract

AbstractWe examine co-movements in private commercial real estate index returns and market liquidity in the US (apartment, office, retail) and for eighteen global cities, using data from Real Capital Analytics over the period 2005–2018. Our measure of market liquidity is based on the difference between supply and demand price indexes. We document for all analyzed markets much stronger commonalities in changes in market liquidity compared to commonalities in real price index returns. We further provide empirical evidence that space markets are less integrated than capital markets by analyzing co-movements in net-operating-income and cap rate spreads (over similar maturity bond yields). In a theoretical simulation model, we show that the strong integration of capital markets compared to space markets, is in fact the reason why market liquidity co-moves so strongly compared to returns. Our results are of interest for large private real estate investors such as pension funds and other institutional investors who are interested in spreading risk. Our findings imply that fully diversified price return benefits may be difficult to obtain, because market liquidity may dry up in all markets simultaneously, which makes portfolio re-balancing more difficult and costly.

Highlights

We pose three questions related to private commercial real estate (CRE) markets: (i) “How strong is the co-movement in changes in market liquidity?” (ii) “How strong is the co-movement in real price index returns?” (iii) “Which factors drive the difference in commonality between market liquidity changes and real price index returns?”
In this paper we have examined commonalities in both price index real returns and liquidity changes for private commercial real estate markets
To return to our three main questions: (i) “How strong is the co-movement in changes in market liquidity?”, (ii) “How strong is the co-movement in real price index returns?”, and (iii) “Which factors drive the difference in commonality between market liquidity changes and real price index returns?”, we find the following

Summary

Motivation and Research Questions

Investors in private commercial real estate (CRE) properties do face price risk, and the risk of illiquidity, the uncertain time it takes to sell properties (Cheng et al, 2010; 2013). Ling et al (2009) study price dynamics and transaction activity for ten segments in private commercial real estate in the UK over the period 1987–2007 They find a statistically significant positive relationship between lagged turnover and contemporaneous capital returns. Brounen et al (2019) study the relation between liquidity and price returns in international listed real estate markets They find wide variations across ten markets using four different liquidity measures (trading volume, stock turnover, Amihud measure and the number of zero return days). Because market liquidity and prices in private real estate markets move together, we compare commonalities in market liquidity changes to commonalities in real price index returns. Section “Co-movements in Market Liquidity, Returns, Net Operating Income and Risk Premium” shows the degree of empirical commonality in both market liquidity changes and price index returns.

Methodology

Findings

Conclusion and Possible Extensions