involve costly, complex bundles of fees that
are tacked onto the property. As a result,
because private markets are relatively
non-transparent, the true value of the underlying commercial real estate assets can
become clouded.
Start Scrubbing
There are a number of advantages working in favor of the NAREIT PureProperty Index. First, because REIT stocks
trade in real time, the index can be calculated on a daily basis. “We are able to
target pure segments of the market and
provide daily updates, just as with any
stock index, without adding statistical
noise,” Geltner says.
Case says this feature of the PureProperty Index offers important benefits that
other indexes can’t match.
“The NPI and TBI are quarterly indexes
and are reported about six weeks after the
end of the quarter to which they apply.
The CPPI is monthly for the national
sample and quarterly for the property-type
and geographic indexes, and it’s reported
with a similar delay,”
he says. “The new indexes will be daily and
reported immediately
following the close of
the market each day.”
Second, Geltner
points out that the
PureProperty Index
takes its key information from transparent
sources. This adds to the index’s utility.
“These indexes are supported by robust,
transparent mathematics with results that
are intuitive and easy to explain,” he says.
Third, using publicly traded securities’ prices makes the index more nimble,
according to Geltner. “Publicly traded
instruments are very liquid and therefore
reflect information very quickly and
efficiently,” he says. “Indices based on
private market appraisals tend to react
more slowly.”
Case agrees, noting that the impact of
an event on a publicly traded company
shows up quickly in its stock price. “The
CONFOUNDING FINDINGS
In developing the new NAREIT PureProperty Index, researchers from the
Massachusetts Institute of Technology Center for Real Estate made some
interesting observations.
• Volatility
One of the major purported benefits of private investment in commercial
real estate is its supposed stability. The thinking goes that the day-to-day
trading of REIT stocks on the open markets helps drive up their volatility.
However, the MIT academics found that PureProperty portfolios exhibited
hardly any more volatility than indexes based on transactions in the private
market during the time span studied. From 2004 to 2007, the volatilities of
the monthly and daily PureProperty Indexes were essentially the same. They
also fell in line with the volatility of the Moody’s/REAL Commercial Property
Price Index.
• Timing
PureProperty Index portfolios demonstrated temporal lead compared to
indexes based on transactions in the direct property market. For example,
the 2007 downturn in commercial real estate pricing showed up months
earlier in the REIT-based PureProperty Index than in the private property
indexes. Consequently, the PureProperty Index’s lead time over the indexes
based on private markets suggests that it provides a better basis for
derivative products.
new PureProperty Indexes
will be based on a huge
number of transactions
in the most liquid, most
information-efficient equity market in the world,
the New York Stock
Exchange,” Case points
out. “Information that
bears on the underlying
value of commercial prop-
erties that are owned by publicly traded
REITs will tend to be reflected almost
immediately in the new PureProperty
Indexes.”
Fourth, Case contends the PureProperty
Index is better suited to modeling than the
other indexes. Therefore, he says the new
index should provide a robust platform for
academic and industry research.
Finally, because the PureProperty Index
is segmented by industry sector and geographic region, it has a variety of practical
uses for both consumers and providers of
financial products. MIT developed a total
of 16 specific models based on swaths of
data from different sectors and regions.
Consequently, derivative-based products
can be created from the PureProperty
Index and its components.
“The real estate asset class is the only
major asset class that lacks instruments
suitable for hedging purposes, so it’s likely
that these indexes will fill a major need
in completing the asset class,” Case says.
“With a transparent methodology, immediate updating and daily frequency, institutional investors are likely to feel comfortable using the new indexes for hedging and
other purposes. And the assets underlying
the indexes are themselves investable, unlike instruments based on the NPI or other
property value indexes.”
Investors will have the opportunity to fill
out their commercial real estate portfolios
using these products. For example, if you’re
light on holdings in the retail sector in the
East, there will be a derivative for that.
“These indexes can be a great new tool
to assist buy-side portfolio managers
seeking return and diversification as well
as investors interested in trading derivatives based on commercial real estate assets,” Case says. ✦
