The Dynamics of Liquidity in Commercial Property Markets: Revisiting Supply and Demand Indexes in Real Estate
32 Pages Posted: 1 Feb 2018 Last revised: 26 Jan 2019
Date Written: January 30, 2018
A common definition of liquidity in real estate investment is the ability to sell property assets quickly at full value, as reflected by transaction volume as a fraction of inventory (”turnover ratio”). The present paper makes a major methodological contribution, as well as a conceptual contribution, in the ability to study and understand such liquidity. First, we extend the Fisher et al. (2003, 2007) methodology for the separate tracking of changes in reservation prices on the demand (potential buyers) and supply (potential sellers) sides of the asset market. We show how to apply the methodology to a repeat sales indexing framework, allowing application to typical commercial property transaction price datasets, which lack appraisal valuations or complete data regarding property characteristics. We also use a Bayesian, structural time series approach to estimate the indexes. These methodological enhancements enable much more granular index estimation, including separate supply and demand indexes for major metropolitan areas in the US. Secondly, we propose a Liquidity Metric defined as the demand minus supply price index levels as a fraction of the corresponding consummated transaction price index level, where the indexes are calibrated to have equal long-term average levels. Using this liquidity construct, we show that the normal liquidity dynamic in commercial property asset markets is ”pro-cyclical”, that is, price and trading volume tending to move together, with demand tending to lead supply and to move more extremely. However, we also observe a liquidity dynamic that we dub ”anomalous”, which occurs about 25 percent of the time at the quarterly frequency, in which the Liquidity Metric declines while consummated prices are still rising. This anomalous dynamic is associated often, but not always, with the end of a period of rapid growth in market values. We show results for a number of major U.S. metro areas, all of which reveal this ”anomaly” just before the Global Financial Crisis, and most of them again only more recently for at least some period since 2016.
Keywords: Liquidity, Commercial real estate, Bayesian repeat sales price index, Equilibrium dynamics, Constant liquidity index
JEL Classification: R30, C11, C32, C41
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