Appraisal Smoothing and Price Discovery in Real Estate Markets

Abstract

This paper reviews the literature on price determination in the private and public real estate markets. In particular, it discusses the processes of appraisal smoothing in the private market and of price discovery between the public and the private markets. In real estate markets, the absence of good quality information on price, whether because of lack of trades or confidentiality, has led to the widespread use of appraisals for market tracking and as the basis for performance measurement. Appraisers have to make an optimum assessment of value, based on fundamental variables and market information, including transactions and a market-wide appraisal index. However, transaction prices are a noisy signal and it is the appraiser's role to extract the signal from the noise in an efficient manner. This involves a process of optimal combination of past and current information and leads to appraisal smoothing. Price discovery is the process by which the opinions of market participants about the value of an asset are combined together into a single statistic—its market price. A development of this basic concept is where two markets have a common component of value and the relevant price information is discovered first in one market and then transmitted to the second market. The process of price discovery is considered between the public and private real estate markets.

Asymmetric Adjustment in the City of London Office Market

“…Because not all letting evidence is publicly available and rental agreements are signed before lease commencement, rent series may be subject to smoothing and temporal aggregation effects (see Geltner et al 2003, for a review of this literature). Finally, even in such a well researched market as that for London offices, there is scope for imperfect knowledge on demand, supply and rents, and on the impact of these on market outcomes.…”

Measuring Liquidity Premiums for Illiquid Assets

“…Third, revised values to private equity and venture capital generally are triggered by the addition of new investor capital to the portfolio company-and remain at cost until the next round of financing. Finally, Edelstein and Quan [2006] and Geltner, MacGregor, and Schwann [2003] showed that real estate values are typically based on appraisal values that, in turn, are based on historical, not current, values.…”

Risk Transfer of Presale Properties and the Construction of a Forward Property Price Index

“…Some researchers advocated the use of a valuation-based method to circumvent the insufficiency of transaction-based methods. However, problems such as the types of variables to be included in the pricing model and the appraisal-smoothing effect have yet to be addressed (Geltner et al, 2003).…”