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

Abstract

We 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.

Portfolio Diversification across U.S. Gateway and Non-Gateway Real Estate Markets

“…The appeal for major markets could be partly attributed to the liquidity and transparency preferences of institutional investors (Ghent, 2021;Ling et al, 2018). Market liquidity depends on both supply-side and demand-side reservation prices, and these can behave quite differently across market types (i.e., gateway versus secondary markets), especially during downturns (Van Dijk et al, 2022). Focusing on New York and Phoenix, as archetypes of gateway and secondary markets, they observe that the gap between demand and supply during the Global Financial Crisis (GFC) was much greater for Phoenix, resulting in a much greater loss of liquidity.…”