Correction Procedures for Appraisal-Based Real Estate Indices

Abstract

This study reviews and critically discusses correction-procedures (also called "unsmoothing-procedures") for appraisal-based indices.Indices tracking values of direct commercial real estate investments are traditionally constructed in an "appraisal-based style" : Since transactions and corresponding prices of individual properties are scarce, values from regular intervals of appraisals for each "index property" are taken for index calculation. Alas, appraisal-values neither necessarily match transaction-prices nor true market values of properties. Instead, they can deviate from market-values due to biases, which arise in appraisals and index construction processes. In the past, some scientific authors suggested to correct (or "unsmooth") appraisal-based indices from several types of biases. They claim that the corrected index returns should rather match the returns of true market values than the original index returns.Primarily, appraisal-based real estate indices were calculated and published for the USA and UK. Those countries are considered as convenient target markets for investors. Due to its early launch, nowadays one long series of an appraisal-based index, which is available and appropriate for time series analysis, is the NCREIF Property Index for U.S.-properties. The 'total' index is composed of an 'income' and a 'capital' (or 'appreciation') component. So the focus of this study is in an application of the correction procedures on the NCREIF Appreciation Index. The techniques of the correctionprocedures are discussed referring to the NPI. Also meaningful modifications are proposed for the correction procedures.