Real Estate Indices
Real estate indices are an increasingly important aspect of real estate investment management. The uses of real estate indices include the estimation of risks and returns for assisting the asset allocation decision-making process, as well as the specification of benchmarks for performance attribution. Performance attribution provides valuable information both for bottom-up investment management (e.g., in the selection of properties or managers) and for top-down investment management (in the determination of asset allocations).
In valuation, real estate investors often focus on the most recent sales of similar and nearby properties to form their central gauge of price change. But best practices for institutional investing call for a more structured and less localized view of valuation and performance attribution. This chapter focuses on the challenges and opportunities of real estate indexation.
The two main approaches to indexation are appraisal based and transaction based, each of which has its own potential problems. This chapter compares these approaches and reviews many of the most popular real estate indices, which vary in terms of methodology used (e.g., appraisal-based vs. various types of transaction-based approaches). The prevalence of a variety of indexation methodologies highlights the fact that all methodologies have nontrivial problems and that real estate analysts should be aware of the challenges associated with each methodology.