Value Indexes Gaining Credibility

Financial analysts have created indexes of everything from stocks and bonds to fine art and coins, but - until recently - real estate values have proved hard to gauge.

"There's just no such thing as the continuous sale of the same product over time, as in General Motors stock," said Susan M. Wachter, a professor at the Wharton Real Estate Center of the University of Pennsylvania.

But Ms. Wachter and others now have the tools needed to fill the void. "The technology and data are there for the first time," Ms. Wachter said.

In good times, inefficiencies helped banks price real estate loans at premiums that seemed attractive. But they also kept banks from putting the risk into any meaningful perspective that might have prevented them from going as far as they did.

Educated Guesses?

Bankers are suffering the consequences of lending hundreds of billions of dollars in the 1980s - on a basis that amounted to guesswork about the value of real estate assets.

The most commonly cited index in use now is the Russell-NACREIF index put out by the National Council of Real Estate Investment Fiduciaries.

This index is based on appraisals, not sales. It tends to understate the variability of real estate prices, noted Jeffrey Fishers, director of real estate studies at the University of Indiana. Downward variability, he noted, has been the bane of many banks that recently provided 100% financing for real estate.

Ms. Wachter recently produced a highly localized index of condominium prices for a New York investor. And Mr. Fisher is part of a group that received a grant from NACREIF and the NACREIF-Homer Hoyt Institute to prepare metropolitan indexes of office building prices.

Choice of Indexes

The National Association of Home Builders is compiling its own index of values of multifamily properties.

If accurate, such indexes promise a tool for allocating lenders' money between real estate and other assets.

Wall Street is poised to sell investment contracts keyed to indexes that would enable banks and investors to hedge their real estate exposure.

And - of particular interest to banks - the regulatory agencies are now clamoring for better ways to evaluate risk.

"The approach is to create indexes," said Lloyd Lynford, president of REIS Reports, which is providing data for several market indicators being incubated in the financial laboratories of academia.

The regulators "believe real estate is a major component of [the demand for bank] capital - and need a better understanding of when to turn the spigot on or off," Mr. Lynford said.

Calculating Appreciation Rates

Using data from REDI Real Estate Information Services on properties that have sold at least twice since 1978, Ms. Wachter calculated appreciation rates over various time periods.

Another approach would have been to use average sales prices. But, Ms. Wachter said, an index based on averages would be skewed toward high-priced or low-priced condos, depending on which is selling better.

In contrast to the appraisal based Russell-NACREIF index, the new indexes would be based on actual transactions, said Mr. Fisher at the University of Indiana. The insensitivity to variations makes the appraisal-based index less useful as a hedging tool, he said.

The challenge in producing a useful office lease index is in gathering enough accurate data, he added. Unfortunately, brokers who have the information on rental concessions by landlords - which is needed to calculate effective rates of return from a property - regard the data as proprietary.

He emphasized that information provided by brokers would be kept confidential, with only aggregate numbers being publicized.

Federal Reserve Chairman Alan Greenspan encouraged the creation of indexes at a meeting on the credit crunch, earlier this year, with Urban Land Institute officials, Mr. Fisher said.

PHOTO : NY Condo Prices Inch Higher?

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