The Dynamics of Liquidity in Commercial Property Markets: Revisiting Supply and Demand Indexes in Real Estate

Abstract

A common definition of liquidity in real estate investment is the ability to sell property assets quickly at full value, as reflected by transaction volume. The present paper makes methodological and conceptual contributions in the study and understanding of liquidity. First, we extend the Fisher et al. (2003, 2007) methodology for the separate tracking of changes in reservation prices on the demand (potential buyers) and supply (potential sellers) sides of the asset market. We show how to apply the methodology to a repeat sales indexing framework, allowing application to typical commercial property transaction price datasets, which lack appraisal valuations or complete data regarding property characteristics. We also use a Bayesian, structural time series approach to estimate the indexes. These methodological enhancements enable much more granular supply and demand index estimation, including at the metropolitan level. Second, we propose a Liquidity Metric based on the indexes, and show that the normal liquidity dynamic in commercial property asset markets is "pro-cyclical", that is, price and trading volume tend to move together, with demand tending to lead supply. But we also observe an "anomalous" dynamic that occurs about 25 percent of the time, in which the Liquidity Metric declines while consummated prices are still rising. This anomalous dynamic is often associated with the end of a period of rapid growth in market values.

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

“…This paper uses as a measure for market liquidity the difference between supply and demand price indexes relative to a standard price index, following Fisher et al (2003) and Fisher et al (2007) and Clayton et al (2008). We use the method of Van Dijk et al (2020), who derive supply and demand indexes in a repeat sales model framework. This approach has the advantage of effectively dealing with heterogeneity in commercial real estate assets, without the need for many property characteristics or assessed values.…”

“…They find a statistically significant positive relationship between lagged turnover and contemporaneous capital returns. Devaney et al (2017) study determinants of variations in transaction activity for a set of 49 US MSA office markets in the period 2002-2015. Van Dijk et al (2020 note that for the US market, liquidity movements tend to be stronger correlated across markets than price movements.…”

“…Fisher et al (2003Fisher et al ( , 2007 develop a method to disentangle buyers' and sellers' reservation prices from transactions data. Van Dijk et al (2020) extend this method in a repeat sales and structural time-series framework such that the method can be applied on most transaction data-sets on a regional scale. Van Dijk et al (2020) further propose a metric for market liquidity based on the difference of buyers' and sellers' reservation prices scaled by the prevailing transactions price.…”

“…Van Dijk et al (2020) extend this method in a repeat sales and structural time-series framework such that the method can be applied on most transaction data-sets on a regional scale. Van Dijk et al (2020) further propose a metric for market liquidity based on the difference of buyers' and sellers' reservation prices scaled by the prevailing transactions price. To answer our question on commonalities, we use this method to construct demand and supply reservation price indexes as well as liquidity indexes on a regional scale.…”

“…The components of the liquidity metric can be estimated by a two-step approach (Heckman, 1979) using a probit model to estimate β b i,t − β s i,t , and an adjusted linear regression model to estimate β i,t . For a more elaborate description of the variables, the model, and estimation procedure we refer to Van Dijk et al (2020). The liquidity metric is theoretically and empirically closely related to other liquidity metrics based on for example the timeon-market in housing or the turnover rate (Van Dijk, 2018).…”