Chart: Commercial Real Estate Quarterly Price Index Moves, Calculated Standard Deviation, Empirical Rule Observations Utilizing FRED Data

Board of Governors of the Federal Reserve System (US), Interest Rates and Price Indexes; Commercial Real Estate Price Index, Level [BOGZ1FL075035503Q], index levels retrieved from FRED, Federal Reserve Bank of St. Louis; Series BOGZ1FL075035503Q, January 16, 2023.The chart herein shows the quarterly change of the Commercial Real Estate Price Index from the Board of Governors of the US Federal Reserve System as of January 17, 2023. The data set utilized for this chart is posted below.

Having a published data set allows for calculation of the standard deviation of these returns, noted above as 2.55%. Since these are quarterly, one would divide that by the square root of 4 to arrive at the annualized standard deviation of 5.1%. The quarterly return of 1.06% would be annualized by compounding the return to arrive at an annualized rate of 4.30%, with the compounding adding just a bit more return than if multiplied by 4.

Commercial Real Estate Price Index Summary Calculations

These changes are for the price index only, whereas owners of commercial real estate generally earn income. That rate varies over time, and there is no such corresponding data set over time of which I am aware.  For approximation purposes, however, we’ll assume a 5% capitalization rate for all periods in order to run some empirical rule calculations.

“Risk means more things can happen than will happen.”

~ Elroy Dimson

Empirical Rule Calculations

Going by this set of data, it would appear the only about once every 666 years would the total return be worse than -10.99% (1 / [1-99.7%] x 50%). That sounds pretty good, but it also doesn’t seem quite right. Allow me to consider some potential faults with this.

First, I have no idea what goes into this index. It is an index of the Fed. One can assume it is highly diversified, as very few investors are. If you are loaded up on retail properties in Wynwood, what happens nationally is only minimally applicable. Additionally, many investors carry debt, and debt magnifies returns. Finally, this does not feel right. I think the standard deviation feels a bit higher than 5.1%. In prior post, Applying the Black & Scholes Option Pricing Model to Commercial Real Estate Option Pricing, I gave a set of reasons for assuming standard deviation as 6.5%. I still feel more comfortable with that level, frankly. What this Fed data has done for me is to get more comfortable that 6.5% itself is not substantially low, and might even be a touch high. Thank you, FRED.

A final note I’d make about this is that an investor, before allowing this to provide comfort regarding assumed risk, should look at the -30.22% index price move for the year of 2009. That more than 3 SD move deviates considerably from the rest of the dataset. That begs the question of whether that is a black swan type event, i.e. an aberration, if there is something amiss with that 2009 price index data, or if there is something about this 1952 to 2022 period that, aside from 2009, was preternaturally steady for commercial real estate prices (or some combination thereof).  My conclusion is that Yogi Berra had it right long ago when he quipped; “It’s tough to make predictions, especially about the future.”

Commercial Real Estate Price Index Level Data:

Board of Governors of the Federal Reserve System (US), Interest Rates and Price Indexes; Commercial Real Estate Price Index, Level [BOGZ1FL075035503Q], index levels retrieved from FRED, Federal Reserve Bank of St. Louis; Series BOGZ1FL075035503Q, January 16, 2023.The chart herein shows the quarterly change of the Commercial Real Estate Price Index from the Board of Governors of the US Federal Reserve System as of January 17, 2023.

~

Don’t rely on this in any way to make investment decisions. These are just observations, and may be incorrect. On that note, if you find an error in the calculations, logic, or assumptions, contact me and let me know!