markets that adjust primarily through price, private markets
adjust via price and liquidity jointly. In down markets, li-
quidity takes the initial brunt of the hit, moderating the im-
pact on values relative to what would transpire in a highly
liquid public market. as has been the case in this downturn,
the dearth of property transactions coincides with a widen-
ing of the bid-ask spread. Demand-side (buyer) valuations
have fallen much further than seller valuations. We can get a
sense of the relative differences from the separate Demand-
and Supply-side value indices that the MIT Center for Real
Estate compiles in conjunction with the TBI. Exhibit 3 shows
cumulative price declines for the TBI, labeled “Transaction
Price” as well as Demand and Supply versions of it.
The TBI Transaction Price index is derived directly from
realized transaction prices, whereas the Demand Price index
is a “constant liquidity” index defined under the assumption
that all adjustment in the real estate asset market takes place
through price change; the price is more reflective of what
the property could be sold for today. Transaction Price is a
variable liquidity index that reflects the joint determination
of the price and liquidity feature of private asset markets;
price and liquidity jointly adjust to market shocks. Changes
in Demand Price will be more volatile than changes in
Transaction Price. The Supply Price essentially tracks seller
reservation prices. Notice that if all adjustment took place in
the price dimension in private property asset markets, more
along the lines of public asset markets, then according to the
MIT index, property prices would have dropped by about
50% to date since the peak in 2007. This of course has not
happened because part of the adjustment has taken place in
the liquidity dimension; sellers have not lowered reservation
prices nearly as much as buyers, suggesting that many of
them place a high value on the option to wait out the credit
market and economic uncertainty.
Through the first quarter of this year, the spread be-
tween cumulative Demand Price and Supply Price declines
widened substantially, as the prices buyers were willing to
pay fell rapidly but the prices sellers were willing to accept
dropped at a much slower rate, reflecting the sharp increase
in the bid-ask spread. In the Spring PREA Quarterlycolumn,
I argued that the current low-liquidity situation could persist
for some time, but eventually mean reversion will take place
as seller reservation prices fall, the distribution of buyer valu-
ations shifts higher, or some combination of each occurs;
something has to give. The continued negative outlook for
real estate space markets coupled with the excess mortgage
debt in the system (more on this later) makes it increas-
ingly likely that many highly leveraged investors will face
significant stress going forward, thereby moving down seller
reservation prices faster than buyer valuations that have al-
ready largely capitalized the negative impacts of future dis-
tress. as shown in Exhibit 3, the second-quarter 2009 MIT
index data, suggests that the seller distribution is shifting.
Following a gradual seven-quarter decline, seller reservation
prices fell 18% in the second quarter! While buyer valua-
tions also continued to fall, the increase in transactions at
considerably lower prices is a necessary perquisite to foster-
ing improved liquidity, price discovery, and ultimately the
bottom of the price cycle.
additional evidence to support the notion that more
owners are willing (forced?) to accept lower prices comes
from the changing nature of transactions in the second quar-
ter. Specifically, according to Moody’s, april transaction data