Commercial Real Estate Returns: An Anatomy of Smoothing in Asset and Index Returns

In this paper we investigate the commonly used auto-regressive filter method of adjusting appraisal-based real estate returns to correct for the perceived biases induced in the appraisal process. Many papers have been written on appraisal smoothing but remarkably few have considered the relationship between smoothing at the individual property level and the amount of persistence in the aggregate appraised-based index. To investigate this issue we analyse a large sample of appraisal data at the individual-property level from the Investment Property Databank (IPD). We find that commonly used unsmoothing estimates at the index level overstate the extent of smoothing that takes place at the individual property level. There is also strong support for an ARFIMA representation of appraisal returns at the index level and an ARMA model at the individual property level.