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

A common definition of liquidity in real estate investment is the ability to sell property assetsquickly at full value, as reflected by transaction volume. The present paper makes methodologicaland conceptual contributions in the study and understanding of liquidity. First, we extendthe Fisher et al. (2003, 2007) methodology for the separate tracking of changes in reservationprices 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 applicationto typical commercial property transaction price datasets, which lack appraisal valuationsor complete data regarding property characteristics. We also use a Bayesian, structural time seriesapproach to estimate the indexes. These methodological enhancements enable much moregranular supply and demand index estimation, including at the metropolitan level. Second, wepropose a Liquidity Metric based on the indexes, and show that the normal liquidity dynamicin commercial property asset markets is “pro-cyclical”, that is, price and trading volume tendto 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 whileconsummated prices are still rising. This anomalous dynamic is often associated with the end ofa period of rapid growth in market values