Journal of Real Estate Finance and Economics, 9:137-164 (1994) 9 1994 Kluwer Academic Publishers Value Indices of Commercial Real Estate: A Comparison of Index Construction Methods JEFFREY D. FISHER Indiana University, Bloomington, Indiana 47405 DAVID M. GELTNER University of Cincinnati, Cincinnati, Ohio 45221-0195 R. BRIAN WEBB Indiana University, Bloomington, Indiana 47405 Abstract The purpose of this paper is to shed light on the history of commercialproperty values over the past decade, and to comparedifferentmethods of constructingcommercial properly value indicesand returns series. We ex- amine three types of indices: (i) Indices that attempt to reconstruct property market values by "unsmoothing" the appraisal-basedRussell-NCREIF Index; (ii) Indicesthat trace averageex post transaction prices of commer- cial property over time; and (iii) an index based on unlevering REIT share prices. By comparingthe different historicalpictures that result fromthe variousindexconstruction methodologies,one gainsinsightinto the nature of commercialproperty price and valuation behavior. The REIT-basedvalues lead the other indicesin time but display greater short-runvolatility.The transactions-based indices lag behind the other series in time, and are consistent with the idea that institutional investorsattempt to hold onto properties until they can sell them for a price at least equal to the current appraised value, in effect trading off liquidity for reduced volatility. Key Words: indices, smoothing, appraisal, hedonic, commercialproperty Value indices that trace the peaks and valleys through time of market prices for different asset classes provide useful information not only to historians and economists but also to practitioners and investors dealing with commodities and capital assets of various types. Estimates of the average appreciation return, standard deviation, and the correlation of returns across asset classes are important variables in models that are used to price assets and make investment decisions. Yet a reliable historical value index is not available to those who study commercial real estate even though the market value of this asset class is measured in the trillions of dollars and represents a significant share of the national wealth and pro- ductive capital. There are two major purposes of this paper. The first is to shed light on the history of commercial property values in the United States over the past decade or so. When were values rising, when were they falling, and, at least relatively speaking, how high did they rise and how far did they fall? The second purpose is to compare and contrast different methods of constructing cormnercial property value indices. Because any single index con- struction method has conceptual or practical weaknesses, we examine five alternative in- dices, based on different assumptions, methods, and data, and compare all of these to the