On the Use of a Cash Flow Time-Series to Measure Property Performance

Modern portfolio theory is increasingly being used to guide real estate portfolio decisions. However, to obtain meaningful results from complex mathematical techniques, the input data must meet at least two conditions: property values must be measured accurately, and the process by which property valuations change over time must be known. Neither of these conditions are satisfied by data currently available. This paper closely examines how value is measured and reported for commercial property. Commonly used time-series from NREI, NCREIF and ACLI are found wanting. An index of value using the popular "repeat sales" method is derived using data from Freddie Mac's multifamily portfolio. The focus of this paper is on developing an alternative measure of property performance based on property net operating income. Two cash flow indices are constructed from publicly available data and evaluated. It is recommended that the methodology developed here be used to create cash flow indices that can supplement or replace existing value indices in property analysis. The cash flow indices have much to offer researchers applying option-based models to real estate.