How Accurate Are Commercial Real Estate Appraisals? Evidence from 25 Years of NCREIF Sales Data

Abstract

In this study, Cannon and Cole provide new evidence on the performance measurement and reporting of commercial real estate returns. They do so by examining the accuracy of commercial real estate appraisals that occurred prior to the sale of properties from the NCREIF National Property Index (NPI) from 1984 to 2010, a period that spans two up-and-down market cycles. The authors find that, on average, appraisals are more than 12% above, or below, subsequent sales prices that take place two quarters following the appraisal. Even in a portfolio context, allowing for offsetting positive and negative differences, appraisals are off by an average 4%–5% of value, even after adjusting for capital appreciation during those two quarters. The authors also provide new evidence regarding how, and by how much, appraised values lag behind sales prices. They find that appraisals appear to lag the true sales prices, falling significantly below in hot markets and remaining significantly above in cold markets. This new evidence provides guidance to investors, regulators, and others about how to interpret real estate indices such as the NPI, which are based on appraised values, in both a rising and a falling market. Finally, the authors find that this “appraisal error” is largely systematic; they can explain more than half of the variation in the signed percentage difference in sales price and appraised value. Hence, appraisal errors are not due solely to property-specific heterogeneity.