Academic journal article Journal of Real Estate Literature

New Ncreif Value Index and Operations Measures

Academic journal article Journal of Real Estate Literature

New Ncreif Value Index and Operations Measures

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Since its inception over 35 years ago, the NCREIF Property Index (NPI) has achieved preeminence as an indicator of the investment performance of institutionally-held commercial property in the United States. The NPI formula is:


where Rt is the total return for period t, MVt is the market value at the end of period t, MVt-1 is the market value at the beginning of period t, PSt is any partial sales in period t, NOIt is the net operating income in period t, and CIt is the capital expenditures (improvements) in period t.

This NPI formula is designed as an approximation of a quarterly internal rate of return (IRR) when NOI is assumed to be received monthly during the quarter and any capital expenditures (CapEx) or partial sales occur mid-quarter. Brueggeman and Giliberto (1987) present a derivation of this formula using a Taylor series expansion of the formula for an IRR under these assumptions. The formula can also be derived from the modified Dietz formula developed by Dietz (1966) and commonly used for performance measurement in the institutional arena. The assumption that NOI occurs at the end of each month is what results in the one-third adjustment in the denominator and the assumption that CapEx and partial sales occur mid-quarter is the reason for the one-half adjustment. For the purpose of this article, the main point is that this formula was designed for returns (i.e., to provide an approximation of an IRR).

The practice in the real estate industry has been to also compute two components of the total return-a so-called income return and an appreciation return (also called a capital return). The income return just uses the Noi in the numerator of the formula and the appreciation return uses the remaining terms, which include the CapEx and partial sales terms.


The NPI is widely-reported and used by real estate investment owners, investors, managers, and consultants, as well as by academics. It has become the de facto yardstick that the industry uses for a variety of performance and analytical purposes including portfolio construction, monitoring, and attribution analysis. But, the NPI was designed as a measure of returns for institutional real estate. Although total return has historically been broken down into income return and appreciation return components, this can be problematic for several reasons: (1) the income return is based on NOI and not net cash flow and thus is not comparable with a "dividend yield" for common stocks; and (2) the appreciation return is net of CapEx and thus is not comparable with other price indices, such as the Moody's/RCA CPPI (Geltner and Pollakowski, 2007).

It should be noted that separating total return into components is common for real estate as investors typically associate less risk with income and more risk with appreciation. However, the income return is not a cash return. the income return is analogous to a capitalization rate, commonly defined as NOI divided by market value. For the appreciation return, CapEx is subtracted from the end-of-quarter market value because you cannot have a "return" by simply adding capital. That is, the value change would at least, in part, be due to making additional investment. However, the appreciation return is not a price change. As noted above, what is also desirable for real estate is both a measure of the cash flow yield, analogous to stock and bond yields, and a measure of a true price index that captures how values change over time.

Young, Geltner, McIntosh, and Poutasse (1995, 1996) and Young (2005) proposed changes to the NPI formula that address some of the above issues. However, after considerable research, NCREIF decided that there was a need for several different types of indices, each optimized for their intended purpose. As noted above, the NPI was designed for returns. …

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