Kansas City Fed Develops New Index to Measure CRE Performance

As any real estate professional knows, the CRE sector directly influences and is influenced by the broader economy. Now the Kansas City Fed has come up with an index it believes can help to measure those interactions for a particular region to enable improved forecasting and planning.

An article by Nicholas Sky, vice president of the Federal Reserve Bank of Kansas City, and researcher Bethany Greene, points to the tight link between CRE activity and the financial sector, including banks and the broader financial markets. And it contends that CRE development in a given area often has more to do with the regional economic landscape than with  aggregate conditions. “Community and regional banking organizations tend to have high CRE loan concentrations, further tightening the regional connections to the sector,” the authors write.

The Kansas City Fed CRE Index is an attempt to decipher these local linkages, and to “offer insight about future growth in construction employment, provide a leading indicator of CRE loan performance, and reveal the drivers of developments in the sector in a timely manner.” It relies on data collected in the KC Fed Beige Book eight times a year from survey participants in the Tenth Federal Reserve District, which includes Colorado, Kansas, Nebraska, Oklahoma, Wyoming, and portions of Missouri and New Mexico. The index is intended as a quarterly indicator of CRE activity in the Tenth District. It serves as a simple tool to track local developments and provides early insights  of future developments.

“The index incorporates a broad range of related economic activities and financial considerations across a variety of commercial property types such as retail properties, hotels, office buildings, multifamily housing, and industrial space,” the KC Fed explains. “The …index explains approximately 69 percent of the observed variation in reported conditions across CRE market characteristics from 2006 to 2023.”

CRE conditions are stronger than the long-run average if the index is positive, while a negative reading suggests the opposite. The current release reveals the state of play for the previous quarter.

The inputs the Fed looks for in building the index are prices for existing CRE space, the availability of existing CRE space, new construction and development of CRE space, construction costs and materials prices for new CRE space, and financial conditions.

According to Sky and Greene, the index may provide an early indicator of changes in the demand for workers in the next six to 12 months. It may also help predict loan performance at regional banks, especially community and regional banks that tend to hold a relatively large share of CRE loans and securities on their balance sheets. Changes in the index may even indicate the share of CRE loans that will be noncurrent in three to six months.

Overall, the index may help make sense of the structural changes in the economy that affect CRE like hybrid work, where people work, and how altered supply chains affect the need for warehouses and industrial space.

“The KC Fed CRE Index may be a useful tool for tracking these developments in a timely manner and delineating the drivers of CRE activity amid these structural shifts,” the authors write.