Discuss real estate investment indexes: how they are built and the biases they may contain

Real estate indexes measure returns in different ways, and each carries biases. Appraisal-based indexes use periodic valuations of institutionally held properties; appraisers anchor on earlier values, so returns lag the market and look smooth, understating volatility and correlation with other assets and flattering risk-adjusted returns. Unsmoothing techniques can remove part of this. Transaction-based indexes use actual sales, either repeat-sales methods or hedonic regressions that control for property characteristics; they respond faster but suffer sample selection bias, because the properties that sell may not represent the market, and they become noisy when volumes are thin. REIT-based indexes are timely but reflect leverage and stock market sentiment. The trap is accepting an appraisal index's low volatility at face value.