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Sense and Nonsense of Diversification Based on
Economic Factors: Do Regional Economic
Factors Influence Regional Real Estate
Investment Returns?
Florian Heydenreich, Daniel Kohlert and Andreas Oehler
Bamberg University, Germany
Chair of Finance
ERES conference 2009
24th – 27th of July
Stockholm
Heydenreich, Kohlert, Oehler
(1) Introduction
Successful real estate investment depends on an understanding of
the determinants of real estate returns (Fraser 1986).
Various studies have shown that economic factors are important
determinants of real estate returns (e.g., Chin 2003, Jackson / White 2005, Ziering /
Hess 1995).
Most studies, however, are based on national economic data
(e.g., Hendershott et al. 1999 and 2002, Wheaton et al. 1997).
Potential conflict between national economic data and regional, local
or object-specific return data and investment strategies.
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(2) Data and Methodology
Level:
Time horizon:
NUTS 2 (27 of 37 UK regions)
1981 – 2004 (yearly)
Return data: IPD Investment Property Databank
Annual total return (TRt), income return (IRt) and capital growth (CAt)
data for office buildings
Economic data: Cambridge Econometrics
Annual GDP (GDPt), unemployment (UEPt), and total investment (INVt)
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(2) Data and Methodology
Panel Analysis
• Static random-effects model (GLS):
Rit = β1x1it+…+ βKxKit + μi + νit
• Dynamic random-effects model (GMM):
Rit = β0Ri, t-1+ β0Ri, t-2+ βKxKit +…+ βKxKit + μi + νit
Rit: return variable (CA, IR, TR) of region i in period t
xKit: macroeconomic demand variable (GDP, UEP, INV) of region i
in period t
βK: parameter, μi: region specific intercept, νit: overall remainder
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(3) Results
Descriptives
Capital Growth
16%
14%
12%
10%
8%
6%
4%
2%
0%
R1 R2 R3 R4 R5 R6 R7 R8 R9 R10 R11 R12 R13 R14 R15 R16 R17 R18 R19 R20 R21 R22 R23 R24 R25 R26 R27
Average Return (1981-2004)
Average Std.Dev. (1981-2004)
R = Region
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(3) Results
Descriptives
Investment Return
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
R1
R2
R3
R4
R5
R6
R7
R8
R9 R10 R11 R12 R13 R14 R15 R16 R17 R18 R19 R20 R21 R22 R23 R24 R25 R26 R27
Average Return (1981-2004)
Average Std.Dev. (1981-2004)
R = Region
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(3) Results
Descriptives
Total Return
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
R1
R2
R3
R4
R5
R6
R7
R8
R9 R10 R11 R12 R13 R14 R15 R16 R17 R18 R19 R20 R21 R22 R23 R24 R25 R26 R27
Average Return (1981-2004)
Average Std.Dev.(1981-2004)
R = Region
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(3) Results
Descriptives (Panel)
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
Panel Analysis: Capital Growth
Panel Analysis: Capital Growth
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
Panel Analysis: Investment Return
Panel Analysis: Investment Return
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(3) Results
Panel Analysis: Total Return
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(3) Results
The estimated regression coefficients reveal autoregression for each
of the dependent variables
Economic factors influence real estate performance criteria
However: UEP not important, GDP not the expected sign
Data (sample) error? Methodological errors?
Does the identical slope assumption make sense?
Extra tests (ADR)
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(4) Extra Tests
Autoregressive Distributed Lag Model (n=2, p=1; regional)
Number of significant regional results per criterion
(univariate)
(multivariate, step-ls!)
GDP
INV
UEP
GDP
INV
UEP
CA
7
9
1
CA
12
14
1
IR
2
15
3
IR
6
16
5
TR
7
7
1
TR
13
15
2
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
(5) Conclusion
The available time series are still to short to offer safe statements
about the influence of the regional economic factors GDP, INV and
UEP on regional real estate performance.
At this point, however, it cannot be recommended to ignore the
peculiarities of single regions and to rely solely on national data.
The lags of the dependent variables often seem to explain regional
real estate performance better than demand-side variables.
There might also be a strong influence of non-macro-economic
factors, particularly supply-side factors, that have greater
explanatory power.
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
Thank you
for your
comments!
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
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Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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Heydenreich, Kohlert, Oehler
Return Formula
CVt  CVt 1  CEt
NRt
TRt  CAt  IRt 

CVt 1  CEt
CVt  CEt
CV = capital value, CE = capital expenditures, NR = net rent
Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors
Influence Regional Real Estate Investment Returns?
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19
CA, GDP
20
CA, INV
21
CA, UEP
22
IR, GDP
23
IR, INV
24
IR, UEP
25
TR, GDP
26
TR, INV
27
TR, UEP
28
CA, ALL
29
IR, ALL
30
TR, ALL
31