Download Chapter 1

Chapter 22
Real Estate Investment
Performance and Portfolio
Considerations
1
Overview







Real Estate Investment Returns Data
Real Estate Investment Performance
Holding Period Returns
Portfolios
Correlation
Efficient Frontier
Real Estate and Potential for Portfolio
Diversification
2
Real Estate Investment
Returns Data

Limited Data




Private, negotiated transactions
Asset is non-homogeneous
Thinly traded market
REIT Data


NAREIT
NCREIF Property Index
3
Real Estate Investment
Returns Data – Continued
4
Real Estate Investment
Returns Data – Continued
5
Cumulative Investment
Returns
6
Real Estate Investment
Performance

Holding Period Returns
PT  PT 1  D1
HPR 
PT 1
PT = End of period price
PT-1 = Beginning of period price
D1 = Dividends
7
Real Estate Investment
Performance – Continued

Example:





Purchase price $100
Sales price $110
Dividend received $5
HPR = $15/$100 = 15%
Geometric Mean Return – compound growth rate
GMR  n (1 HPR1)(1 HPR2 )(1 HPRn ) 1


Arithmetic Mean – simple average return
Consider the following annual returns:




15%, 20%, -30%, 22%
Arithmetic mean = (25+20-30+22)/4 = 9.25%
Geometric mean =[(1.25)(1.2)(0.7)(1.22)]0.25-1
Geometric mean = 6.39%
8
Holding Period Returns
9
Real Estate Investment
Performance – Continued


Historical Comparisons
Risk





Business Risk
Default Risk
Liquidity Risk
Variability in asset returns & risk premiums
Coefficient of Variation

Risk per unit of return
10
Real Estate Investment
Performance – Continued
11
Portfolios

Portfolio Returns
HPRP  Wi (HPRi )  Wj (HPR j ).........



Example
Portfolio




Where W’s are weights
Asset A: weight 30%, return 10%
Asset B: weight 40%, return 15%
Asset C: weight 30%, return 18%
Portfolio Return

(0.3x10)+(0.4x15)+(0.3x18)= 14.4%
12
Portfolios – Continued
13
Portfolios – Continued

Portfolio Risk

Standard deviation



Covariance


Not a weighted average
There is interaction between returns of assets
Absolute measure of how asset returns move
together
Correlation


Relative measure of movement
Range of +1 to -1
ij 
COVij
σ iσ j
14
Correlation
15
Correlation Matrix
16
Efficient Frontier
Portfolio Returns of NCREIF and S&P 500
Portfolio Return (percent)
4.50
4.00
3.50
3.00
2.50
2.00
1%
2%
3%
4%
5%
6%
7%
8%
Portfolio standard deviation %
17
Efficient Frontier – 3 Assets
(Stock, bonds, and NCREIF)
18
Real Estate and Potential for
Portfolio Diversification

Portfolio Diversification with REITs and
NCREIF


It looks like REITs may not provide diversification
benefits due to positive correlation with stocks
(~0.5)
Private real estate investments returns
approximated by NCREIF provide greater potential
for diversification




NAREIT returns are more volatile than that of NCREIF
This is because NCREIF index is appraisal based
NAREIT index returns reflect overall market fluctuations
as well
NAREIT index may be a poor hedge against inflation
compared to NCREIF
19
Diversification by Property
Type
20
Diversification by Property
Location
21