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Chapter 22:
Real Estate Investment
Performance and Portfolio
Considerations
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Real Estate Investment
Performance
 Limited data
– Private, negotiated transactions
– Asset is non-homogeneous
– Thinly traded market
– Real estate specific data sources
 NAREIT
 NCREIF Property Index
22-2
Exhibit 22-2
Cumulative Total Returns REITs, S&P 500, NCREIF,
Bonds, and T-Bill Indexes, 1985-2009
22-3
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
22-4
Real Estate Investment
Performance
 Example 22-1:
– Purchase price $100
– Sales price $110
– Dividend received $5
– HPR = $15/$100 = 15%
22-5
Real Estate Investment
Performance
 Geometric Mean Return
GMR  n (1 HPR1)(1 HPR2 )(1 HPRn ) 1
 Arithmetic Mean – a simple (non-compounded)
average
22-6
Real Estate Investment
Performance
 Example 22-2
– Consider the following annual returns:
 15%, 20%, -30%, 22%
– Arithmetic mean = (25+20-30+22)/4 = 9.25%
– Geometric mean =[(1.25)(1.2)(.7)(1.22)].25-1
– Geometric mean = 6.39%
22-7
Real Estate Investment
Performance
 Historical comparisons
 Risk
– Business risk
– Default risk (from leverage)
– Liquidity risk
 Variability in asset returns & risk premiums
22-8
Real Estate Investment
Performance
 Coefficient of Variation
– = Standard Deviation of Returns/Mean Return
– Risk per unit of return
– Also known as “risk-to-reward” ration
 Portfolios
– Asset efficiency: Does adding an asset to a portfolio
add to returns while maintaining or lowering portfolio
risk?
 Portfolio Returns
HPRP  Wi (HPRi )  Wj (HPR j ) ...
Where W’s are weights
22-9
Exhibit 22-8
Portfolio Returns of NCREIF and S&P 500 Stocks, 19782009
22-10
Exhibit 22-9
Efficient Frontiers
22-11
Real Estate Investment
Performance
 Example 22-3
 Portfolio
– Asset A: weight 30%, return 10%
– Asset B: weight 40%, return 15%
– Asset C: weight 30%, return 18%
 Portfolio return
– (.3x10)+(.4x15)+(.3x18)= 14.4%
22-12
Real Estate Investment
Performance
 Portfolio risk
– Standard deviation
 Not a weighted average
 There is interaction between returns of assets
 Covariance
– Absolute measure of how two data series
(such as asset returns) move together over
time
22-13
Real Estate Investment
Performance
 Correlation
– Relative measure of movement
– Range of +1 to -1
ij 
COVij
σ iσ j
– For example, as the correlation approaches +1, two
series are said to move very closely together. The
converse is also true.
22-14
Real Estate Investment
Performance
 Portfolio weighting
– Efficient frontier
 Maximum return for a given risk level
 Diversification & real estate
– Historical evidence
– NCREIF Index & appraisal smoothing
– Traded REITs & public markets risk
22-15
Exhibit 22-10
NCREIF versus NAREIT (REITs) Quarterly Returns,
1985-2009
22-16
Real Estate Investment
Performance
 Diversification
– Property Type & Location
 Global diversification
– Evolution of global REIT structures
– CMBS markets
– International Indices
 Socially responsible property investing
22-17
Exhibit 22-11
NCREIF Returns by Property Type, Four Quarter Rolling
Total
22-18
Exhibit 22-12
NCREIF Returns by Selected MSA, Four Quarter Rolling
Total
22-19
Real Estate Investment
Performance
 Diversification & global cities
 Risks of global investment
– Currency risk
– Incomplete information
– Different tax laws & property rights
– Political risk
– Communication & culture differences
22-20
Exhibit 22-14
Largest Commercial Real Estate Markets
22-21
Exhibit 22-15
GDP Growth Rates for Different Global Cities
22-22
Real Estate Investment
Performance
 Derivatives
– Derivatives allow investors to take a position
in real estate without actually buying or selling
properties.
– Long & short positions
– Overexposure & underexposure to property
types
22-23