chapter 22: real estate investment performance and portfolio considerations

McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Chapter 22: Real Estate Investment

Performance and Portfolio Considerations

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Real Estate Investment Real Estate Investment PerformancePerformance

Limited data– Private, negotiated transactions– Asset is non-homogeneous– Thinly traded market– Real estate specific data sources

NAREITNCREIF Property Index

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Exhibit 22-2Cumulative Total Returns REITs, S&P 500, NCREIF,

Bonds, and T-Bill Indexes, 1985-2009

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Holding Period Returns

PT = End of period price

PT-1 = Beginning of period price

D1 = Dividends

1T

11TT

P

DPPHPR

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Example 22-1:– Purchase price $100– Sales price $110– Dividend received $5

– HPR = $15/$100 = 15%

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Geometric Mean Return

Arithmetic Mean – a simple (non-compounded) average

1nn21 )HPR(1)HPR)(1HPR(1GMR

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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%

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Historical comparisons Risk

– Business risk– Default risk (from leverage)– Liquidity risk

Variability in asset returns & risk premiums

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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

Where W’s are weights

... )HPR(W)HPR(WHPR jjiiP

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Exhibit 22-8Portfolio Returns of NCREIF and S&P 500 Stocks, 1978-

2009

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Exhibit 22-9Efficient Frontiers

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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%

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Portfolio risk– Standard deviation

Not a weighted averageThere is interaction between returns of assets

Covariance– Absolute measure of how two data series

(such as asset returns) move together over time

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Correlation– Relative measure of movement– Range of +1 to -1

– For example, as the correlation approaches +1, two series are said to move very closely together. The converse is also true.

ji

ijij σσ

COV

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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

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Exhibit 22-10NCREIF versus NAREIT (REITs) Quarterly Returns,

1985-2009

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Diversification– Property Type & Location

Global diversification– Evolution of global REIT structures– CMBS markets– International Indices

Socially responsible property investing

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Exhibit 22-11NCREIF Returns by Property Type, Four Quarter Rolling

Total

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Exhibit 22-12NCREIF Returns by Selected MSA, Four Quarter Rolling

Total

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Diversification & global cities Risks of global investment

– Currency risk– Incomplete information– Different tax laws & property rights– Political risk– Communication & culture differences

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Exhibit 22-14Largest Commercial Real Estate Markets

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Exhibit 22-15GDP Growth Rates for Different Global Cities

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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

chapter 22: real estate investment performance and portfolio considerations

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