Real Estate Investment Performance and Portfolio Considerations Chapter 22 Real Estate Investment Performance and Portfolio Considerations

Overview Real Estate Investment Returns Data Real Estate Investment Performance Holding Period Returns Portfolios Correlation Efficient Frontier Real Estate and Potential for Portfolio Diversification

Real Estate Investment Returns Data Limited Data Private, negotiated transactions Asset is non-homogeneous Thinly traded market REIT Data NAREIT NCREIF Property Index

Real Estate Investment Returns Data – Continued

Real Estate Investment Returns Data – Continued

Cumulative Investment Returns

Real Estate Investment Performance Holding Period Returns PT = End of period price PT-1 = Beginning of period price D1 = Dividends

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 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%

Holding Period Returns

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

Real Estate Investment Performance – Continued

Portfolios Portfolio Returns Example Portfolio Portfolio Return Where W’s are weights Example Portfolio 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%

Portfolios – Continued

Portfolios – Continued Portfolio Risk Standard deviation Not a weighted average There is interaction between returns of assets Covariance Absolute measure of how asset returns move together Correlation Relative measure of movement Range of +1 to -1

Correlation

Correlation Matrix

Efficient Frontier

Efficient Frontier – 3 Assets (Stock, bonds, and NCREIF)

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

Diversification by Property Type

Diversification by Property Location