On the pulse of the property world Market segmentation and portfolio management Luigi Pischedda Davide Manstretta Roberto Martinez Diaz An analysis of the Italian property market

On the pulse of the property world Sources: IPD Aim of the study lReal estate investors use diversification as a risk-reducing factor when deciding their portfolios’ asset allocation. lMarket segmentation is a way of determining the asset allocation which will diversify the portfolio, that is, minimise the overall risk of the portfolio at the expenses of the smallest possible reduction in returns. lThe way in which market segmentation achieves this result is by grouping together assets with similar return profiles. The assets thus clustered together will show a small variance in returns within each of the segments, which will in turn differ greatly from one another, as far as performance is concerned. lIPD provides the market with a standard segmentation from which institutional investors who own one or more balanced portfolios can draw inspiration for their investment strategies. lThe present study shows the explanatory power of the IPD standard segmentation with respect to the variability of returns for the Italian market, and explores a few alternative segmentations.

On the pulse of the property world Sources: IPD The IPD Italian universe Main sector weights as a %age of market value lAs at the end of 2009, the databank included circa 1,600 properties, for a total market value of over Euro 19bn. lTraditionally, the office sector has been the main focus of institutional investors’ asset allocation year endSince index inception

On the pulse of the property world Sources: IPD The IPD standard segmentation for the Italian property market Once again, a focus on the office sector

On the pulse of the property world Sources: IPD The IPD standard segmentation for the Italian property market Once again, a focus on the office sector lThe amount of office data collected led the IPD standard segmentation to a greater breakdown for offices:

On the pulse of the property world Sources: IPD The IPD standard segmentation for the Italian property market Explanatory power (R 2, 1yr total return) lR 2 indicates the proportion of variability in returns explained by the chosen segmentation. The average R 2 for the 13 segments of the standard segmentation over the 6 years considered is 9.7%.

On the pulse of the property world Sources: IPD The trade-off: explanatory power vs. complexity Standard segmentation, minimum and maximum breakdown lWe expect that increasing the number of segments the explanatory power of the segmentation increases too, and vice versa: lBut are investors ready to deal with the amount of complexity caused by an extremely detailed segmentation?

On the pulse of the property world Sources: IPD The trade-off: explanatory power vs. complexity Standard segmentation, minimum and maximum breakdown lThe three segmentations behave as expected:  Min breakdown: average R 2 = 6.3%  Standard: average R 2 = 9.7%  Max breakdown: R 2 = 18.6%

On the pulse of the property world Sources: IPD The trade-off: explanatory power vs. complexity Standard segmentation, minimum and maximum breakdown lThe results are confirmed using 3yrs rolling average  Min breakdown: average R 2 = 10.8%  Standard: average R 2 = 16.5%  Max breakdown: R 2 = 26.9%

On the pulse of the property world Sources: IPD Introducing alternative segmentations Detailed breakdown for offices & retail and offices & industrial lWhat happens to the explanatory power of the segmentation if we slightly increase the number of segments?

On the pulse of the property world Sources: IPD Introducing alternative segmentations Detailed breakdown for offices & retail and offices & industrial lOffices & retail vs. Offices & industrial:  Standard: average R 2 = 9.7%  Offices & retail: R 2 = 15.3%  Offices & industrial: R 2 = 10.3%

On the pulse of the property world Sources: IPD Introducing alternative segmentations Detailed breakdown for offices & retail and offices & industrial lOffices & retail vs. Offices & industrial:  Standard: average R 2 = 16.5%  Offices & retail: R 2 = 23.8%  Offices & industrial: R 2 = 18.7%

On the pulse of the property world Sources: IPD Conclusions lIPD provides the market with a standard segmentation from which institutional investors who own one or more balanced portfolios can draw inspiration for their investment strategies. lThe explanatory power of the IPD standard segmentation can be improved by adding as many as 9 segments (given the current size of the databank), but the price of explaining up to 27% of the variability in returns (R 2 3yrs rolling average) is an increased complexity. lAn R 2 of nearly 24% (3yrs rolling average) can be achieved by a small increment in the number of segments if we consider a relatively detailed breakdown for offices and retail. lFuture improvements to the study might include the geographic segmentation for the retail sector and the calculation of the probability of outperformance when stock- picking within the segments.

On the pulse of the property world Intellectual Property Rights and use of IPD statistics as benchmarks Whether in the public domain or otherwise, IPD's statistics are the intellectual property of Investment Property Databank Limited. It is not permissible to use data drawn from this presentation as benchmarks. © Investment Property Databank Limited (IPD) Database Right, Investment Property Databank Limited (IPD) All rights conferred by law of copyright and by virtue of international conventions are reserved by IPD Luigi Pischedda IPD 1 St John’s Lane London EC1M 4BL United Kingdom Direct: +44 (0) Mobile: +44 (0) Fax: +44 (0) Thank you for your time