1. 20th ERES Conference 3th - 6th July 2013 Vienna Change of the Tools Used for Real Estate Risk Analysis Rafał Wolski, PhD Department of Industry Economics and Capital Market University of Lodz Magdalena Zaleczna, PhD Department of Investment and Real Estate University of Lodz

2. Introduction: Analysis of the composition of the investment portfolio based on Modern Portfolio Theory is performed under the assumption of risk measurement with standard deviation. However, even Markowitz (1956) suggested that the measure of downside risk may be an interesting tool.

3. Introduction: The studies based on downside measures in analysing the real estate market were conducted among others by Sivitanides (1998), Sing and Ong (2000),Cheng and Wolverton (2001), Cheng (2005), Kroencke and Schindler (2010).

4. The aim of the paper: The downturn in the market distorts economic calculation. Authors examine how the downturn disrupts the risk measures and what results can be achieved by optimizing the investor's investment portfolio using different risk measures.

5. The research hypothesis: In a period of recession downside risk measures provide investors a false sense of security underestimating the investment risk.

6. The area of analysis The analysis was conducted on direct and indirect Polish real estate market data. The analysis also includes government bonds as an alternative investment. Analyzed data covered the period from the fourth quarter of 2005 to the third quarter of 2012.

7. The area of research needs a short introduction: Polish real estate market: – Direct investment (retail, office and warehouse real estate); – Indirect investment (real estate investment funds certificates, securities of developers and construction companies, mortgage/covered bonds);

8. Direct real estate investment in Poland - yields Source: Knight Frank

9. Indirect investment – real estate investment fund In Poland only closed-end investment funds are allowed to invest in real estate, directly. The minimal number of real estate in portfolio is 4. The maximal spending on one real estate is 25% of collected money. The portfolio should be built during 24 months.

10. Indirect investment – real estate investment fund 2005200620072008200920102011 Real estate investment funds 371015172127 As % of all investment funds 1,62,93,64,74,655,3 The family of investment funds 346791113 As % of all families of investment funds 131518 212226

11. Indirect investment – real estate investment fund In April 2004 the first close-end real estate investment fund was established (Arka BZ WBK Fundusz Rynku Nieruchomości). During subsciption period there was collected 339.5 million PLN (71.25 million EURO) of capital. 1 certificate had the value of 97 PLN (20,36 EURO).

12. Arka BZ WBK Fundusz Rynku Nieruchomości – change of certificate price (PLN)

13. Indirect investment – developers and construction companies on stock exchange One small part of Polish stock exchange is devoted to developers, there is a special index prepared for them. There is 24 companies listed in the index whereas there is 30 developers noted on the Warsaw Stock Exchange (June 2013).

14. Indirect investment – mortgage/covered bonds The market of mortgage bonds in Poland is really modest. The first mortgage bank was established in 1999, the first issuance was in 2000, however the highest number of these banks in Poland was 4, now there are only 2 and their activity is limited due to some legal constrains.

15. Indirect investment – mortgage/covered bonds issuance in Poland (EUR million)

16. Methodology: In a study four measures of risk were computed. The analysis was performed to obtain the optimal portfolio, assuming optimization of relationship between rate of return and different risk measures. It was assumed that investors are free to allocate their resources between the studied investment tools. Portfolio revaluation takes place every six months, and in the last year, after three quarters.

17. Results: In the first stage authors analyzed statistics describing the nature of real estate investment. Descriptive measures were used, dispersion, sensitivity and location. The analysis led to reflection that risk measures do not give answers, which of them allows to predict the future of assets in the best way. Thus, in a second step, analysis was performed based on the investment portfolio optimization using various measures of risk.

18. Results: Results of the analysis indicate a low efficiency dawnside risk measures. For both: semi standard deviation and semi Beta investors have noted a serious loss. This was in contrast with traditional risk measures that allowed investors to achieve a small, but still a profit. It should be noted that the tested period is a time of market downturn.

20. Conclusions: In the study authors adopted an unrealistic assumption of revaluation of the portfolio every six months. While in the case of indirect investment is not a serious problem, whereas in the case of direct investment, such procedure may not be possible. The study was carried out in such a form, however, to verify the nature of the risk measures. The authors recognize the need for further research and more elaborated methodology of the survey.

21. Conclusions: A period of recession impairs economic calculation. The analysis allowed us to demonstrate that dawnside risk measures are not the best choice in selecting assets for the portfolio. Classical measure under these conditions proved to be better protecting investors against losses.

22. Thank you Rafał Wolski rwolski@uni.lodz.pl Magdalena Zaleczna mzaleczna@uni.lodz.pl