The impact of real estate on the terminal wealth of the UK mixed-asset portfolio

The argument for the inclusion of real estate in the mixed-asset portfolio has concentrated on examining its effect in reducing the portfolio risk - the time series standard deviation (TSSD), mainly using ex-post time series data. However, the past as such is not really relevant to the long-term institutional investors, such as the insurance companies and pension funds, who are more concerned the terminal wealth (TW) of their investments and the variability of this wealth, the terminal wealth standard deviation (TWSD), since it is from the TW of their investment portfolio that policyholders and pensioners will derive their benefits. These kinds of investors with particular holding period requirements will be less concerned about the within period volatility of their portfolios and more by the possibility that their portfolio returns will fail to finance their liabilities. This variability in TW will be closely linked to the risk of shortfall in the quantity of assets needed to match the institution’s liabilities. The question remains therefore can real estate enhance the TW of the mixed-asset portfolio and/or reduce the variability of the TW. This paper uses annual data from the United Kingdom (UK) for the period 1972-2001 to test whether real estate is an asset class that not only reduces ex-post portfolio risk but also enhances portfolio TW and/or reduces the variability of TW.

The persistence of real estate fund performance

This paper examines the short and long-term persistence of tax-exempt real estate funds in the UK through the use of winner-loser contingency table methodology. The persistence tests are applied to a database of varying numbers of funds from a low of 16 to a high of 27 using quarterly returns over the 12 years from 1990 Q1 to 2001 Q4. The overall conclusion is that the real estate funds in the UK show little evidence of persistence in the short-term (quarterly and semi-annual data) or for data over a considerable length of time (bi-annual to six yearly intervals). In contrast, the results are better for annual data with evidence of significant performance persistence. Thus at this stage, it seems that an annual evaluation period, provides the best discrimination of the winner and loser phenomenon in the real estate market. This result is different from equity and bond studies, where it seems that the repeat winner phenomenon is stronger over shorter periods of evaluation. These results require careful interpretation, however, as the results show that when only small samples are used significant adjustments must be made to correct for small sample bias and second the conclusions are sensitive to the length of the evaluation period and specific test used. Nonetheless, it seems that persistence in performance of real estate funds in the UK does exist, at least for the annual data, and it appears to be a guide to beating the pack in the long run. Furthermore, although the evidence of persistence in performance for the overall sample of funds is limited, we have found evidence that two funds were consistent winners over this period, whereas no one fund could be said to be a consistent loser.

The return due to diversification of real estate to the US mixed-asset portfolio

Booth and Fama (1992) observe that the compound return and so the terminal wealth of a portfolio is greater than the weighted average of the compound returns of the individual investments, a difference referred to as the return due to diversification (RDD). Thus assets that offer high RDD should be particularly attractive investments. This paper test the proposition that US direct real estate is such an asset class using annual data over the period 1951-2001. The results show that adding real estate to an existing mixed-asset portfolio increases the compound return and so the terminal wealth of the fund. However, the results are dependent on the percentage allocation to real estate and the asset class replaced.

When does direct real estate improve portfolio performance?

For over twenty years researchers have been recommending that investors diversify their portfolios by adding direct real estate. Based on the tenets of modern portfolio theory (MPT) investors are told that the primary reason they should include direct real estate is that they will enjoy decreased volatility (risk) through increased diversification. However, the MPT methodology hides where this reduction in risk originates. To over come this deficiency we use a four-quadrant approach to break down the co-movement between direct real estate and equities and bonds into negative and positive periods. Then using data for the last 25-years we show that for about 70% of the time a holding in direct real estate would have hurt portfolio returns, i.e. when the other assets showed positive performance. In other words, for only about 30% of the time would a holding in direct real estate lead to improvements in portfolio returns. However, this increase in performance occurs when the alternative asset showed negative returns. In addition, adding direct real estate always leads to reductions in portfolio risk, especially on the downside. In other words, although adding direct real estate helps the investor to avoid large losses it also reduces the potential for large gains. Thus, if the goal of the investor is offsetting losses, then the results show that direct real estate would have been of some benefit. So in answer to the question when does direct real estate improve portfolio performance the answer is on the downside, i.e. when it is most needed.

Serial persistence in individual real estate returns in the UK

Persistence of property returns is a topic of perennial interest to fund managers as it suggests that choosing those properties that will perform well in the future is as simple as looking at those that performed well in the past. Consequently, much effort has been expended to determine if such a rule exists in the real estate market. This paper extends earlier studies in US, Australian, and UK markets in two ways. First, this study applies the same methodology originally used in Young and Graff (1996) making the results directly comparable with those in the US and Australian property markets. Second, this study uses a much longer and larger database covering all commercial property data available from the Investment Property Databank (IPD), for the years 1981 to 2002 for as many as 216,758 individual property returns. While the performance results of this study mimic the US and Australian results of greater persistence in the extreme first and fourth quartiles, they also evidence persistence in the moderate second and third quartiles, a notable departure from previous studies. Likewise patterns across property type, location, time, and holding period are remarkably similar leading to the conjecture that behaviors in the practice of commercial real estate investment management are themselves deeply rooted and persistent and perhaps influenced for good or ill by agency effects

Real estate in the mixed-asset portfolio: the question of consistency

The recent poor performance of the equity market in the UK has meant that real estate is increasingly been seen as an attractive addition to the mixed-asset portfolio. However, determining whether the good return enjoyed by real estate is a temporary or long-term phenomenon is a question that remains largely unanswered. In other words, there is little or no evidence to indicate whether real estate should play a consistent role in the mixed-asset portfolio over short- and long-term investment horizons. Consistency in this context refers to the ability of an asset to maintain a positive allocation in an efficient portfolio over different holding periods. Such consistency is a desirable trait for any investment, but takes on particular significance when real estate is considered, as the asset class is generally perceived to be a long-term investment due to illiquidity. From an institutional investor’s perspective, it is therefore crucial to determine whether real estate can be reasonably expected to maintain a consistent allocation in the mixed-asset portfolio in both the short and long run and at what percentage. To address the question of consistency the allocation of real estate in the mixed-asset portfolio was calculated over different holding periods varying from 5- to 25-years.

Is ESG commitment linked to investment performance in the real estate sector?

The linkage between corporate commitment to environmental, social and governance (ESG) issues and investment performance has generated a substantial body of research outside the real estate sector. Nevertheless, the relationship between the environmental performance and financial performance of companies is still not well understood as studies have found mixed and contradicting results. Drawing upon the KLD database which contains ratings on seven ESG dimensions from 2003-2009, this paper investigates the relationship between the ESG rating and the financial performance of a sample of US real estate firms. Since the primary transmission channel from ESG activities to financial performance may be better reflected by a firm's intangible assets, we model both Tobin's q and the total annual return in a panel framework with time and sector specific fixed effects. Our results are largely consistent with the existing literature finding a positive relationship between CFP and CSP. Further, the time scale of the lagged effects seems plausible.

Re-thinking commercial real estate market segmentation

Investments in direct real estate are inherently difficult to segment compared to other asset classes due to the complex and heterogeneous nature of the asset. The most common segmentation in real estate investment analysis relies on property sector and geographical region. In this paper, we compare the predictive power of existing industry classifications with a new type of segmentation using cluster analysis on a number of relevant property attributes including the equivalent yield and size of the property as well as information on lease terms, number of tenants and tenant concentration. The new segments are shown to be distinct and relatively stable over time. In a second stage of the analysis, we test whether the newly generated segments are able to better predict the resulting financial performance of the assets than the old dichotomous segments. Applying both discriminant and neural network analysis we find mixed evidence for this hypothesis. Overall, we conclude from our analysis that each of the two approaches to segmenting the market has its strengths and weaknesses so that both might be applied gainfully in real estate investment analysis and fund management.

The impact of minimum services laws on real estate brokerage competitive intensity

As many as fourteen US states have now mandated minimum service requirements for real estate brokerage relationships in residential transactions. This study attempts to determine whether these minimum service laws have any impact on brokerage competition. Federal government agencies allege such laws discourage competition because they limit the offering of nontraditional brokerage services. However, alternatively, a legislative “bright line” definition of the lowest level of acceptable service may reduce any perceived risk in offering non-traditional brokerage services and therefore encourage competition. Using several empirical strategies and state-level data over nine years (2000-08), we do not find any consistent and significant impact (positive/negative) of minimum services laws on number of licensees per 100 households, our proxy for competition. Interestingly, we also find that association strength, as measured by Realtor association membership penetration, has a strong deterring effect on competition.

Continental shift? An analysis of convergence trends in European real estate equities

European economic and political integration have been recognised as having implications for patterns of performance in national real estate and capital markets and have generated a wide body of research and commentary. In 1999, progress towards monetary integration within the European Union culminated in the introduction of a common currency and monetary policy. This paper investigates the effects of this ‘event’ on the behaviour of stock returns in European real estate companies. A range of statistical tests is applied to the performance of European property companies to test for changes in segmentation, co-movement and causality. The results suggest that, relative to the wider equity markets, the dispersion of performance is higher, correlations are lower, a common contemporaneous factor has much lower explanatory power whilst lead-lag relationships are stronger. Consequently, the evidence of transmission of monetary integration to real estate securities is less noticeable than to general securities. Less and slower integration is attributed to the relatively small size of the real estate securities market and the local and national nature of the majority of the companies’ portfolios.