Depreciation and its impact on the total return of UK commercial real estate, 1994-2003

Depreciation is a key element of understanding the returns from and price of commercial real estate. Understanding its impact is important for asset allocation models and asset management decisions. It is a key input into well-constructed pricing models and its impact on indices of commercial real estate prices needs to be recognised. There have been a number of previous studies of the impact of depreciation on real estate, particularly in the UK. Law (2004) analysed all of these studies and found that the seemingly consistent results were an illusion as they all used a variety of measurement methods and data. In addition, none of these studies examined impact on total returns; they examined either rental value depreciation alone or rental and capital value depreciation. This study seeks to rectify this omission, adopting the best practice measurement framework set out by Law (2004). Using individual property data from the UK Investment Property Databank for the 10-year period between 1994 and 2003, rental and capital depreciation, capital expenditure rates, and total return series for the data sample and for a benchmark are calculated for 10 market segments. The results are complicated by the period of analysis which started in the aftermath of the major UK real estate recession of the early 1990s, but they give important insights into the impact of depreciation in different segments of the UK real estate investment market.

Risk management and the corporate real estate portfolio

In a global business economy, firms have a broad range of corporate real estate needs. During the past decade, multiple strategies and tactics have emerged in the corporate real estate community for meeting those needs. We propose here a framework for analysing and prioritising the various types of risk inherent in corporate real estate decisions. From a business strategy perspective, corporate real estate must serve needs beyond the simple one of shelter for the workforce and production process. Certain uses are strategic in that they allow access to externalities, embody the business strategy, or provide entrée to new markets. Other uses may be tactical, in that they arise from business activities of relatively short duration or provide an opportunity to pre-empt competitors. Still other corporate real estate uses can be considered “core” to the existence of the business enterprise. These might be special use properties or may be generic buildings that have become embodiments of the organisation’s culture. We argue that a multi-dimensional matrix approach organised around three broad themes and nine sub-categories allow the decision-maker to organise and evaluate choices with an acceptable degree of rigor and thoroughness. The three broad themes are Use (divided into Core, Cyclical or Casual) – Asset Type (which can be Strategic, Specialty or Generic) and Market Environment (which ranges from Mature Domestic to Emerging Economy). Proper understanding of each of these groupings brings critical variables to the fore and allows for efficient resource allocation and enhanced risk management.

Required returns for real estate in UK pension fund portfolios

The position of Real Estate within a multi-asset portfolio has received considerable attention recently. Previous research has concentrated on the percentage holding property would achieve given its risk/return characteristics. Such studies have invariably used Modern Portfolio Theory and these approaches have been criticised for both the quality of the real estate data and problems with the methodology itself. The first problem is now well understood, and the second can be addressed by the use of realistic constraints on asset holdings. This paper takes a different approach. We determine the level of return that Real Estate needs to achieve to justify an allocation within the multi asset portfolio. In order to test the importance of the quality of the data we use historic appraisal based and desmoothed returns to examine the sensitivity of the results. Consideration is also given to the Holding period and the imposition of realistic constraints on the asset holdings in order to model portfolios held by pension fund investors. We conclude, using several benchmark levels of portfolio risk and return, that using appraisal based data the required level of return for Real Estate was less than that achieved over the period 1972-1993. The use of desmoothed series can reverse this result at the highest levels of desmoothing although within a restricted holding period Real Estate offered returns in excess of those required to enter the portfolio and might have a role to play in the multi-asset portfolio.

Apartment ownership: the English version needs reforming

In this contribution, the English commonhold system, which enables the development of freehold units in a multi-unit development, is critically re-visited. Provision is made for the development of freehold apartments on land with a registered commonhold title. At the date of registration, a management body for the scheme, the commonhold association, must be in place. Each purchaser of a unit in the relevant building obtains freehold property on purchase. The property and management of the building housing the units and of the common areas of the scheme are, by contrast, withheld from unit holders and vested in the commonhold association, which is a special kind of body corporate. Since the coming into force of the English legislation, a set of defects have been detected. This contribution re-assesses the main problem areas and makes a number of reform suggestions drawing on material from a number of jurisdictions, notably South Africa, France and Germany. Avoidable problems are likely to arise with any conversions to commonhold from the predominant English long lease system, owing to the narrowness of the conversion rules. The manner in which ownership of units and the common parts are regulated, a key aspect in any such system, merits re-assessment. It seems that here the English rules survive comparison. The rules pertaining to constitution of the commonhold association fail to provide sufficient safeguards for unpaid scheme creditors. The rules relating leasing of commonhold units seem inadequately thought out. There is a conspicuous absence of real remedies for non-payment of assessments by unit holders. The effect of these and other aspects may help to explain why commonhold has had a limited numerical impact. The time for a second generation reforming statute may have come.

Occupational futures? Divesting real estate and corporate PFI

Property ownership can tie up large amounts of capital and management energy that business could employ more productively elsewhere. Competitive pressures, accounting changes and increasingly sophisticated occupier requirements are building demand for new and innovative ways to satisfy corporate occupation needs. The investment climate is also changing. Falling interest rates and falling inflation can be expected to undermine returns from the traditional FRI lease. In future, investment returns will be more dependent on active and innovative management geared to the needs of occupiers on whom income depends. Occupier and investor interests, therefore, look set to coincide, but unlocking the potential for both parties will depend on developing new finance and investment vehicles that align their respective needs. In the UK, examples include PFI in the public sector and off-balance sheet financing in the private sector. In the USA, “synthetic lease” structures have also become popular. Growing investment market experience in assessing risks and returns suggests scope for further innovative arrangements in the corporate sector. But how can such arrangements be structured? What are the risks, drivers and barriers?

Can institutional investors bias real estate portfolio appraisals? Evidence from the market downturn

This paper investigates the extent to which institutional investors may have influenced independent real estate appraisals during the financial crisis. A conceptual model of the determinants of client influence on real estate appraisals is proposed. It is suggested that the extent of clients’ ability and willingness to bias appraisal outputs is contingent upon market and regulatory environments (ethical norms and legal and institutional frameworks), the salience of the appraisal(s) to the client, financial incentives for the appraiser to respond to client pressure, organisational culture, the level of moral reasoning of both individual clients and appraisers, client knowledge and the degree of appraisal uncertainty. The potential of client influence to bias ostensibly independent real estate appraisals is examined using the opportunity afforded by the market downturn commencing in 2007 in the UK. During the market turbulence at the end of 2007, the motivations of different types of owners to bias appraisals diverged clearly and temporarily provided a unique opportunity to assess potential appraisal bias. We use appraisal-based performance data for individual real estate assets to test whether there were significant ownership effects on performance during this period. The results support the hypothesis that real estate appraisals in this period reflected the differing needs of clients.

Thermal and visual performance of real and theoretical thermochromic glazing solutions for office buildings

Thermochromic windows are able to modulate their transmittance in both the visible and the near-infrared field as a function of their temperature. As a consequence, they allow to control the solar gains in summer, thus reducing the energy needs for space cooling. However, they may also yield a reduction in the daylight availability, which results in the energy consumption for indoor artificial lighting being increased. This paper investigates, by means of dynamic simulations, the application of thermochromic windows to an existing office building in terms of energy savings on an annual basis, while also focusing on the effects in terms of daylighting and thermal comfort. In particular, due attention is paid to daylight availability, described through illuminance maps and by the calculation of the daylight factor, which in several countries is subject thresholds. The study considers both a commercially available thermochromic pane and a series of theoretical thermochromic glazing. The expected performance is compared to static clear and reflective insulating glass units. The simulations are repeated in different climatic conditions, showing that the overall energy savings compared to clear glazing can range from around 5% for cold climates to around 20% in warm climates, while not compromising daylight availability. Moreover the role played by the transition temperature of the pane is examined, pointing out an optimal transition temperatures that is irrespective of the climatic conditions.