An analysis of commercial real estate returns: an anatomy of smoothing in asset and index returns

In this article, we investigate the commonly used autoregressive filter method of adjusting appraisal-based real estate returns to correct for the perceived biases induced in the appraisal process. Many articles have been written on appraisal smoothing but remarkably few have considered the relationship between smoothing at the individual property level and the amount of persistence in the aggregate appraisal-based index. To investigate this issue we analyze a large sample of appraisal data at the individual property level from the Investment Property Databank. We find that commonly used unsmoothing estimates at the index level overstate the extent of smoothing that takes place at the individual property level. There is also strong support for an ARFIMA representation of appraisal returns at the index level and an ARMA model at the individual property level.

“Financial alchemy” or a zero sum game? Real estate finance, securitisation and the UK property market

Following the US model, the UK has seen considerable innovation in the funding, finance and procurement of real estate in the last decade. In the growing CMBS market asset backed securitisations have included $2.25billion secured on the Broadgate office development and issues secured on Canary Wharf and the Trafford Centre regional mall. Major occupiers (retailer Sainsbury’s, retail bank Abbey National) have engaged in innovative sale & leaseback and outsourcing schemes. Strong claims are made concerning the benefits of such schemes – e.g. British Land were reported to have reduced their weighted cost of debt by 150bp as a result of the Broadgate issue. The paper reports preliminary findings from a project funded by the Corporation of London and the RICS Research Foundation examining a number of innovative schemes to identify, within a formal finance framework, sources of added value and hidden costs. The analysis indicates that many of the gains claimed conceal costs – in terms of market value of debt or flexibility of management – while others result from unusual firm or market conditions (for example utilising the UK long lease and the unusual shape of the yield curve). Nonetheless, there are real gains resulting from the innovations, reflecting arbitrage and institutional constraints in the direct (private) real estate market

Real options and game theoretical approaches to real estate development projects: multiple equilibria and the implications of different tie-breaking rules

This paper contributes to a fast growing literature which introduces game theory in the analysis of real option investments in a competitive setting. Specifically, in this paper we focus on the issue of multiple equilibria and on the implications that different equilibrium selections may have for the pricing of real options and for subsequent strategic decisions. We present some theoretical results of the necessary conditions to have multiple equilibria and we show under which conditions different tie-breaking rules result in different economic decisions. We then present a numerical exercise using the in formation set obtained on a real estate development in South London. We find that risk aversion reduces option value and this reduction decreases marginally as negative externalities decrease.

Spatial concentration in institutional industrial real estate investment in the England and Wales

In two recent papers Byrne and Lee (2006, 2007) examined the geographical concentration of institutional office and retail investment in England and Wales at two points in time; 1998 and 2003. The findings indicate that commercial office portfolios are concentrated in a very few urban areas, whereas retail holdings correlate more closely with the urban hierarchy of England and Wales and consequently are essentially ubiquitous. Research into the industrial sector is very much less developed, and this paper therefore makes a significant contribution to understanding the structure of industrial property investment in the UK. It shows that industrial investment concentration is between that of retail and office and is focussed on LAs with high levels of manual workers in areas with smaller industrial units. It also shows that during the period studied the structure of the sector changed, with greater emphasis on the distributional element, for which location is a principal consideration.

The cost of choice: how corporate real estate managers evaluate business space options

Firms are faced with a wider set of choices when they identify a need for new office space. They can build or purchase accommodation, lease space for long or short periods with or without the inclusion of services, or they can use “instant office” solutions provided by serviced office operators. But how do they evaluate these alternatives and are they able to make rational choices? The research found that the shortening of business horizons lead to the desire for more office space on short-term contracts often with the inclusion of at least some facilities management and business support services. The need for greater flexibility, particularly in financial terms, was highlighted as an important criteria when selecting new office accommodation. The current office portfolios held were perceived not to meet these requirements. However, there was often a lack of good quality data available within occupiers which could be used to help them analyse the range of choices in the market. Additionally, there were other organisational constraints to making decisions about inclusive real estate products. These included fragmentation of decisions-making, internal politics and the lack of assessment of business risk alongside real estate risk. Overall therefore, corporate occupiers themselves act as an interial force to the development of new and innovative real estate products.

Timing and the holding periods of institutional real estate

The literature on investors’ holding periods for equities and bonds suggest that high transaction costs are associated with longer holding periods. Return volatility, by contrast, is associated with short-term trading and hence shorter holding periods. High transaction costs and the perceived illiquidity of the real estate market leads to an expectation of longer holding periods. Further, work on depreciation and obsolescence might suggest that there is an optimal holding period. However, there is little empirical work in the area. In this paper, data from the Investment Property Databank are used to investigate sales rate and holding period for UK institutional real estate between 1981 and 1994. Sales rates are investigated using the Cox proportional hazards framework. The results show longer holding periods than those claimed by investors. There are marked differences by type of property and sales rates vary over time. Contemporaneous returns are positively associated with an increase in the rate of sale. The results shed light on investor behaviour.

Commercial real estate return distributions: a review of literature and empirical evidence

This paper review the literature on the distribution of commercial real estate returns. There is growing evidence that the assumption of normality in returns is not safe. Distributions are found to be peaked, fat-tailed and, tentatively, skewed. There is some evidence of compound distributions and non-linearity. Public traded real estate assets (such as property company or REIT shares) behave in a fashion more similar to other common stocks. However, as in equity markets, it would be unwise to assume normality uncritically. Empirical evidence for UK real estate markets is obtained by applying distribution fitting routines to IPD Monthly Index data for the aggregate index and selected sub-sectors. It is clear that normality is rejected in most cases. It is often argued that observed differences in real estate returns are a measurement issue resulting from appraiser behaviour. However, unsmoothing the series does not assist in modelling returns. A large proportion of returns are close to zero. This would be characteristic of a thinly-traded market where new information arrives infrequently. Analysis of quarterly data suggests that, over longer trading periods, return distributions may conform more closely to those found in other asset markets. These results have implications for the formulation and implementation of a multi-asset portfolio allocation strategy.

Sector and regional factors in real estate returns

This paper presents a simple method to measure the effect of sector and regional factors in real estate returns, and thus provides a quantitative framework for analysing the relative impact of these two diversification categories to real estate portfolio selection. Using data on Retail, Office and Industrial properties spread across 326 real estate locations in the UK, over the period 1981 to 1995, the results show that the performance of real estate is largely sector-driven. A result in line with previous work. Which implies that the sector composition of the real estate fund should be the first level of analysis in constructing and managing the real estate portfolio. As a consequence real estate fund managers need to pay more attention to the sector allocation of their portfolios than the regional spread.

Portfolio size and the reduction of dispersion: the case of the United Kingdom commercial real estate market

This paper investigates the potential benefits and limitations of equal and value-weighted diversification using as the example the UK institutional property market. To achieve this it uses the largest sample (392) of actual property returns that is currently available, over the period 1981 to 1996. To evaluate these issues two approaches are adopted; first, an analysis of the correlations within the sectors and regions and secondly simulations of property portfolios of increasing size constructed both naively and with value-weighting. Using these methods it is shown that the extent of possible risk reduction is limited because of the high positive correlations between assets in any portfolio, even when naively diversified. It is also shown that portfolios exhibit high levels of variability around the average risk, suggesting that previous work seriously understates the number of properties needed to achieve a satisfactory level of diversification. The results have implications for the development and maintenance of a property portfolio because they indicate that the achievable level of risk reduction depends upon the availability of assets, the weighting system used and the investor’s risk tolerance.