Gauging the investment potential of international real estate markets

Investing in real estate markets overseas means venturing into the unknown, where you meet unfamiliar political and economic environments, unstable currencies, strange cultures and languages, and so although the advantages of international diversification might appear attractive, the risks of international investment must not be overlooked. However, capital markets are becoming global markets, and commercial real estate markets are no exception, accordingly despite the difficulties posed by venturing overseas no investor can overlook the potential international investment holds out. Thus, what strategies are appropriate for capitalising on this potential? Three issues must be considered: (1) the potential of the countries real estate market in general; (2) the potential of the individual market sectors; and (3) the investment process itself. Although each step in foreign real estate investment is critical, the initial assessment of opportunities is especially important. Various methods can be used to achieve this but a formal and systematic analysis of aggregate market potential should prove particularly fruitful. The work reported here, therefore, develops and illustrates such a methodology for the over 50 international real estate markets.

The impact of 9/11 on US REIT returns: fundamental or financial?

Following the attack on the World Trade Center on 9/11 volatility of daily returns of the US stock market rose sharply. This increase in volatility may reflect fundamental changes in the economic determinants of prices such as expected earnings, interest rates, real growth and inflation. Alternatively, the increase in volatility may simply reflect the effects of increased uncertainty in the financial markets. This study therefore sets out to determine if the effects of the attack on the World Trade Center on 9/11 had a fundamental or purely financial impact on US real estate returns. In order to do this we compare pre- and post-9/11 crisis returns for a number of US REIT indexes using an approach suggested by French and Roll (1986), as extended by Tuluca et al (2003). In general we find no evidence that the effects of 9/11 had a fundamental effect on REIT returns. In other words, we find that the effect of the attack on the World Trade Center on 9/11 had only a financial effect on REIT returns and therefore was transitory.

The consistency of private and public real estate within mixed-asset portfolios

This study considers the consistency of the role of both the private and public real estate markets within a mixed-asset context. While a vast literature has developed that has examined the potential role of both the private and public real estate markets, most studies have largely relied on both single time horizons and single sample periods. This paper builds upon the analysis of Lee and Stevenson (2005) who examined the consistency of REITs in a US capital market portfolio. The current paper extends that by also analyzing the role of the private market. To address the question, the allocation of both the private and traded markets is evaluated over different holding periods varying from 5- to 20-years. In general the results show that optimum mixed-asset portfolios already containing private real estate have little place for public real estate securities, especially in low risk portfolios and for longer investment horizons. Additionally, mixed-asset portfolios with public real estate either see the allocations to REITs diminished or eliminated if private real estate is also considered. The results demonstrate that there is a still a strong case for private real estate in the mixed-asset portfolio on the basis of an increase in risk-adjusted performance, even if the investor is already holding REITs, but that the reverse is not always the case.

An evaluation of the performance of UK real estate forecasters

Given the significance of forecasting in real estate investment decisions, this paper investigates forecast uncertainty and disagreement in real estate market forecasts. It compares the performance of real estate forecasters with non-real estate forecasters. Using the Investment Property Forum (IPF) quarterly survey amongst UK independent real estate forecasters and a similar survey of macro-economic and capital market forecasters, these forecasts are compared with actual performance to assess a number of forecasting issues in the UK over 1999-2004, including forecast error, bias and consensus. The results suggest that both groups are biased, less volatile compared to market returns and inefficient in that forecast errors tend to persist. The strongest finding is that forecasters display the characteristics associated with a consensus indicating herding.

Another look at the relative importance of sectors and regions in determining property returns

This paper re-examines the relative importance of sector and regional effects in determining property returns. Using the largest property database currently available in the world, we decompose the returns on individual properties into a national effect, common to all properties, and a number of sector and regional factors. However, unlike previous studies, we categorise the individual property data into an ever-increasing number of property-types and regions, from a simple 3-by-3 classification, up to a 10 by 63 sector/region classification. In this way we can test the impact that a finer classification has on the sector and regional effects. We confirm the earlier findings of previous studies that sector-specific effects have a greater influence on property returns than regional effects. We also find that the impact of the sector effect is robust across different classifications of sectors and regions. Nonetheless, the more refined sector and regional partitions uncover some interesting sector and regional differences, which were obscured in previous studies. All of which has important implications for property portfolio construction and analysis.

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.

Valuation accuracy: reconciling the timing of the valuation and sale

Carsberg (2002) suggested that the periodic valuation accuracy studies undertaken by, amongst others, IPD/Drivers Jonas (2003) should be undertaken every year and be sponsored by the RICS, which acts as the self-regulating body for valuations in the UK. This paper does not address the wider issues concerning the nature of properties which are sold and whether the sale prices are influenced by prior valuations, but considers solely the technical issues concerning the timing of the valuation and sales data. This study uses valuations and sales data from the Investment Property Databank UK Monthly Index to attempt to identify the date that sale data is divulged to valuers. This information will inform accuracy studies that use a cut-off date as to the closeness of valuations to sales completion date as a yardstick for excluding data from the analysis. It will also, assuming valuers are informed quickly of any agreed sales, help to determine the actual sale agreed date rather than the completion date, which includes a period of due diligence between when the sale is agreed and its completion. Valuations should be updated to this date, rather than the formal completion date, if a reliable measure of valuation accuracy is to be determined. An accuracy study is then undertaken using a variety of updating periods and the differences between the results are examined. The paper concludes that the sale only becomes known to valuers in the month prior to the sale taking place and that this assumes either that sales due diligence procedures are shortening or valuers are not told quickly of agreed sale prices. Studies that adopt a four-month cut-off date for any valuations compared to sales completion dates are over cautious, and this could be reduced to two months without compromising the data.

Evaluating the effectiveness of common structures in property portfolio construction

A good portfolio structure enables an investor to diversify more effectively and understand systematic influences on their performance. However, in the property market, the choice of structure is affected by data constraints and convenience. Using individual return data, this study tests the hypothesis that some common structures in the UK do not explain a significant amount about property returns. It is found that, in the periods studied, not all the structures were effective and, for the annual returns, no structures were significant in all periods. The results suggest that the drivers represented by the structures take some time to be reflected in individual property returns. They also confirm the results of other studies in finding property type a much stronger factor in explaining returns than regions.

The compulsory purchase of farmland: identifying severance and injurious affection claims

In situations of compulsory purchase of farmland, claims for the injurious affection of retained land can form a substantial part of the overall claim for compensation. This paper seeks to identify the problems of identifying injurious affection and severance items, and examines how statutory provision and subsequent case law have dealt with them.

The impact of real estate on the mixed-asset portfolio in periods of financial stress

The case for holding real estate in the mixed-asset portfolio is typically made on its stabilising effect as a result of its diversification benefits. However, portfolio diversification often fails when it is most needed, i.e. during periods of financial stress. In these periods, the variability of returns for most asset classes increases thus reducing the stabilising effect of a diversified portfolio. This paper applies the approach of Chow et al (1999) to the US domestic mixed-asset portfolio to establish whether real estate, represented by REITs, is especially useful in times of financial stress. To this end monthly returns data on five assets classes: large cap stocks, small cap stocks, long dated government bonds, cash (T-Bills) and real estate (REITs) are evaluated over the period January 1972 to December 2001. The results indicate that the inclusion of REITs in the mixed-asset portfolio can lead to increases or decreases in returns depending on the asset class replaced and whether the period is one of calm or stress. However, the inclusion of REITs invariably leads to reductions in portfolio risk that are greater than any loss in return, especially in periods of financial stress. In other words, REITs acts as a stabilising force on the mixed-asset portfolio when it is most needed, i.e. in periods of financial stress.

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.

Monetary integration and real estate markets: an investigation of the impact of the introduction of a single currency on real estate performance

This paper assesses the impact of the monetary integration on different types of stock returns in Europe. In order to isolate European factors, the impact of global equity integration and small cap factors are investigated. European countries are sub-divided according to the process of monetary convergence. Analysis shows that national equity indices are strongly influenced by global market movements, with a European stock factor providing additional explanatory power. The global and European factors explain small cap and real estate stocks much less well –suggesting an increased importance of ‘local’ drivers. For real estate, there are notable differences between core and non-core countries. Core European countries exhibit convergence – a convergence to a European rather than a global factor. The non-core countries do not seem to exhibit common trends or movements. For the non-core countries, monetary integration has been associated with increased dispersion of returns, lower correlation and lower explanatory power of a European factor. It is concluded that this may be explained by divergence in underlying macro-economic drivers between core and non-core countries in the post-Euro period.

Local environmental action in Japan: the transfer of the groundwork approach

This paper is the basis for a report on the transfer of the UK Groundwork approach to Japan. It details the background and history of Groundwork in the UK and sets out some of the relevant context in Japan. A Japanese case study (plus two further secondary cases) is detailed and conclusions and recommendations are drawn from the work to help suggest future directions for GW and environmental action in Japan in the future.