1

Chapter 22

Real Estate Investment Performance and Portfolio

Considerations

2

Overview Real Estate Investment Returns Data Real Estate Investment Performance Holding Period Returns Portfolios Correlation Efficient Frontier Real Estate and Potential for Portfolio

Diversification

3

Real Estate Investment Returns Data

Limited Data Private, negotiated transactions Asset is non-homogeneous Thinly traded market REIT Data

NAREIT NCREIF Property Index

4

Real Estate Investment Returns Data – Continued

5

Real Estate Investment Returns Data – Continued

6

Cumulative Investment Returns

7

Real Estate Investment Performance Holding Period Returns

PT = End of period price

PT-1 = Beginning of period price

D1 = Dividends

1T

11TT

P

DPPHPR

8

Real Estate Investment Performance – Continued Example:

Purchase price $100 Sales price $110 Dividend received $5 HPR = $15/$100 = 15%

Geometric Mean Return – compound growth rate

Arithmetic Mean – simple average return Consider the following annual returns:

15%, 20%, -30%, 22% Arithmetic mean = (25+20-30+22)/4 = 9.25% Geometric mean =[(1.25)(1.2)(0.7)(1.22)]0.25-1 Geometric mean = 6.39%

1nn21 )HPR(1)HPR)(1HPR(1GMR

9

Holding Period Returns

10

Real Estate Investment Performance – Continued Historical Comparisons Risk

Business Risk Default Risk Liquidity Risk

Variability in asset returns & risk premiums

Coefficient of Variation Risk per unit of return

11

Real Estate Investment Performance – Continued

12

Portfolios Portfolio Returns

Where W’s are weights Example Portfolio

Asset A: weight 30%, return 10% Asset B: weight 40%, return 15% Asset C: weight 30%, return 18%

Portfolio Return (0.3x10)+(0.4x15)+(0.3x18)= 14.4%

).........HPR(W)HPR(WHPR jjiiP

13

Portfolios – Continued

14

Portfolios – Continued Portfolio Risk

Standard deviation Not a weighted average There is interaction between returns of assets

Covariance Absolute measure of how asset returns

move together Correlation

Relative measure of movement Range of +1 to -1

ji

ijij σσ

COV

15

Correlation

16

Correlation Matrix

17

Efficient FrontierPortfolio Returns of NCREIF and S&P 500

2.00

2.50

3.00

3.50

4.00

4.50

1% 2% 3% 4% 5% 6% 7% 8%

Portfolio standard deviation %

Po

rtfo

lio

Ret

urn

(p

erce

nt)

18

Efficient Frontier – 3 Assets (Stock, bonds, and NCREIF)

19

Real Estate and Potential for Portfolio Diversification Portfolio Diversification with REITs and

NCREIF It looks like REITs may not provide

diversification benefits due to positive correlation with stocks (~0.5)

Private real estate investments returns approximated by NCREIF provide greater potential for diversification

NAREIT returns are more volatile than that of NCREIF

This is because NCREIF index is appraisal based NAREIT index returns reflect overall market

fluctuations as well NAREIT index may be a poor hedge against

inflation compared to NCREIF

20

Diversification by Property Type

21

Diversification by Property Location