Global Real Estate Markets Cycles and Fundamentals

Global Real Estate Markets Cycles and FundamentalsBradford Case
William Goetzmann
Pension Plans and Real Estate
“Pension-plan investment in real estate is extremely limited and much smaller than one would expect based on most mean-variance models” – Ciochetti et al. (1999)
Target based on MV models: 15-20%
Actual allocation: 3-4%
Stocks and Bonds (Titman and Quan, 1999)
Regional Diversification (Goetzmann and Ibbotson 1990)
International Diversification (Eichholz 1996, Eichholz and Harzell, 1996), Liu and Mei, 1998, and others)
Relatively high average return
Goetzmann and Ibbotson (1990),
Provides a good hedge against inflation
Goetzmann and Ibbotson (1990), Titman and Quan (1999), Anari and Kolari (2002)
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Direct holdings in properties
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Returns on direct investment difficult to measure due to:
Appraisals
Taxes
Behavioral biases
Evidenced by diversification benefits
Important common component to real estate returns
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Global versus local factors
Separate global from local factors in real estate returns
Are national real estate markets correlated through a global or local GDP factor?
Role for Shiller’s “macro futures”?
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World real estate markets are correlated through common GDP effects
A global real estate portfolio is a bet on trends in global production
After controlling for global GDP, local effects are generally small.
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Yields and cap-rates
Approximate effective rents
Prime industrial, office, and retail real estate in 22 cities around the world,1987-1997
Converted to U.S. real dollars
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R = effective rent
U.S. Office .54 correlation to NCREIF
Little correlation to NAREIT
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CorrelationTest
Test 1: Remove own GDP effect via regression. Examine change in avg. correlation
Test 2: Remove global EW GDP effect via regression. Examine change in average correlation
GDP factor = real $-valued percent change in annual GDP
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Global vs. Local Factors
R2 from TS regression on global vs. local & global (Chow test)
Ratio: )R2/global R2
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Local Factor Variance Ratio
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Contemporaneous GDP factor significant
Current GDP and lag-2 value significant
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Industrial has greatest benefit
Office has least benefit
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GDP-Hedged Diversification
How well does international diversification work if you could hedge GDP risk?
Diversification limits:
Robert Shiller: “Macro Markets”
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Conclusions
Cross-border correlations of real estate captured by common exposure to world GDP
Real estate is fundamentally local, but its covariance is global
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
IndustrialOfficeRetail
Industrial
Office
Retail
Unhedged
Hedged
Time
: Annual Returns For all Markets and Property Types: 1987 - 1997
Time