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Real Estate Investment: Education & Practice: Do the Theories fit the Applications?
Keith Lown & Michael WhiteNottingham Trent University
• Most degree programmes include classes on investment analysis – Modern Portfolio Theory and The Capital Asset Pricing Model
• Real estate investment constitutes a major research area• Theories used in equity markets usually taught in real
estate degrees
• But how relevant are these theories for real estate investment?
Investment Theory & Practice
Modern Portfolio Theory
Modern Portfolio Theory (and its spin-off The Capital Asset Pricing Model) won Nobel Prizes for 3 famous financial economists:
Harry Markowitz b.1927- University of Chicago- Modern Portfolio Theory (1952)
John Lintner b.1916, d.1983- Harvard Business School- Capital Asset Pricing Model
William F Sharpe b.1934- UCLA- A Simplified Model for Portfolio Analysis
The Market Model
• The expected return on an asset could be expressed as a linear function of the expected return on the market as a whole
Expected Rate of Return
Asset Specific variable
β Beta valueExpected rate of return
on market
• Return on any asset related to a common index (the market as a whole) rather than on each other (as in MPT)
The Capital Asset Pricing Model
Calculation of β Beta:
Covariance of rate of return on the asset and portfolio
Variance of the rate of return on the market
β Beta Values
β = 1 asset/share rises and falls in line with the market
β = >1 asset/share rises and falls are more volatile than the market – Aggressive Asset
β = <1 asset/share rises and falls fluctuate less than market - Defensive Asset
β = 0 asset/share has no risk
Used Extensively in Analysis of Equities Markets
The Capital Asset Pricing Model
Equities Beta Calculations
CAPM Vocabulary has crept into Real Estate…
• Formula for the single asset portfolio including Beta
Theory and Practice
Research• Are these models used by real estate
investors/fund managers?• Can they be adopted?• Should they be adopted?
• Clear limitations when considering the practicalities of investing in what is an imperfectly traded market with lumpy assets
• Is it appropriate only as top level asset allocation and not at sector selection?
Asset allocation
Funds
Real EstateBondsEquities
Direct Indirect
Asset allocation
Funds
Real EstateBondsEquities
Direct Indirect
Offices Retail Industrial Other Indirect
Asset allocation
Direct
Offices Retail Industrial Other
City Centre
Out of Town
BusinessParks
High Street
Retail Parks
Shopping Centres
Logistics Estates HotelsStudent
Resi. Leisure
Shopping Centres
Regional Dominant Town Centre Suburban
Town Centre
Prime Secondary Tertiary
Where can MPT/CAPM be employed?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
Asset Allocation• No consideration of international investment• Is, can or should CAPM be used in determining allocations to
direct real estate?• If not, why teach it on real estate courses?
• Primary drivers for real estate investment = returns and liquidity not necessarily diversification
Research Methodology
Quantitative Research• Structured interviews with property fund
managers
Qualitative Research• Is this even possible in that historic
performance data for individual properties is not available in a format that can be useable?
Research MethodologyStructured Interviews with Property Fund managers.
Areas to be covered:
The asset allocation process utilised?Structure characteristics of their funds?Decision Making ProcessPortfolio AllocationRole of DiversificationBenchmarking provisions
The Pilot StudyEarly Indications from 3 UK Fund Managers
The money coming into property is ever
more sophisticated…
We have to speak the right language
Property is small beer compared to
Equities
There just isn’t the data to use CAPM
properly
CAPM can be another way of
analysing real estate assets
Property does not lend itself to such
analysis
We are more interested in risk
management
It is worthwhile teaching but…
These tools are only used at a top level
asset class allocation
Real Estate Investment Education & Real Estate Investment Practice:
Do the Theories fit the Applications?
Keith Lown & Michael WhiteNottingham Trent University
Questions?