Real Estate Investment Performance and Portfolio

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

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 (2520-3022)/4 9.25
• Geometric mean (1.25)(1.2)(0.7)(1.22)0.25-1
• Geometric mean 6.39

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 Ws 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

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

15
Correlation
16
Correlation Matrix
17
Efficient Frontier
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