Real Estate Investment: Education

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Real Estate Investment Education Practice Do
the Theories fit the Applications? Keith Lown
Michael White Nottingham Trent University
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Investment Theory Practice

• 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?

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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
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The Capital Asset Pricing Model

• 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
Expected rate of return on market
ß Beta value

• Return on any asset related to a common index
  (the market as a whole) rather than on each other
  (as in MPT)

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The Capital Asset Pricing Model

• Calculation of ß Beta

Covariance of rate of return on the asset and
portfolio
Variance of the rate of return on the market
ß Beta Values ß 1 asset/share rises and falls
in line with the market ß gt1 asset/share rises
and falls are more volatile than the market
Aggressive Asset ß lt1 asset/share rises and
falls fluctuate less than market - Defensive
Asset ß 0 asset/share has no risk
Used Extensively in Analysis of Equities Markets
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Equities Beta Calculations
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CAPM Vocabulary has crept into Real Estate

• Formula for the single asset portfolio including
  Beta

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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?

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Asset allocation
Funds
Real Estate
Bonds
Equities
Indirect
Direct
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Asset allocation
Funds
Real Estate
Bonds
Equities
Direct
Indirect
Offices
Retail
Industrial
Other
Indirect
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Asset allocation
Direct
Offices
Retail
Industrial
Other
City Centre
Out of Town
Business Parks
High Street
Shopping Centres
Retail Parks
Logistics
Estates
Hotels
Student Resi.
Leisure
Shopping Centres
Regional Dominant
Town Centre
Suburban
Town Centre
Prime
Secondary
Tertiary
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Where can MPT/CAPM be employed?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
MPT/CAPM?
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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

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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?

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Research Methodology
Structured Interviews with Property Fund
managers. Areas to be covered
The asset allocation process utilised? Structure
characteristics of their funds? Decision Making
Process Portfolio Allocation Role of
Diversification Benchmarking provisions
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The Pilot Study
Early Indications from 3 UK Fund Managers
The money coming into property is ever more
sophisticated
There just isnt the data to use CAPM properly
CAPM can be another way of analysing real estate
assets
We have to speak the right language
We are more interested in risk management
Property does not lend itself to such analysis
Property is small beer compared to Equities
It is worthwhile teaching but
These tools are only used at a top level asset
class allocation
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Real Estate Investment Education Real Estate
Investment Practice Do the Theories fit the
Applications? Keith Lown Michael
White Nottingham Trent University
Questions?