1 chapter 22 real estate investment performance and portfolio considerations
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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
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Real Estate Investment Returns Data
Limited Data Private, negotiated transactions Asset is non-homogeneous Thinly traded market REIT Data
NAREIT NCREIF Property Index
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Real Estate Investment Returns Data – Continued
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Real Estate Investment Returns Data – Continued
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Cumulative Investment Returns
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Real Estate Investment Performance Holding Period Returns
PT = End of period price
PT-1 = Beginning of period price
D1 = Dividends
1T
11TT
P
DPPHPR
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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
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Holding Period Returns
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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
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Real Estate Investment Performance – Continued
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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
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Portfolios – Continued
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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
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Correlation
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Correlation Matrix
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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)
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Efficient Frontier – 3 Assets (Stock, bonds, and NCREIF)
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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
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Diversification by Property Type
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Diversification by Property Location
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