andrew baum and david hartzell, global property investment, 2011 property performance – a long...

Andrew Baum and David Hartzell, Global Property Investment, 2011

Property performance – a long term view


Total return

• Income return = Y0-1/CV0

• Capital return is the change in value over the measurement period divided by the value at beginning of the period

• CR = [CV1 - CV0]/CV0

• Total return is the sum of income return and capital return• TR = [Y0-1 + CV1 - CV0]/CV0

• CV0 = Y0/K0 (Rental value / cap rate) • CV1 = Y1/K1


C ap rate m ovem ent R ental grow th

C apital return Incom e return

Total return

Components of total return


What drives property returns (UK)?

Source: IPD, 2007

1987 1988 1993 2004 2005 2006 1981-2006 mean

-10

-5

0

5

10

15

20

25

30

35

Rental growth Cap rate change Income return


But yields (cap rates) cannot fall forever…

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20080

2

4

6

8

10

12

IPD Annual Equivalent Yields(%)

Source: IPD, PFR, 2008

Mean: 7.99%

Low: 2006, 5.37%


And cap rate change does not deliver returns (UK)

19871988

19932004

20052006

20072008

1987-2008 Ave

-30

-20

-10

0

10

20

30

Income return Cap rate change Rental growth(%)

Source: IPD, 2009


• “Despite the relatively short sample period available, we find that property is likely to hedge inflation well.”

• “Ibbotson and Fall, Ibbotson and Siegel, Brueggeman, et al., Fogler, Hartzell, et al., and Rubens, et al., conclude that real estate compensates the investor for inflation risk. When real estate is added to a mixed-asset portfolio, the inflation risk of the expanded portfolio is substantially below that of the original portfolio (ex-real estate).”

• “Unlike previous studies, this study examines real estate performance during both high and low inflation periods. The results show that real estate does provide an inflation hedge.”

Property and inflation: academic work


-1.00% 0.00% 1.00% 2.00% 3.00% 4.00%

France

Germany

Netherlands

Sweden

UK

Europe

Inflation

Nom rental growth

Property rental growth and inflation


19951996

19971998

19992000

20012002

20032004

20052006

0

1

2

3

4

5

6

7

8

9

10

Index-linked gilt yields (10 year) Property yield(%)

Property and index linked gilts are related

Source: IPD, Datastream


Summary

• There is a strong relationship between nominal rental growth and inflation

• Correlation between index-linked bond yields and property yields is around 75%, with a mean difference of 5.4%

• This suggests investors believe that property is an inflation hedge


Summary

• K = RFR N + Rp – (GN – D) • K = RFR R + i + Rp – (GR + i – D) • In equilibrium, the delivered return on real estate is the same as the

required return, so: • K + (GR + i – D) = RFRR + i + Rp

• The delivered return on real estate is produced by the cap rate, or initial yield, plus net nominal rental growth

• Strong relationship between net nominal rental growth and inflation - real rental growth has been close to zero

• Delivered return on real estate is produced by the cap rate, or initial yield, plus inflation


0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%

France

Germany

Netherlands

Sweden

UK

Spain

Europe

Yield plus infl

Total return

Property returns: yield plus inflation


Shocks

• Property returns have tracked the income yield plus inflation, plus a small premium

• In any individual year, there can be 'shocks' which deliver unusually high or low total returns. These will typically be either rental growth shocks or re-pricing shocks

• In 1987 and 1988, we saw positive rental growth shocks; in 1993 we saw a re-pricing shock which delivered a total return of around 20% despite rental value falls of around 4%

• In 2004, 2005 and 2006 we saw three re-pricing shocks pushing returns into the high teens despite generally flat rents. Cap rates cannot fall forever, so this was followed by the inevitable pricing reversal of 2007-8, another shock


Long term returns

• The long term picture is simple and predictable

• The return on the IPD Global Property Index for the nine-year period from 2001-2009 in U.S. Dollars was 8.6%, around 6.5% real, with the average cap rate close to that value - the delivered long run return on global real estate was produced by the cap rate plus inflation

• Over 1987-2010, the UK property delivered an average total return of exactly 10%. Capital growth attributable to ERV growth averaged roughly 3.5% (the rate of UK inflation over the period); capital growth attributable to yield movement was around just under -0.5%, and the income return was around 7%


What drives property returns (UK)?

19871988

19932004

20052006

20072008

20092010

1987-2008 Ave

-30

-20

-10

0

10

20

30

Income return Cap rate change Rental growth(%)

Source: IPD, 2011


Summary

• We should expect the delivered long run return on real estate to be produced by the cap rate, or initial yield, plus inflation

• Cap rates have a natural value relative to indexed bonds, and over-pricing should be apparent by this measure

• When cap rates are low by this measure returns may be poor, as in the period following 2006; when cap rates are high, as in 2009, there will be an additional source of return to enjoy

• Cap rate adjustments are often rapid, producing shocks

andrew baum and david hartzell, global property investment, 2011 property performance – a long...

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