Real Estate in an ALM Framework: The Case of Fair Value Accounting

This study examines the liability hedging characteristics of both direct and indirect real estate with the advent of fair value accounting obligations for pension funds. We explicitly model pension obligations as being subject to interest and inflation risk to analyze the ability of real estate investments in hedging the fair value of pension liabilities and to quantify its role in an asset liability management (ALM) portfolio. We find that the portfolio composition differs depending on the definition of liability return. When liability returns solely follow actuarial changes, the mean‐variance efficient portfolio allocations toward direct real estate and fixed income decrease compared to the asset‐only optimization. When accounting for nominal liability obligations, real estate offers hedging benefits against interest rates for short holding periods but not for long‐term institutional portfolios. The inclusion of inflation risk renders a limited role for direct real estate in an ALM portfolio, while indirect real estate obtains no allocation. Inflation is at the heart of the discrepancy between reported and predicted pension plan allocations. Once accounting for inflation, the projected allocations come close to reported ones.     

The Predictability of International Real Estate Markets, Exchange Rate Risks and Diversification Consequences

International real estate related securities are investigated to see whether they offer any incremental diversification benefits over foreign stocks using mean-variance analysis together with a multifactor latent variable model. Diversification benefits are found to be primarily driven by unanticipated returns which are partially driven by changes in exchange rate risk. Although exchange rate risk accounts for a larger portion of the return fluctuation in real estate related securities relative to common stocks, international real estate securities provide some incremental diversification benefits over common stocks even if currency risks are hedged.     

Real Estate Investments,Product Market Competition and Stock Returns

By limiting operating flexibility, real estate investments are found to increase firm risk, thus expected returns. This study introduces product market competition as a critical determinant of the relation between real estate investments and stock returns. As part of capacity strategies, these investments are generally associated with increased market power and lower cash flow volatility in oligopolistic industries. I present a simple model of oligopolistic competition showing a negative relation between real estate holdings and firm beta, and empirically confirm this prediction. Controlling for product market competition enhances identification of the endogenous relation between real estate investments and stock returns.     

Real Estate Investment Funds: Performance and Portfolio Considerations

This paper presents the results of a study dealing with a number of issues regarding real estate investment. Utilizing a data set consisting of returns from two of the oldest, continuously operating commingled real estate funds (CREFs), questions relative to investment performance, inflation hedging attributes and diversification benefits are addressed. The methodology used in exploring these issues are variants of the traditional capital asset pricing model (CAPM), extended to consider uncertain inflation (CAPMUI) and an arbitrage pricing model in which real estate performance is judged relative to a more inclusive market index representing larger numbers of substitute investments. Finally, issues relative to portfolio performance are considered by constructing portfolios containing all possible combinations of real estate, stocks and bonds to assess the potential for diversification benefits and portfolio performance.     

The Cross-Sectional Dispersion of Commercial Real Estate Returns and Rent Growth: Time Variation and Economic Fluctuations

We estimate the cross-sectional dispersions of returns and growth in rents for commercial real estate using data on U.S. metropolitan areas over the sample period 1986 to 2002. The cross-sectional dispersion of returns is a measure of the risk faced by commercial real estate investors. We document that, for apartments, offices, industrial and retail properties, the cross-sectional dispersions are time varying. Interestingly, their time-series fluctuations can be explained by macroeconomic variables such as the term and credit spreads, inflation and the short rate of interest. The cross-sectional dispersions also exhibit an asymmetrically larger response to negative economics shocks, which may be attributable to credit channel effects impacting the availability of external debt financing to commercial real estate investments. Finally, we find a statistically reliable positive relation between commercial real estate returns and their cross-sectional dispersion, suggesting that idiosyncratic fluctuations are priced in the commercial real estate market.     

Real Estate Investment Analysis: New Developments in Traditional Leverage Concepts

The advantages of utilizing leverage in real estate investments has received much attention in the past, but little guidance has been offered that shows the investor the most opportune leverage position for a given investment alternative. Traditional leverage concepts are explored in this article, prior to developing a financial indifference point model and a continuous-function degree of financial leverage (DFL) formula. The indifference point and DFL as shown here are relatively simple to calculate and provide additional insights into risk, return and leverage concepts for real estate investments.     

Real Estate Investment Acquisition Rules for Life Insurance Companies and Pension Funds: A Survey

Real estate comprises the major wealth of the United States as well as the world. Life insurance companies and pension funds are rapidly becoming major investors in real estate due to their large portfolios and annual cash inflows. Aggregate inflows of life insurance companies and pension funds are estimated to be about 150 billion dollars per year. Increasing amounts of these funds are believed to be going into real estate investments. This study surveys life insurance companies and pension managers on all facets of their real estate investments. The survey covers real estate portfolio size and type, portfolio composition, investment by property type, international investments, before-tax analysis, after-tax analysis, diversification strategies, computer usage, holding period assumptions and criteria for obtaining mortgages, equity positions and construction loans. The results of this study are then compared and contrasted with previous studies.     

Product Market Competition and Corporate Real Estate Investment under Demand Uncertainty

This article theoretically and empirically analyzes the interactions among corporate real estate investment, product market competition and firm risk. In our model, firms own strategic real estate or lease generic real estate. Our model predicts that strategic real estate ownership is positively correlated with industry concentration and negatively related to demand uncertainty. Also, firm risk is higher for firms with more strategic real estate operating in a more concentrated market. This prediction arises because smaller investments induce greater market competition, which effectively eliminates the right tail of the firm's profit distribution. We provide strong empirical support for our predictions. In particular, firm value is more volatile in less competitive markets for a given level of demand uncertainty.     

Macroeconomic Risk Factors and the Role of Mispriced Credit in the Returns from International Real Estate Securities

We examine the canonical influence of global market, currency and inflation risks on the returns from international real estate securities. In addition, we study how mispricing of credit in the local banking systems is related to the returns from these securities. We analyze a global sample of real estate securities over the period 1999 to 2011 to test our hypotheses. We find support for the anticipated relationships between macroeconomic risk factors and the returns from international real estate securities. Our evidence also supports the expected link between local credit market conditions and the performance of international real estate securities.     

Real Estate in a Mixed‐Asset Portfolio: The Role of the Investment Horizon

In this article, three oft‐mentioned special characteristics of the real estate asset market—high transaction costs, marketing period risk and return predictability—are addressed in analyzing the role of U.K. commercial real estate investments in a mixed‐asset portfolio. Due to favorable horizon effects in risk and return, the allocation to real estate in a portfolio with stocks, bonds and cash increases strongly with the investment horizon. Examining the relative importance of return predictability, transaction costs and marketing period risk for the optimal allocation to real estate, the article finds that the consideration of return predictability is very important, except for short‐term horizons. Accounting for transaction costs is crucial for short‐ and medium‐term investors. Marketing period risk appears to be negligible. Traditional mean‐variance analysis—that is, ignoring return predictability, transaction costs and marketing period risk—can be very misleading.     

An Empirical Study of Derivatives use in the REIT Industry

We examine the use of derivatives in the real estate investment trust (REIT) industry. Tax considerations and speculative motives should not be important factors here, as REITs pay no corporate income tax and their speculative activities are limited by regulations. We find that 41 % of REITs use interest-rate derivatives, although the amount of derivatives on average is not high. Our principal results are that larger REITs and mortgage REITs are more likely to use derivatives. However, in terms of the amount of derivatives, REITs that are smaller and have a larger amount of debt tend to use more derivatives. We interpret the results as evidence supportive of substantial entry costs for hedging and financial-distress costs being a major consideration for the level of hedging. REITs with greater ratio of market to book value of assets also tend to use more derivatives. However, this result is not robust across different sample sets. We therefore view this as weak evidence supporting the agency-cost explanation for hedging. Additional analysis on interest-rate risk and hedging activities finds that mortgage REITs tend to increase their hedging activities when interest rates decrease, while the opposite is true for equity REITs. We interpret this as evidence consistent with prepayment risk being a major factor for mortgage REITs, while equity REITs primarily hedge to control funding costs.     

The Economics of Maintenance for Real Estate Investments

We propose a theory of urban decay. Following a negative real estate demand shock, property managers optimally suspend maintenance and the probability that they ever restart can be modest. Because maintenance expenditures are proportionately less risky than are the incremental building profits they generate, managers impose a more demanding profit standard on maintenance than on the initial investment. This differential in profit standards means that rather than maintain existing investments, property managers favor new investments, which, if marginally acceptable, they also leave unmaintained. Contractually required maintenance ( e.g ., for publicly subsidized real estate investments), increases the minimum profit for the initial investment acceptance and discourages subsidized real estate investments in favor of unsubsidized investments. However, the required profit for acceptance of a permanently maintained investment is below the profit boundary for maintenance if maintenance is not contractually required. Consequently, the subsidy that induces the investment is least expensive if maintenance is not required, more expensive if maintenance is permanently required and most expensive if maintenance is induced immediately after initial construction but thereafter is at the discretion of the manager. All of our findings are strongest for poorer quality properties.     

Bank Real Estate Lending and the New England Capital Crunch

The stock of real estate loans held by New England banks has declined dramatically. Given the limited potential for real estate investments, weak demand for real estate loans is to be expected. However, supply as well as demand factors may account for some of the decline in bank real estate loans. This paper documents that bank lending for real estate may have been constrained by a capital crunch, whereby poorly capitalized banks shrank their assets, including real estate loans, to satisfy capital requirements. Because the loss of bank capital is so widespread in New England, bank-dependent borrowers may have difficulty obtaining real estate financing.     

房地产的虚拟性与宏观经济稳定

本文从虚拟经济的角度深入剖析了房地产的虚拟资产特性，指出房地产是一种虚拟资产．房地产这种虚拟资产的特性是其虚拟性介于普通商品和金融资产之间。文章同时指出．正是房地产的这种虚拟资产特性使其成为联系实体经济和虚拟经济的纽带。除了扰动作用以外，房地产更能起到稳定经济的作用。这表现在两个方面：一方面。与金融资产相比．房地产价格具有相对的稳定性．这使其成为商业银行发放贷款的重要的抵押品；另一方面，房地产价格的长期稳定增长对货币发行量的稳定增长有重要影响。可见，房地产的虚拟资产特性对于银行贷款和货币供给的稳定增长．从而对整个经济的稳定增长具有重要意义。     

The Investment Performance of Real Estate Limited Partnerships

Real estate limited partnerships have become an increasingly popular form of investment over the past decade. Many investors have been drawn to these investment vehicles because of the high claimed rates of return earned by investors in previous partnerships. However, there has been little analysis of the historical rates of return on these investments other than that provided by the syndicators in offering prospectuses. This paper examines the returns earned by investors in real estate limited partnerships over the past decade. These results are compared with previous studies of the investment performance of real estate. Because of the importance of the tax shield aspects of these investments, we calculate the after-tax rate of return for investors in several marginal tax brackets.     

Optimal Real Estate Portfolios

In recent years, increasing attention has been paid the problem of analyzing, evaluating and selecting real estate investments within the context of a portfolio. Most approaches simply attempt to adapt existing theory and models from the well-developed literature of securities investments. Most adaptations or extensions to real estate are not without serious problems, however, because of several fundamental difficulties relating to optimization technology inadequacies and a general lack of reliable and consistent market data.
This article deals with the major problems of utilizing some of the classic securities investment models for real estate. Further, a risk-return model is advanced which overcomes most of the fundamental problems outlined earlier in the article.     

Real Estate Returns: A Comparison with Other Investments

Real estate returns, measured unleveraged, have been between those of stocks and bonds over 1960–1982. Due to appraisal smoothing and imperfect marketability, one must be careful about directly comparing measured real estate returns with those on other assets. It is likely, however, that low correlations with stocks and bonds make real estate a diversification opportunity for traditional portfolio managers. In addition, the issue of how various assets are priced is addressed. While stocks are priced primarily on market or beta risk, and bonds are priced primarily on interest rate and default risk, the real estate pricing mechanism includes residual risk and non-risk factors such as taxes, marketability costs and information costs.     

Analysis of the Characteristics of Individual Investors in Real Estate Securities and Income-Producing Property

Analysis of the responses to a nationwide survey of investors demonstrates that individuals who invest in real estate differ in a predictable way from those who invest in assets other than real estate. Two types of real estate investment vehicles are studied: income-producing (rental) property and real estate securities. A multiple group discriminant analysis model is presented which successfully classifies prospective investors into four groups (owners of income property only, real estate securities only, both, neither) with a predictive accuracy more than double the chance probability of correct classification. The results provide insights useful in policy analysis and the design and marketing of real estate investments.     

Another Take on Real Estate's Role in Mixed‐Asset Portfolio Allocations

This article examines real estate's role in institutional mixed‐asset portfolios using both private‐ and public‐real estate indices, as a means of examining varying real estate‐related risk/return opportunities. In so doing, this article also examines the effects of: (1) increasing the investment horizon, (2) placing constraints on the maximum allocation to any one asset class, and (3) varying the risk preferences of investors. The empirical results suggest—using infinite‐horizon returns and all of the caveats that accompany such a perspective—that real estate allocations of approximately 10–15% of the mixed‐asset portfolio represent an upper bound for most investors. For those investors preferring low‐risk portfolios, (unlevered) private real estate is the vehicle serving this allocation preference; for those investors preferring high‐risk portfolios, public real estate (with its embedded leverage of 40–50%) is the vehicle serving this allocation preference—with such vehicles serving as substitutes for a variety of noncore real estate strategies. In some sense, the distinction between private and public real estate is more about the use of leverage. For those investors preferring moderate‐risk portfolios, an intermediate‐leverage approach seems optimal.     

A Model of Time‐on‐Market and Real Estate Price Under Sequential Search with Recall

This article develops a model and provides a closed‐form formula to uncover the theoretical relationship between real estate price and time on market (TOM). Our model shows a nonlinear positive price‐TOM relationship, and it identifies three economic factors that affect the impact of TOM on sale price. We demonstrate that conventional metrics for real estate return and risk, which are borrowed in a naïve fashion from finance theory, do not account for marketing period risk and tend to overestimate real estate returns and underestimate real estate risks. Our model provides a simple way to correct such bias. This theory helps to explain the apparent “risk‐premium puzzle” in real estate.