Public Real Estate Limited Partnership Returns: A Preliminary Comparison with Other Investments

Real Estate Limited Partnership (RELP) securities have attracted substantial investor interest, but limited research study. This paper, utilizing a very recent database of actual RELP secondary market transactions, provides preliminary evidence regarding the relative performance of RELP securities, as well as the interrelationships between RELP returns and the returns of Treasury bills and bonds and common stock. Results suggest that RELP returns are negatively correlated with common stock returns, but are positively correlated with the rate of inflation. RELP returns do not consistently exceed the rate of inflation nor do they exceed common stock returns. RELP returns also failed to outperform a broadly-based income property index.     

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.     

Commercial Real Estate Returns

In the commercial real estate market, which is perceived to be relatively inefficient, investors have comparative advantages; hence there are significant costs to diversification. This paper presents for the first time a series of market (or quasi-market) returns for a large data base. This data base is believed to be the most complete commercial real estate data base yet constructed. The paper empirically evaluates the benefits of diversification along various dimensions within the commercial real estate opportunity set. The analysis confirms certain aspects of prior work concerning inflation protection and diversification opportunities while concluding that even investment grade real estate investments are heterogeneous assets.     

Real Estate Returns and Inflation

The ability of assets to protect an investor from purchasing power risk due to inflation has received a good deal of attention in the literature recently. The focus of much of this research has been on the properties of common stocks as inflation hedges. Bodie [1976] finds that the real return on equity is negatively related to both anticipated and unanticipated inflation; a similar result is obtained by Fama and Schwert [1977] . Bernard and Frecka [1983] examine individual common stock returns and find that the majority exhibit this negative relationship. This paper uses similar logic to examine the ability of a well-diversified portfolio of real estate to hedge against anticipated and unanticipated inflation.     

International Real Estate Returns: A Multifactor, Multicountry Approach

We examine the risk and return characteristics of publicly traded real estate companies from 14 countries over the period 1990 to 2001. Our data are monthly country-level commercial real estate indexes constructed by the European Public Real Estate Association (EPRA). We find substantial variation in mean real estate returns and standard deviations across countries. Using various global- and country-level factor models, we find that there is evidence of a strong global market risk component, measured relative to the Morgan Stanley Capital International world index, in most countries. However, even after controlling for the effects of global market risk, an orthogonalized country-specific market risk factor is highly significant, especially for real estate indexes in Asia–Pacific markets. We find that a country-specific value risk factor has some explanatory power in addition to the country-specific market factor, but U.S.-based market, value and size risk factors do not provide any additional explanatory power. These findings imply that the international diversification opportunities with real estate companies are more complex than previously thought.     

A Different Look at Commercial Real Estate Returns

Commercial real estate makes up a relatively small percentage of most institutional portfolios, even though the existing literature has consistently reported attractive risk-return characteristics that would suggest much larger allocations. This discrepancy has been explained by a perceived lack of comparability between return series calculated for real estate and those calculated for other asset classes. Just as investors actively involved in the futures markets do not consider individual common stocks to be traded continuously, those active in the stock market do not consider real estate to be traded continuously. In both cases, adjustments to reported returns are necessary to achieve a degree of comparability. This study makes such adjustments, using sales data from properties that help comprise the National Council of Real Estate Investment Fiduciaries / Frank Russell Company (NCREIF/FRC) Index to generate a "transaction-driven" commercial real estate return series. Examination of the risk-return characteristics of this series shows that it is quite different from traditionally reported real estate return series and far more consistent with risk-return characteristics that have been reported for other asset classes.     

Real Estate Returns and Risk with Heterogeneous Investors

This article develops a theoretical framework and formulates a unified risk metric that integrates both real estate price risk and uncertainty of time on market (TOM). We demonstrate that real estate sellers with different degrees of financial distress face not only different marketing period risks, but also receive different return distributions upon successful sales. The major findings of this article can be summarized as follows. First, we show that real estate return and risk, which account for both price and TOM risk, are investor specific, varying over investors with different financial circumstances and holding periods. Second, the traditional valuation of real estate return and risk, which is based solely on the return distribution of a successful sale without considering the uncertainty of TOM and the investor's financial circumstances, underestimates real estate risk and exaggerates real estate return. Third, our empirical applications in both residential and commercial real estate markets show that the Sharpe ratio estimated by the traditional approach is seriously overstated—to the largest extent for investors with high financial distress. In addition, we find that, given the typical 5‐ to 7‐year holding period for real estate, the Sharpe ratios estimated by integrating both price and TOM risk are much in line with the performance of financial assets. These findings can help to explain the apparent “risk‐premium puzzle” in real estate.     

Market Microstructure and Real Estate Returns

This paper examines the Real Estate Investment Trust (REIT) market microstruc-ture and its relationship to stock returns. When compared with the general stock market, REIT stocks tend to have a lower level of institutional investor participation and are followed by fewer security analysts. In addition, REIT stocks that have a higher percentage of institutional investors or are followed by more security analysts tend to perform better than other REIT stocks. Our results seem to confirm Jensen's ( 1993 , p. 868) proposition that ownership structure (that is, who owns the firm's securities) affects the value of the firm. Our findings also have implications about the well documented phenomenon that the financial performance of Commingled Real Estate Funds (CREFs) is better than that of REITs.     

Unsmoothing Real Estate Returns: A Regime‐Switching Approach

We propose newly developed unsmoothing techniques for appraisal‐based real estate returns based on a regime‐switching threshold autoregressive (TAR) model. We show that when true returns follow a TAR process, conventional linear autoregressive techniques are misspecified and underestimate true variance. Two exogenous variables, equity returns and gross domestic product growth, outperform other variables as regime indicators and appear to capture risks of downturns in real estate. We extend the model to the smoothing equation, allowing for switching behavior by appraisers, using two new techniques: the TAR‐AR and TAR‐TAR approaches. The “co‐switching” specification opens up a new frontier of empirical research. We estimate the TAR‐TAR using FT returns as the regime indicator, and we find results that outperform conventional smoothing models and have plausible economic explanations.     

Historic Returns and Institutional Real Estate Portfolios

This study employs a sample of equity REIT portfolios from 1972–78 to investigate various aspects of real estate returns. Return estimates are derived for the unlevered cash yields by property size, type and location. Based on these data, the effects of certain kinds of diversification on risk-adjusted returns are examined. Finally, historic REIT portfolios are compared to current commingled fund portfolios and suggestions made concerning the benefits of restructuring.     

Continental Factors in International Real Estate Returns

This paper examines the extent to which real estate returns are driven by continental factors. This subject is relevant for determining the country allocation of international real estate portfolios. If returns are driven by a continental factor, investors should look for diversification opportunities outside their own continent. This paper finds strong continental factors in North America and especially in the United States. For the Asia–Pacific region, real estate returns are not driven by a continental factor. The results suggest that, for European, North American and Asia—Pacific real estate portfolio managers, the Asia—Pacific region provides attractive international diversification opportunities.     

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.     

The Walkability Premium in Commercial Real Estate Investments

This article examines the effects of walkability on property values and investment returns. Walkability is the degree to which an area within walking distance of a property encourages walking for recreational or functional purposes. We use data from the National Council of Real Estate Investment Fiduciaries and Walk Score to examine the effects of walkability on the market value and investment returns of more than 4,200 office, apartment, retail and industrial properties from 2001 to 2008 in the United States. We found that, all else being equal, the benefits of greater walkability were capitalized into higher office, retail and apartment values. We found no effect on industrial properties. On a 100‐point scale, a 10‐point increase in walkability increased values by 1–9%, depending on property type. We also found that walkability was associated with lower cap rates and higher incomes, suggesting it has been favored in both the capital asset and building space markets. Walkability had no significant effect on historical total investment returns. All walkable property types have the potential to generate returns as good as or better than less walkable properties, as long as they are priced correctly. Developers should be willing to develop more walkable properties as long as any additional cost for more walkable locations and related development expenses do not exhaust the walkability premium.     

Heterogeneous Investor Sentiment and Institutional Real Estate Investments

Commercial real estate investors differ in their sentiment due to factors such as market expertise, investment strategies and expectations about future market conditions. Focusing on the office market, we investigate whether investors with a multiasset investment focus such as pension funds or insurance companies rely on the sentiment of specialized real estate investors such as public REITs or private developers/owners as source of information in their investment decision‐making. Using disaggregated sentiment measures and vector autoregression (VAR) we find evidence that changes in REIT and private real estate investor sentiment lead to changes in institutional investor sentiment in the suburban office and office REIT market. Our findings suggest that institutional investors rely on the sentiment of specialized real estate investors to make real estate investment decisions. Our study contributes to the existing literature on sentiment in commercial real estate markets by emphasizing the heterogeneity of investor sentiment and introducing a disaggregated sentiment measure. We also contribute to the institutional herding literature.     

A Test of Weak-Form Efficiency in Residential Real Estate Returns

This paper tests weak-form efficiency of residential real estate returns for the city of Memphis, Tennessee. The database for the study is comprised of the population of all sales of single-unit residential property over a fifteen-year period, 1970–1984. The city was divided into ten submarkets based on Memphis City Planning Commission planning districts. An analysis of variance procedure was utilized to stabilize the variance both within and across submarkets and nonmarket financing was partially controlled by eliminating transactions with loan-to-value ratios greater than 95%. The remaining transactions were then used to generate a mean return series. The advantage of the mean over the single transaction series used by Gau is that it represents the most likely outcome for the investor trying to duplicate investment performance since "property unique" features would be expected to cancel. Seven of the ten submarkets exhibited time patterns; however, after adjusting for transaction costs, all ten submarkets were determined weak-form efficient for the period 1970–1984. This was not true for the short horizon holding period, 1970–1975. In four sub-markets an asymmetric version of Alexander's filter rule was able to outperform a buy-and-hold, even for round- trip transaction costs as high as 10%.     

Appraisal-Based Real Estate Returns under Alternative Market Regimes

In this article we use Monte Carlo simulation to study the statistical properties of real estate returns. We set up a model where transactions prices are noisy signals of true prices. We then consider a number of appraisal rules, derived from Bayesian and non-Bayesian theory, to estimate the current true price and rate of return. The class of exponential smoothing and Kalman filter rules perform well at both the disaggregate (returns on an individual property) and aggregate (returns on a real property portfolio) levels. A special case of exponential smoothing (α= 1.0) places all weight on current market data. Since this case eliminates smoothing, our results suggest that appraisers should place all weight on current data (no weight on past data) provided that they want to estimate returns rather than values. However, these results should be used with caution if sales prices are very noisy.     

Commercial Real Estate Returns: An Anatomy of Smoothing in Asset and Index Returns

In this article, we investigate the commonly used autoregressive filter method of adjusting appraisal‐based real estate returns to correct for the perceived biases induced in the appraisal process. Many articles have been written on appraisal smoothing but remarkably few have considered the relationship between smoothing at the individual property level and the amount of persistence in the aggregate appraisal‐based index. To investigate this issue we analyze a large sample of appraisal data at the individual property level from the Investment Property Databank. We find that commonly used unsmoothing estimates at the index level overstate the extent of smoothing that takes place at the individual property level. There is also strong support for an ARFIMA representation of appraisal returns at the index level and an ARMA model at the individual property level.     

Global Financial Integration and Real Estate Security Returns

Have globalization and increasing economic and financial integration affected the rates of return of publicly traded real estate companies around the world? Using a set of multifactor models for annual data for 946 firms from 16 countries over the sample period, 1995–2002, we estimate the impact of a country's economic openness on returns of publicly traded real estate firms, controlling for the effects of global capital markets, domestic macroeconomic conditions and firm‐specific variables. We find that a country's real estate security excess (risk‐adjusted) returns are negatively related to its openness. The results are robust across different multifactor model specifications and are a testament to increasing global financial integration and its interplay with the real estate sector.     

Estimating Returns on Commercial Real Estate: A New Methodology Using Latent-Variable Models

Despite their widespreao use as benchmarks of U.S. commercial real estate returns, indexes produced by the National Council of Real Estate Investment Fiduciaries (NCREIF) are subject to measurement problems that severely impair their ability to capture the true risk–return characteristics–especially volatility–of privately held commercial real estate. We utilize latent-variable statistical methods to estimate an alternative index of privately held (unsecuritized) commercial real estate returns. Latent-variable methods have been extensively applied in the behavioral sciences and, more recently, in finance and economics. Unlike factor analysis or other unconditional statistical approaches, latent variable models allow us to extract interpretable common information about unobserved private real estate returns using the information contained in various competing measures of returns that are measured with error. We find that our latent-variable real estate return series is approximately twice as volatile as the aggregate NCREIF total return index, but less than half as volatile as the NAREIT equity index. Overall, our results strongly support the use of latent-variable statistical models in the construction of return series for commercial real estate.     

REIT and Commercial Real Estate Returns: A Postmortem of the Financial Crisis

In the years surrounding the financial crisis, the share prices of equity Real Estate Investment Trusts (REITs) were much more volatile than the underlying commercial real estate prices. To better understand this phenomenon we examine the cross‐sectional dispersion of REIT returns during this time period with a particular focus on the influence of their capital structures. By looking at both the debt ratio and the maturity structure of the debt, we separate the pure leverage effect from the effect of financial distress. Consistent with leverage and financial distress costs amplifying the price decline, we find that the share prices of REITs with higher debt‐to‐asset ratios and shorter maturity debt fell more during the 2007 to early‐2009 crisis period. Although REIT prices rebounded with the bounce back in commercial real estate prices, financial distress costs had a permanent effect on REIT values. In particular, we find that REITs with more debt due during the crisis period tended to sell more property and issue more equity in 2009, when prices were depressed.