Abstracts for Vol. 2, No. 2 of the Journal of Real Estate Portfolio Management

The Use of MPT for Real Estate Portfolios in an Uncertain World

Richard B. Gold

This study examines the impact of uncertainty on the asset allocation algorithm. By "bootstrapping" the error terms from OLS-generated equations, multiple frontiers are estimated and "areas of indifference" are created. Since these alternative portfolios are as "efficient" as the original portfolios on the unperturbed frontier, the unique solution provided by traditional mean-variance optimization technique is called into question. The analysis concludes that ranges, rather than specific investment targets, should be the preferred method of mean-variance optimization. Ranges are not only statistically robust, but also circumvent many of the practical problems associated with owning an illiquid asset, such as valuation issues and lumpiness.

Second, the study also examines the role of multi-family housing in a real estate portfolio in the presence of uncertainty. using economically determined ex ante property-type returns, the model's results suggest that most institutional portfolios are likely to be significantly underweighted in apartments using traditional asset allocation techniques.

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Diversification Potential from Real Estate Companies in Emerging Capital Market

Christopher B. Barry, Mauricio Rodriguez and Joseph B. Lipscomb

This study uses the Emerging Markets Data Base from the International Finance Corporation to examine emerging market real estate as an asset class using data on companies classified as real estate firms by SIC codes. It documents the paucity of such firms until very recent years and notes some limitations in their use as proxies for the underlying real estate investment opportunities. Nevertheless, the results indicate that real estate in emerging markets provides diversification benefits to common stock portfolios and real estate portfolios. Emerging market real estate has experienced high risk in recent years, but the returns from emerging market real estate have generally low correlations with the returns on portfolios of developed-market stocks and/or real estate. This study also describes investment restrictions that limit foreign access to direct investment in emerging market real estate. The relaxation of such restrictions in the case of other asset classes has been met with significant increases in market values. Finally, institutional facts about emerging markets that have acted to limit public ownership of real estate assets within those markets are described.

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Management Style and Asset Allocation in Real Estate Portfolios

James R. Webb and F. C. Neil Myer

This study applies the management style model developed by Sharpe to the returns on private equity real estate. Returns from twenty-six open-end and closed-end commingled funds over the period from the fourth quarter of 1989 to the third quarter of 1995 are used to estimate implied allocations for five property types (office, retail, R&D office, warehouse, apartment). These allocations are then compared to the actual allocations for these funds. For many funds the returns on the five property-type portfolios are able to explain an important part of the variation in the fund's return. The ability to reproduce the actual allocations of the portfolios is somewhat less impressive. For a small, but not insignificant, portion of the funds, the property type has little ability to explain the fund's returns.

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Property-Type Diversification in Real Estate Portfolios: Multiple-Period Return Measure vs Single-Period Return Measures

Petros S. Sivitanides

This study utilizes historical NCREIF data to calculate three series of internal rates-of-return for four property types. These estimates are subsequently used for the derivation of return and risk measures that are compared to respective measures derived on the basis of annual returns. Both measures are eventually used in combination with mean-variance model for the derivation of optimal allocations across property types. The results suggest that the use of annual returns, as opposed to IRRs, in asset allocation models, may lead to overestimation of expected returns, risks and diversification benefits of optimal portfolios, as well as to inefficient or suboptimal allocations of funds across property types.

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Property Investment in Hong Kong

Y. H. Chiang and S. Ganesan

In this article, Hong Kong transaction-based data collected during the 1980s and 1990s seems to confirm European and American findings that, in terms of risk and return, direct property investment is superior to that of property stocks. Returns from property investment also have a low correlation with that of stocks. Analyses based on the security market line show that property investment in the office, retail, industrial, and residential sectors all yield returns higher than what the market, comprising both property and stocks, required during the decade between 1984 and 1995. Such characteristics suggest that institutional investors in Hong Kong should have included direct property in their portfolios in order to capitalize on its diversification potential and its return/risk superiority. However, direct property is seldom included in their portfolios.

This exclusion of direct property from portfolios by fund managers is attributed to the segmentation of the property and stock markets, and the large proportion of unsystematic risk of direct property investment. In contrast to stock investments, direct property investment has the problems of lumpiness and illiquidity, as well as higher information, transaction and management costs. In addition, investment managers of investment funds may perceive property investment as highly risky and out of their specialization.

However, in view of the growing importance of institutional investors in Hong Kong, alternative opportunities promoting better rewards should be explored. Despite its peculiarities, direct property investment, or its securitization, remains a likely candidate for inclusion in portfolios to achieve this goal. After all, only the institutional funds have enough muscle to diversify the unsystematic risk of direct property investment and capitalize on its diversification potential and return/risk superiority.

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Economic Fundamentals and the Performance of Warehouse Property in Large U.S. Metropolitan Areas

Emil E. Malizia

The economic fundamentals of large metropolitan areas appear to influence the performance of warehouse properties located in these areas and may offer useful criteria for establishing real estate diversification categories. Economic fundamentals (centrality, diversity, and resilience), as well as growth, stability, specialization, and other economic factors are used to establish diversification categories. Metropolitan areas are grouped by these categories, and warehouse property returns for these categories are compared. The differences in returns between categories for most economic factors are not statistically significant. The differences are statistically significant for stability and when centrality, diversity and resilience are used together.

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