Abstracts for Vol. 4, No. 2 of the Journal of Real Estate Portfolio Management

The Effect of International Real Estate Securities on Portfolio Diversification

Jacques N. Gordon, Todd A. Canter, and James R. Webb

Previous research has documented the risk-reduction benefits of international real estate securities to a real estate portfolio, but has stipped short of examining the effect of these securities on a mixed-asset portfolio. To this end, this study evaluates international real estate securities within the framework of a mixed-asset portfolio consisting of U.S. corporate bonds, U.S. real estate securities, and international common stocks. Each asset class was examined from a risk-return perspective and the results indicate that international real estate securities offer significant diversification benefits for a U.S. mixed-asset portfolio for a U.S. investor. In order to examine the risk-reduction potential from international property stocks on a U.S. mixed-asset portfolio, efficient frontiers were constructed fro each combination of asset classes. This study covers a thirteen-year time span from 1984 through 1997.

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Geographic Diversification and Economic Fundamentals in Apartment Markets: A Demand Perspective

Ping Cheng and Roy T. Black

This study explores the diversification opportunities across the U.S. metropolitan apartment markets and attempts to discover the crucial economic factors for determining the relationship of asset performances among different MSAs. Historical data of local economy and apartment markets are collected for forty U.S. Metropolitan Statistical Areas (MSAs). Cluster analysis is used to develop homogeneous groupings of the metropolitan apartment markets. a bootstrap simulation technique is combined with the cluster analysis to improve the stability of the output. The optimal MSA cluster grouping is then linked with a set of economic variables by using a multiple discriminant analysis (MDA) technique. The results of cluster analysis provide strong evidence for the existence of homogeneous groups in the metropolitan apartment markets, and the discriminant model identified six demand-side factors that are significant in determining the group membership of the individual MSAs.

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The Relationship between Size and Return for Foreign Real Estate Investments

C. Mitchell Conover, H. Swint Friday, and Shelly Howton

In this study, we utilize a relatively new databse to examine whether small foreign real estate firms have higher returns than large foreign real estate firms. We examine this issue from the perspective of a U.S. investor who forms portfolios of international real estate firms on the basis of U.S. dollar market value of equity. Using eleven years of foreign real estate data for more than 1200 observations in twenty countries, we find that large firms have higher returns and lower risk than small firms. These results hold when returns are denominated in either local currency or dollars. Further, the relationship between firm size and return is monotonic across portfolio groupings.

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A Real Estate Portfolio Strategy for Europe: A Review of the Options

Eamonn D'arcy and Stephen Lee

This study examines the basis for the construction of pan-European real estate portfolio strategy within the context of increased economic and monetary integration in Europe and the differences that exist between European property markets in their institutional structure. Utilising data on returns by property type from 1990 to 1996 taken from the ONCOR international data set, a limited empirical examination is carried out of portfolio strategies as an illustration of the issues raised. The findings of this analysis clearly indicate that, portfolios need to be constructed on a country basis, a portfolio concentrated in secondary cities outperforms a similar one in capital cities, and the composition of the optimal portfolio exhibits considerable inter-temporal instability.

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Employment Growth and Real Estate Return: Are They Linked?

Youguo Liang and Will McIntosh

Real estate returns and employment growth rates over the 1983 - 1997 period for forty-six major MSAs are used to examine the relationship between employment growth and real estate return. The results suggest: (1) Employment growth contributes to real estate return only in the short term. There is no relationship between expected return and employment growth over the long term (e.g., ten years). Employment growth, however, tends to reduce return beta and return volatility. (2) Employment beta and volatility are positively linked, respectively, to return beta and volatility. (3) Both employment beta and return beta are priced in the marketplace, that is, a larger beta is likely to be associated with a higher expected return. To investors, this study confirms the validity of employment analysis for investment decisionmaking because employment growth characteristics are related to return characteristics. Investors, however, are cautioned against aggressively pricing employment growth into their ten-year IRRs, especially for a long-term investment.

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Leverage and Real Estate Investment in Mixed-Asset Portfolios

James W. Boyd, Alan J. Ziobrowski, Brigitte J. Ziobrowski, and Ping Cheng

Academics examining real estate's potential to improve the efficieny of mixed-asset portfolios usually view the situation from the perspective of the debt-free equity investor. This study investigates the implications for portfolio performance of holding leveraged real estate. Of particular interest is the effect of including leveraged real estate in portfolios held by nontaxable institutions. To investigate these effects, a bootstrap estimate with a Markowitz mean-variance analysis is used to generate efficient portfolio frontiers from annual investment performance data covering both securities and real estate. The efficient frontiers represent different assumed opportunity sets which vary depending on the inclusion of debt-free real estate, leveraged real estate and real estate tax effects. All the appraisal-based real estate data used in this study were adjusted for "smoothing".

Overall, the results are consistent with theoretical expectations. Beginning with a securities-only opportunity set (stocks, corporate bonds and t-bills), adding debt-free real estate produced higher portfolio efficiency (lower risk) for all investors except those with the very lowest risk preference. For nontaxable investors, leveraging the real estate caused a decline in mixed-asset portfolio efficiency. However, for taxable investors, leveraging the real estate improved portfolio performance.

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REIT Size and Earnings Growth: Is Bigger Better, or a New Challenge?

Glenn R. Mueller

1995, 1996, and 1997 were explosive growth years for real estate investment trusts (REITs) to acquire properties and grow as large as possible, as quickly as possible. Property acquisitions were the easiest way to increase a REIT's total earnings; however the growth in earnings per share is the key to long-term stock price increases and this becomes more difficult as a REIT grows in size. Larger total size eventually causes the FFO per-share growth rate to decline, as additional acquisitions are such a small percentage of overall company earnings, and the additional shares that must be issued to acquire more properties makes per-share FFO growth more difficult. While process seemed to be driven by size growth these last few years, in the long run, REIT process should be driven by FFO per-share growth because the stock market's dividend discount model applies to REIT's as well as other stocks.

The REIT growth race that began in 1992 has created a new mega-cap REIT group in 1998. These mega-cap REITs apprear to be going through a "metamorphosis" where they will either, become an index proxy for the rental growth of their private real estate sectors or, start becoming operating companies with different characteristics and risks. This research questions whether Bigger total size is really Better as the earnings per-share growth rate slows down as the number of outstanding equity shares increases -- a mega-cap REIT problem evidenced by a dramatic price decline in the first half of 1988. Only the future will tell whether the mega REITs can sustain earnings per-share growth. Some possible alternatives are to sell properties that do not have growth potential and reinvest in higher growth investments or that some of today's mega-cap REITs may be forced to break up into smaller regional focussed REITs to regain profitable growth, just like the 1980 conglomerates that are now spinning off highly focused and specialized companies to maximize shareholder value. At the other end of the size spectrum, small-cap REITs under $500 million have been just as profitable as the large-cap REITs in the past five years, because they can grow more profitably from a small base.

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A Downside-Risk Approach to Real Estate Portfolio Structuring

Petros S. Sivitanides

This study uses annual NCREIF returns to examine the implications of the Downside-Risk (DR) approach for real estate portfolio structuring and to identify the biases that may be introduced by the Modern Portfolio Theory (MPT) approach. The results indicate that the most efficient portfolio differs across investors with different Minimum Required Return (MRR) levels. They also suggest that the MPT and DR approaches produce optimal portfolios with different compositions only within a limited range of returns on the efficient frontier. In the case of investors with an MRR equal to the risk-free rate or the average NCREIF return, MPT portfolios are only minimally less efficient than the respective DR portfolios.

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