THE EVOLUTION OF
REAL ESTATE PORTFOLIO MANAGEMENT PRACTICES
IN THE PENSION FUNDS
OF THE
UNITED STATES OF AMERICA
by
Timothy M. Taylor
M.B.A., University of Pennsylvania - Wharton
(1980)
B.S., U.S. Naval Academy, Annapolis
(1973)
Submitted to the
Department of Urban Studies & Planning
in partial fulfillment of the
requirements for the degree of
MASTER OF SCIENCE
in Real Estate Development
at the
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
September 1990
Q®Timothy M. Taylor
The author hereby grants to MIT permission to reproduce
and to
distribute copies of this thesis document in whole or in
part.
Signature
of
Author
Timothy M. Taylor
Department of Urban Studies & Planning
27 July 1990
Certified by
Marc 'A. Louargand
Lecturer
Department of Urban Studies & Planning
Thesis Supervisor
Accepted by
Glofia Schuck
Chairperson
Interdepartmental Degree Program
MASS3 ACHUS1ETTSINSTITUTE
in Real Estate Development
OF TECHNOI0 GY
SEP 19 1990
LIBRARIES
RafOth
1
THE EVOLUTION OF
REAL ESTATE PORTFOLIO MANAGEMENT PRACTICES
IN THE PENSION FUNDS
OF THE
UNITED STATES OF AMERICA
by
Timothy M. Taylor
Submitted to the Center for Real Estate Development
of the Department of Urban Planning and Studies
on 27 July 1990
in partial fulfillment of the requirements for the
Degree of Master of Science
ABSTRACT
Real estate capital markets are generally seen as
lagging securities markets by ten to twenty years in the
application of modern portfolio theory. This applies to
both the efficiency of the market itself, as well as to
the level of sophisticated market analysis.
This has
important implications to portfolio managers in the face
of increasing competition for optimal returns. Modern
portfolio theory has
provided the methodology for
structuring such optimal portfolios for over three
decades.
This thesis reviews how modern portfolio theory is
itself an
evolution of
increasingly sophisticated
principles, which by no coincidence are applied to
stock equity and fixed income bond markets first, before
finding
application in
real estate.
The thesis
reviews the literature for examples applying to real
estate. A trend becomes apparent that demonstrates the
increasing level
of sophistication that
has been
employed for research and implementation in analyzing
real estate equity investments, particularly in the face
of institutional entrants to the market.
A particular segment of the institutional market, the
pension fund industry, was surveyed in 1990 for the
level of sophistication in its real estate portfolio
management. The results serve to test eight hypotheses,
which when aggregated, demonstrate that perceptible
changes have occurred in the sophistication of portfolio
management techniques on the
part of the pension
industry.
Thesis Supervisor:
Marc A. Louargand, Ph.D.
Lecturer, School of Architecture
Department of Urban Studies & Planning
THE EVOLUTION OF
REAL ESTATE PORTFOLIO MANAGEMENT PRACTICES
IN THE PENSION FUNDS
OF THE UNITED STATES OF AMERICA
Title Page
1
Abstract
2
Table of Contents
3
Introduction..The Thesis
Chapter 1 ....
Real Estate:
The Asset
4 -
11
12 -
18
Chapter 2
....
Modern Portfolio Theory
19 -
38
Chapter 3
....
MPT Application to Real Estate
39 -
49
Importance of Diversification
49 -
55
MPT Significance to Institutional 56 -
65
Chapter 4
..
Real Estate Investors.
Chapter 5
....
Results and Analysis of a Survey
Thesis Objective & Hypotheses
66 -
Methodology & Inherent Bias
68 - 73
Results
74 -
93
94 -
96
97 -
99
Chapter 6 .... Conclusions
Appendix A
...
Survey Questionnaire
68
Reference Bibliography.........................100 -104
THESIS
By most accounts of the academic literature on real
estate investment, this class
non-traditional investment
than twenty years ago
real
estate as
addressed
in
Appraisal
an
the
Journal
subject.
It
is
in the financial
investment
literature
acquisition.
grade
On
two
to
In fact,
noticeably
1960,
articles
pin-point
a
when
The
on
the
single
real estate into the realm
asset
an
wasn't even
until
published
difficult
an investment
world less
(Melnikoff (34) p.407).
exogenous event that brought
as
of asset was considered a
suitable for
individual
portfolio
investment
basis,
however, the 1961 revision to the Internal Revenue Code,
Sections 856-8, which created
real estate
as the
the raison d'etre for the
investment trust (REIT), can
major impetus.
Similarly, the
Employee Retirement Income Security
provided an indirect push
insurance
pension
companies in
funds and
real estate.
these
be considered
enactment of the
Act (ERISA) in 1974
for increasingly wealthy life
their role
various pension
as fiduciaries
funds to
for
invest in
ERISA established rules and guidelines for
sizeable
investors
to
minimize
the
risk
of
catastrophic losses within their portfolios by exhorting
them
1 See
to
prudently
diversify their
investments.
The
F.Case, Comparable Real Estate Investment
Experience, The Appraisal Journal 28:337-344,July 1960;
and J.D.Landauer, Real Estate as an Investment, The
Appraisal Journal 38:426-434, October 1960.
literature on real
the virtues
of the
terms of its
residual
time had extolled
cyclical nature
of real
value as an inflation hedge,
value
economic
estate up to that
from
appreciation due
features
(Hartzell,
estate in
and its high
to
its
unique
Hekman,and
Miles
(22) ,p.238).
Although ERISA had the effect of indirectly coaxing
the
markets'
increasingly
lenders, such as
wealthier
investors
pension funds, into real
and
estate as an
investment, there were a great many reasons why this did
not
occur overnight.
From
the
standpoint of
equity
investment, there are five possible explanations:
1) TAX
EXEMPTION: Pension funds are
tax-exempt if
they operate in accordance with Departments of Labor and
Treasury regulations.
The four primary sources of value
to real estate are:
a)
b)
c)
d)
Cash Flow Return including the
Amortization Return; and
Gain from Tax Shelter, and
Return from Appreciation
Because
many
inordinate amount
of
ordinary
overpriced to
real
estate deals
concentrated
of their attention on
income,
real
estate
an
the sheltering
looked
relatively
the tax-exempt pension funds.
Since the
Tax Reform Act of 1986 (TRA) significantly reduced these
tax
benefits,
a
further
impetus
for
pension
fund
investing in real estate equity has emerged; as a result
they should now be able to better compete for individual
projects
or multi-project
portfolios,
level tax-benefit playing field.
given the
more
2)
of
VARIABILITY/VOLATILITY
As
RETURNS:
the
primary measure of risk, the perception of volatility in
the
cycles) made
returns (because of economic
real estate
role of
fiduciary
pension
funds
less likely
to
consider the asset class.
3)
LABOR
INTENSITY:
Pension
passive investors, who looked at
intensive,
management
Professional
funds
been
real estate as a labor
challenge in
management
have
existed
deriving
to
returns.
alleviate
this
burden, but their fee structure served to further reduce
the expected real return.
4) LACK
OF INFORMATION:
capital markets,
while
In comparison
with other
investors and lenders have
found that
information sources
of investment-required
data
may be available on single properties, the data required
for portfolio
inclusion, primarily for the
purposes of
diversification, is scarce or severely limited.
5)
LACK OF
SOPHISTICATED ANALYSIS:
Pension funds
have grown accustomed to the very sophisticated theories
on investment analysis that have governed investments in
the stock and bond markets (Conroy, Miles and Wurtzebach
{l0},p.607).
basis
The
for what
combination of these have
has
become known
as Modern
Theory (MPT) with the following theories
formed the
Portfolio
and models by
time frame and authors that conceived them:
Portfolio Efficient Frontier
Capital Asset Pricing Model
Arbitrage Pricing Theory
Options Pricing Model
1952
1964
1976
1973
Markowitz
Sharpe
Ross
Black&Scholes
Options Pricing Model
(expanded to consider
market inefficiencies)
Mortgages
1979
1979
and construction
estate investments
Cox, Ross, &
Rubenstein
Rendleman &
Barter
loans, as
direct real
were likewise viewed askance
by the
pension funds, as the cost and administrative burdens of
first
originating, and
then
servicing
them made
the
vehicles unworthy for the time and effort, when compared
with
investing in
stocks and
and Stone {8},p.607).
bonds (Brueggeman,Fisher
(There were several other reasons
for the funds' reluctance to invest in these instruments
as well, and they will be dealt with later.)
Despite the pessimistic rationale for not investing
in real estate, some 39,375 pension funds alone, as of 1
July 1989,
reported over
trillion of
$113.5 billion of
assets invested
in tax-exempt
their $2.2
real estate
assets (Money Market Directory {38) p.xiv; and Pension &
Investment
Age {26}
billion in real estate
p.33).
This
includes over
$90.3
equity (79.6%), $17.9 billion in
hybrid debt assets (15.7%), and $5.3 billion in mortgage
assets (4.7%).
A more current gauge comes from Pensions
& Investments
(Ring
{42}
p.1),
discretionary tax-exempt assets
of
professional money
trillion as
reported
at
although equity
the
article
1990.
or roughly
reported at
Real estate
converted,
real estate is quoted
as
$102.57
the
total
handled by the universe
managers is
of 1 January
6%
wherein
billion.
$130
$2.174
equity is
billion,
further along in
Regardless,
the
investment in real estate equity over the past ten years
has more than
with
its
doubled, and shows signs
current
allocation within
of keeping pace
the
mixed
asset
portfoios.
There is
estate community
markets, real
a generalized axiom within
that in relation to
estate is
the real
the other capital
nominally twenty
years behind
the other asset markets in terms of sophisticated market
analysis.
Russell
For
Company,
example,
when
Blake
Eagle
asked about
of
the
the
Frank
relevance
of
modern portfolio theory to equity real estate investing,
commented
that,
"We'll
well-accepted principles
end
up
with
and methods.
a
few
We're
good
now where
the stock market was during the 1960's - and that's what
happened
there."
may be due
relation to
(Lewis
{31),p.160).
This
to the very unique nature of
other capital
markets.
perception
real estate in
Among
the factors
that differentiate real estate in a relative sense are:
a) Indestructibility and Immobility
0 Adaptability of use over time
b) Capital intensity
0 Imperfect divisibility
0 High transactional costs
0 Illiquidity
c) Heterogeneity of the product
0 Locational differences
0 Exclusively privatized transactions
O Property-specific financing
0 Infrequency of trades
d) Local versus a national,or international
orientation
0 Availability of property-specific data
0 Nuances of local governmental controls
0 Regional economic volatility
0 Responsiveness to market forces of supply and deman
e) Informational lag of ex-post data
0 Non-public information of transactions
0 No national market exchange
an ever-increasing
estate industry changes at
The real
Evidence of this general condition can be seen in
pace.
areas
of
change
from
entrepreneurialism
institutionalization; fragmented
integrated
ownership
corporations;
franchise to globalization.
real estate
regard,
and from
is
and
total
local, regional
It should be noted that the
industry is not
but
entities to vertically
direct investment
to securitization;
to
being singled out
rather the
continuation
in this
of
business
trends begun in the decade of the 80's.
With this
real
estate
growth and
market,
refinement occurring
one
would
expect
in the
a
similar
sophistication in the investment analysis of real estate
as
into
a preferred
portfolio
the developments
asset.
of this
industry over the last thirty
Ricks (1964),
Interesting
aspect of
insight
the emerging
years has been tracked by
Wiley (1976), Farragher (1982),
and Page
(1983), which were all consolidated and compared by Webb
{49}
using survey
that
although
the
data from
1982-83.
Webb
largest investors
in
concluded
real
estate
(pension fund managers and life insurance companies) had
in
fact
criteria,
improved
on
their
that improvement
essence yielded
quality
was only
suprising results
of
investment
marginal, and
in many areas
in
as to
the
lack
of
sophistication
in
techniques
for
investment analysis.
This study attempts to determine if the real estate
investment
portfolio
After
community has
made
management methods
all, the
perceptible changes
since Webb's
1982 study.
real estate
(mortgages,
investment in
mortgage securities,
and equity)
has risen from a liberally
in
by the
pension funds
estimated $40 to $56 billion
in 1982 (Webb (49),p.496) to over $113.5 billion in 1989
(MMD {38},pp.xix,xx).
fund asset base
virtually no
year after
This
compares with total pension
of $135 billion in 1971
when there was
investment in real estate
both Fama's (13) treatise
of capital markets and
equity, and one
on the efficiency
PRISA began its marketing effort
to pension funds (Melnikoff (34).
that over $1 billion in U.S.
Today it is estimated
tax-exempt funds are being
committed to real estate investment per month!
two
ensuing
stock
collapse, and
estate
a major
in the
extreme
market
within
bond
loan community
the
management in the ensuing
tax-exempt cash
a
lending debacle related
savings and
anxiety
crashes,
However,
community
years.
being allocated
market
to real
have caused
of
portfolio
With the magnitude of
to real
estate equity
investments, along with the endogenous volatility of the
real
estate
market
over
the
last
five
years
in
particular, the author makes the general hypothesis that
the
evolution
practices
of
real
have improved
estate
portfolio
significantly
10
management
in their
level
of sophistication since Webb's (49) survey in 1982.
There is
a renewed
awareness and interest
refamiliarized with portfolio
evidenced by the Pension
conducting
its
Management
in 1990
first
Technology {33).
assistance and
in becoming
management techniques, as
Real Estate Association (PREA)
annual
at the
Institute
of
Portfolio
Massachusetts Institute
The author wishes to
of
acknowledge the
support of Professor Marc
A.
Louargand
of MIT, who as the driving force behind the first annual
MIT/PREA Institute,
involved me in the
early stages of
the conference, so that this study could be conducted to
help serve the educational content of the Institute.
the extent that
where a
stand in
this paper can shed
significant portion
it will have met its goal.
11
further insight on
of today's
their sophistication of real
To
money managers
estate analysis,
CHAPTER 1
REAL ESTATE: THE ASSET
one inextricable
assets the
universe of
Within the
link among
them is their individual
ability to possess
value from
which exchanges of other
goods and services
value from
real
allow it
on its
own merits,
The
scarcity,
and adaptability
considered a
to be
in the
property.
estate (relative
locational importance,
longevity,
vehicle
form of real
the physical
precepts of
economic
interests, and benefits
the rights,
ownership of
use)
an asset, real estate derives its
As such
can be made.
of
suitable investment
as well
as a
significant
component of portfolio wealth.
To
be
sure,
disadvantages
investment
too.
illiquid investment
For
in
one,
in its
real
it
estate
is
has
relatively
pure equity form,
its
an
and this
difficulty of converting the investment to cash requires
high
transactional costs
Secondly,
its
in terms
fortunes
are
economic cycles, although the
may not
As
be phased
such, it
nonetheless
is
by nature
Lastly,
complex investment
flavor
from a
standpoint.
a
on
linked
to
economic cycle.
longer term
short
it is
with a
and money.
real estate cycles may or
and
a manually
investment,
long
term
intensive and
distinctively local/regional
managerial, as
These
inextricably
with the underlying
dependent
fluctuations.
of time
well as
unique features
asset create both opportunities
a transactional
of the
real estate
and risks which must be
serious
any
analyzed by
and
comprehended
thoroughly
investor.
The
analysis
portfolio
in
the
to
exists
thesis.
this
of
very foundation
analysis
Investment
insignificant
an
However, the differences are
flirtation with semantics.
significant
be
seem to
may
and
analysis
investment
between
difference
the
predict
future
prospects of returns for specific types of assets, while
portfolio analysis concerns the prediction of the amount
and
variability
the forms
in
represented
These returns,
assets.
diverse
group of
a
from
of returns
of
periodic receipts, tax-sheltered income, amortization of
and
principal,
exchange value to be placed
returns
variability
compared
allows
with that
the
of
assessment
an
value
of real
other assets.
an
These same
on real estate.
with
coupled
when
enable
value,
residual
terminal
their
of
estate
to
In this
be
latter
context a portfolio of assets can be produced to satisfy
any financial objective.
the
extensive mathematics
of
use
Just how this is done requires
under
significant,
qualified assumptions.
Real estate
investment analysis
on a
is predicated
simple objective: to maximize wealth through the highest
returns
relative to
Sirmans
{28},p.382-3).
separately
acquisition
holding
and
to
their attendant
jointly
The
over
development
period, and
on along
returns
the
risks (Jaffe
risks
vary
cycle:
from
and
life
and through
and
a
managerial
to redevelopment
and/or
decision-making
today all are
a
exist
there
While
disposition.
approaches to
multitude
of
real estate
investment,
focused either on the return
or the risk
record of
real estate
The track
component,
or both.
investment
throughout
the
indicates
1970's
a
heavy
reliance on the return component for investment analysis
and
decision-making
(Jaffe
and
Sirmans
{28},p.381).
Risk was largely subjective, and those successful in the
business
skills
were
given
credit for
acquired through
local
markets.
models,
today
this
(Jaffe
Firstenburg
and
gut-instincts:
familiarity of
the existence
still remains
Sirmans
and Zisler
approach, one
that is
extensive
Despite
attitude
their
factor in
{28),
{45),p.1).
i.e. the opportunity cost
of quantitative
quite
p.392;
prevalent
and
Regardless of
the analysis remains
in comparing the investment
the
Ross,
the
key, and
to something else,
of not investing in something
else.
In order to accommodate the tenure and variability of
the
multiple
aspects
(depreciation,
tax-loss
real estate investment, a
of investment
of
returns,
carry-forwards)
and
benefits
derived
from
framework for the measurement
performance had to be
developed in order
to facilitate the comparison of investment alternatives.
The
quantitative
technique
that
standardization has become known
flow
(DCF) method.
finance
text since
It has
allows
this
as the discounted cash
become prevalent
the 1970's,
for
although in
in every
one case,
Brueggeman
et
al.{8),
mentioned.
The
technique focuses
cash
flows
expected over
investment.
returns
the
As is
are
the
inputed.
The
for each
cash
on the
below,
subject
distribution, which is most
value
itself
holding
highlighted
themselves
specific
term
to
is
never
valuation of
period of
the
the cash
flow
a
probability
often deterministic, i.e. a
cash
flows
flow
are
variable that
partitioned
into
is
the
following categories for real estate:
Cash Flow (CF) from:
Operations
~
Tax Savings (Payments)
|
Refinancing
|
Disposition net of reversion__I
These cash
flows when discounted
All in terms
of Monthly,
Quarterly, or
Annual Terms
by a utility
rate of
return, i.e. hurdle rate, internal rate of return (IRR),
financial rate of return (FMRR), etc., yields a value, a
present value (PV)
investor
would
be
or net present value
willing
income-producing capacity of
to
DCF can
to
used by a lender
determine
capital.
The
a
proper
general
(NPV), that an
pay
the asset.
for
the
net
Alternatively,
(construction loan, mortgage)
yield for
the
use
mathematical
of
form
of
their
the
discounted cash flow looks as follows:
PV
= CF
+ CF2 +...
+ CF
_
+
1-2-n-----(1+r)1 (1+r)2
(1+r)n-1
CFn
+
TPn
(1+r)n (1+r)n
And PVrei =PVe + PVm
Where
PVrei
= present value of the real estate
investment
PVe
= present value of the equity
returns
PVm
= present value of mortgage
TP
= periodic equity cash flow to
an investor over a holding
period from 1 to n.
= net reversionary cash flow
(terminal price minus
amortization of mortgage).
r
= specific rate of return
CF
measure
The
DCF
method
has
comparative rankings of
been
of
an
discussed, can
for
vehicles.
for
However, a complete
investment's potential,
as
not be complete without
the variety
utilized
investment opportunities across
a spectrum of investment
picture
commonly
and multitude
previously
an appreciation
of risks
involved.
In
real estate the generic term, risk, is used to cover all
those factors which may influence the expected return in
a negative or
same thing
positive way.
is that
Another way
of saying the
risk encompasses all
those factors
that will produce a return
In this
other than the one expected.
sense risk is pervasive
throughout every stage
of real estate's life cycle, as well as every accounting
category
that is
required
to derive
a periodic
cash
flow.
The task
risks
of explicitly
in any
nothing of
individual
a portfolio
quantifying the
real estate
of real estate
first appears intimidating.
have been
risk in
al.(40}).
Some
techniques are:
project, to
investments, at
in quantifying
facilitate decision making
of
the more
say
Several simplified methods
utilized, nonetheless, to aid
order to
plethora of
common
risk
(Pyhrr et
assessment
How long will it take to recover the
initial cash investment under
deterministic cash flow conditions?
Payback Period:
Risk-Adjusted Discount Rate: Adjusting upwards the
required rate of return from the
investment.
Risk-Adjusted Forecasts: Adjusting -downward the benefits
(CF) expected from the investment.
Sensitivity Analysis: Assigning different input
variables to represent deterministic
assessments of risk, in order to
gauge the impact of any combination
to the ultimate measure of
performance.
Probability Distributions: Probablistic assignments to
each uncertain variable in
combination with them all to
simulate the probable outcome for
all variables, individually and
aggregately, on the ultimate
performance measure.
Utility Assignment: The investor specifies preferences
of risk and return in the form of a
preference matrix. Input variables
are weighted as high, probable, and
low, and the performance measure for
each is computed.
While these
serve to
methods help
various risks, their treatment
unsophisticated
(i.e.
appropriately
is mostly subjective and
scientifically
Nonetheless, all are still
estate, as well as
explicitly identify
being utilized today in real
other investments.
relates
unsupportable).
much of
what
Pyhrr et al.{40)
the
rest of
industry instinctively feels in their commentary:
the
Real
decision
estate
makers
have
always
claimed to take calculated risks, but few have
Without
risks.
with
explicitly
typically
people
assumptions
rules of
in
risk
decision
concentrate
four
few
may
be
key
a few
situation, and
Although some
a decision.
considerations
on a
making,
future, examine
about the
mathematics of risk are
the
to deal
the knowledge of how
thumb, mull over the
then make
risk
calculate those
how they
clear just
made it
of the
explicit,
the
often left largely to
horsemen
of
the
implicit
decision-making apparatus:
judgement, hunch, instinct, and intuition.
Pyhrr, Cooper, Wofford, Kapplin, and Lapides (40) p.75.
CHAPTER 2
MODERN PORTFOLIO THEORY
also for
potential against
the analysis of
complements
other
dissimilar
type) by
the
property for evaluation of its
analysis of a particular
investment
only for
not
analysis:
paradigm for
a
provides
(MPT)
theory
portfolio
modern
that
risk
composite
return and
of expected
the interdependency
It is
other opportunities,
a particular property,
investments
(either
of
marginally increasing
but
as it
like
or
the overall
portfolio return and/or reducing the overall variability
of that
portfolio return.
It represents
a conceptual
framework based on that
found in other endeavors, where
the scientific method of
observable measurement of data
has
been
beneficial
in
explaining
and
predicting
behavior.
MPT was
not invented necessarily by
one particular
symbolize
place in
a body
of research
time as an evolution
on
the
it has
that has
come to
developed over
As
on the quantitative techniques of
budgeting, but
reliance
Rather
of previous quantitative work.
its basis, MPT relies
capital
time.
one person at
structured
"return"
not
solely from
component
of
a
capital
investments, but also to one that considers and includes
the measurability
of the total "risk"
interdependency between
compared to
other assets
component.
the two components can
of similar
type in
This
then be
order to
derive
investment
the
MPT then goes a step further by analyzing the
decision.
class, such as
assets
between
inter-relationships
of optimal
question
one
than
It is
art works, etc.
providing
ultimately
of
of more
stock-equities, fixed-income bonds, real
estate, precious metals, classic
capable
for
rationale
quantitative
a
allocation of
to
the
capital across
all
an
answer
asset classes.
The earliest
auspicious beginnings
credit for the
of MPT is given to Markowitz, who as a doctoral graduate
researched
student,
theory to see
time to
application
the
how equity securities moved
one another.
probability
of
in price and
to develop
this way he began
In
the idea that an asset's value was indeed the product of
return and risk, that both could be quantified, and that
an efficient set of assets could be developed into a
2
portfolio2. He thereby altered the consideration for an
displayed on the next page
investment as is graphically
in Figure 1.
Up
realize
to
in
this time,
his objective
order
to maximize
considered
nothing short
one's eggs
in a
investment
opportunities
of
investor
his wealth,
prudence not
single basket.
out
for an
there
in
it was
to put
There were
to
all
plenty of
the
capital
markets, one just needed to select the opportunity that
2 As a result of his doctoral research, he first
published his idea in "Portfolio Selection," The Journal
of Finance,7, March 1952, pp.77-91. The theory was
further developed and produce in his book: (Harry M.
Markowitz) Portfolio Selection:Efficient Diversification
of Investment, (New York: John Wiley & Sons, 1959).
20
FIGURE 1
EVOLUTION OF DIVERSIFICATION
THE RISK/RETURN SPACE
RETURN
E(R)
Asset A
Expected
Return
0
C
Low
High
Asiet A
Standard Deviation
RISK
NAIVE DIVERSIFICATION
RISK/RETURN SPACE AND
THE EFFICIENT FRONTIER
RETURN
E (R)
Efficient Frontier
Shadow of Dominance
Corner Portfolc
RISK
1C2
3
DI
4
EFFICIENT DIVERSIFICATION
21
P
the
gave
portfolio
wherein
this
could be
various
among
return
highest
the asset
approach,
by educated
diversified
asset
types
has
A
risk.
decisions
industries/services
and
was utilized.
which
reasonable
for a
Markowitz challenged
become
as
known
naive
diversification of a portfolio, and embarked on a theory
to
quantify both
construct a
the
model for
reward and
risk.
In order
this theory, Markowitz
to
set down
the following assumptions. 3
1.
An investor's objective is to maximize the
utility of terminal wealth.
2.
To do this investors make choices on the basis
of return and risk. Returns are measured by
the expected return or mean of the expected
returns, and risk is measured by the variance
of those expected returns. Implicitly, to
attain a greater expected return, an investor
must accept a greater degree of risk.
3.
A rational investor in the quest of the
objective will have a goal to diversify away
the risk to the most optimal extent possible.
4.
All investors have homogeneous expectations of
returns and risks.
5.
Investors have identical time horizons in
which terminal wealth will be realized.
6.
Information is freely and simultaneously
available to all investors.
3 The simplifications for these have been derived from
Harrington (20) pp.27-35.
Markowitz' argument acquiesced that there was nothing in
the model that could increase the expected return or
selected
carefully
of
combination
the
However,
investment.
single
any
risk of
inherent
the
reduce
investment assets could be derived such that the overall
return could
portfolio
the extent possible, i.e.
portfolio risk eliminated, to
Such
a model could
cost) of
an additional
for a given return.
the least risk
benefit (or
evaluate the
then
risk, or conversely,
return for the given
the greatest
attendant
and the
higher,
be
investment asset to the overall portfolio.
The mathematical constructs
for the development of
were divided into two
predominant aspects of
the model
investment
selection:
variability
of those
returns.
expected
and
return
expected
The
risk
expected
the weighted average of all
return of the portfolio was
possible returns, and as such is a linear function.
n
E(R )=
P-'=1
37
w
*
where,
R
E(R )
j
w.
3
R.
The
mentioned
individual asset's
as being
will not receive
variance
deviation.
or its
These
is the expected
portfolio return,
is an asset,
is the proportion
of asset j in the
portfolio,
is the return of
asset j
risk
has previously
that the
the probability
the expected rate of
more
widely used
graphical terms, as follows:
investor
return, i.e. the
root, the
can be expressed in
been
standard
mathematical and
Variance
~n2
2
2
=
where P
-
is the probability of return, R .
Standard deviation
=
(y 2
High|
Probability
of
Occurrence
pP
E(R))
2
A and B are two
-different investment
assets
I
-
Low|---------------------------------Return ->
However,
in
portfolio risk
or
context
standard deviation
benefit
of
Since an
to
portfolio,
of
a
is generally argued to
expected return.
its
the
the
well.
the
be the variance,
relative to
the
asset must be considered for
other
covariance
inter-relationship as
the return
portfolio,
assets
must
in
the
account
overall
for
The general form
*the
for this
portfolio risk is:
n
(7p
2n
(wi
=1 o+1
pr
2
n
*02) + 2
o 1i~
h
r1 jzi l
(wi*
*p )( (7'i ()
w=
w.
proportion of the portfolio allocated to asset i,
j,
j,
and
i
assets
between
coefficient
= correlation
Sor . = standard deviation of asset i or j to the
1
expected return, where
N
=_proportion of the portfolio allocated to asset
i2j
=1Z
(Ri
E(Ri))
-
N
(Pu
*(Yi
* 4Y*)
= covariance between any two assets
genius of Markowitz' development
The true
A fundamental aspect
portfolio.
assets within the
the covariance of the
application of
was the
of portfolio theory is
the idea that the riskiness inherent in any single asset
the riskiness of
portfolio is different from
held in a
By using
p.355).
assets
an absolute sense, as they
Using the same notation that has been
far, covariance in a
developed thus
or more
covariance two
the
could be tracked together in
varied over time.
Brigham (52)
isolation (Weston and
held in
that asset
mathematical sense
is expressed as:
N
Cov.
[Ri - (Ri)] * [Rj
i=1=1 ---------------------------
2
=
-
(Rj)]
N
(Ri or j) is
where
Theoretically,
the covariance
infinity to negative infinity.
with
a
positive
covariance
from positive
can range
By convention two assets
have
to
are said
their
assets whose
Conversely, two
together".
returns "move
the mean
have a negative covariance.
returns are countercyclical
The difficulty in using such an absolute measure is that
an investor
has difficulty gauging just
how beneficial
is the magnitude of the covariance, either negatively or
positively.
covariance was
of
the movement
assets.
the need
Thus,
for a relative
useful to facilitate
in
returns of
the
This relative
measure is
measure of
the interpretation
the
two or
more
the coefficient
of
correlationf , and as is defined in the equation of
portfolio
risk above,
it
is equal
to the
covariance
divided
the
of
the product
by
standard
two assets'
deviations.
Cov
The coefficient
combination can not
two assets in
-1, since
than the
/ C7i * CT
of correlation only ranges from
this
of
understanding
coefficient
its association with another
explained by
move more
Perhaps a more
identity of that combination.
intuitive
+1 to
be
can
widely known
statistical measure, the correlation of determination.
The correlation coefficient,fD,itself is the square
statistical coefficient of determination,
2
may be interpreted as the
r2,
of the
root
2
r2.
measure,
This
proportion of variation in the dependent variable, E(R),
that has been accounted
for by the relationship between
., expressed in a regression line.
C.
R.Ri or .jand
and
orj3
Mathematically, another way of notating this:
1 - unexplained variation
r2 = explained variation =
--------------------total variation
-----------------total variation
Since r 2 can equal from 0 to 1, r or
to +1.
When
p
can range from -1
1
is positive, therefore, the covariance
will be positive, and the overall second term in the 0Y,
This is another way of
equation will be positive.
saying that
increase when the correlation
are
positively
portfolio
assets are
the portfolio will
the overall variance of
Similarly,
correlated.
variance, i.e.
coefficient of the assets
risk, will
negatively correlated.
the
overall
be reduced
With
when
this construct
Markowitz provided the theoretical framework under which
26
portfolios could be developed
at
best eliminate
minimize
it.
among different assets to
risk (variation)
An
optimal
and at
portfolio
the least,
could
then
be
developed using an investor's utility information in the
form of isoquants, to locate the point of tangency along
the efficient frontier and
the major
premise of
diminishing marginal
the highest isoquant.
utility theory
is the
Since
notion of
utility, these isoquants
are also
curved, as well as that of the efficient frontier.
facilitates
the location
of an
This
optimal portfolio,
by
creating a more distinctive tangency of the two curves.
An important point
there
are N
terms.
As
investment
variance
to note is that
variance terms,
an example,
assets, then
terms, but
if
yet (N2
a
in the
1950's and
60's.
30
compute 30
terms in
order to
measures was enough to
pre- personal
Other
covariance
This excruciating process
Markowitz techniques
acceptance
N)
have to
870 covariance
of determining these statistical
ensure that
-
portfolio contained
one would
calculate the portfolio risk.
with N assets,
would not
find ready
computer days
reasons existed as
of the
well.
The
Wall Street capital market workers, the researchers, the
analysts, and the asset managers were all rankled by the
assumptions
assumptions
of
Markowitz'
were true,
services add to the
the complexity
to everyone,
then
theory.
of what
For
if
value did
the
their
process (Harrington (20) p.25)?
of investment information
and understood by everyone
If
was available
who had access
to
it, then
the
relegated to
entire brokerage
simply order-taking.
community would
The mistrust
be
of the
underlying assumptions of MPT, along with the complexity
of
calculations
required
to
efficient portfolio made the
ensure
a
technically
theory unacceptable to the
majority of the financial community in general.
However
embattled the
Markowitz portfolio
theory
may have found itself on Wall Street, it offered academe
a framework
This
which could
be expanded
occurred throughout
the 1960's
modification to the basic
simplify the tedium
explain
of
McGraw Hill,
asset pricing
directly
upon
mathematical
ultimately
risk.
his work since
subject , entitled Portfolio
(New York:
Professor
published the
the early 1960's
on the
Theory and Capital Markets
model
(CAPM).
work
mechanism, linear
asset's
as help to
In 1970,
1970), wherein he
Markowitz'
allow an
a
model emerged that could help
Sharpe of Stanford University
culmination of
capital
and eventually
of calculation, as well
the dimensions
William F.
through research.
developed a
The CAPM
and
utilized
regression, that
performance
built
a
would
in terms
of
return and risk to be compared to the performance of the
overall
market
of
assets,
without
the
tedium
thousands of combinations of correlation coefficients.
As the name, CAPM, implies, Sharpe sought to
See William F. Sharpe, "A Simplified Model of
Portfolio Analysis," Management Science, 9(January
1963), pp.227-293; and "Capital Asset Prices: A Theory
of Market Equilibrium under Conditions of Risk," The
Journal of Finance, (September 1964), pp.425-442.
28
of
quantifiably explain
context of
the price
an overall
of an asset
within the
market equilibrium.
The market
could be composed of all assets in the securities market
for
instance, or
form
the combination
an imaginary
concepts
were the
of asset
classes to
universal
market.
same, but
inherently the
The
fundamental
model was
couched in terms of a single investment entity (asset or
portfolio of them) against a broad market which included
the
investment entity.
He proposed
further division of risk because
the broader
market that
that there
was a
of the asset's role in
hadn't been
addressed before.
The specific risk of an
asset had been dealt with under
the
However, Sharpe
Markowitz
model.
there was in addition
assets were combined.
had demonstrated how the
combining
lower.
with
In so doing an
another
wind up on the efficient
treatment of the market
significantly
shown.
there
was
variance and the portfolio
frontier.
Yet it was Sharpe's
or systematic risk that brought
free asset with
If such an asset could exist, then
it meant that the shape
be
whose variance
possibility of a risk
some nominal return.
of return by
optimal return could be attained
with a correspondingly lower
into context the
Markowitz
specific risk of an individual
minimized for a given rate
the asset
that
a market related, or system-level
risk that existed when
asset could be
reasoned
of the efficient frontier could
different
than
what
Markowitz
had
Furthermore, somewhere on the efficient frontier
had to
exist a
point, representing
the overall
optimal mix of
return and risk, when all
of the market
assets were taken together.
At such a point, no further
optimization of
risk within the
return and
possible, unless
an investor
market was
could borrow at
the risk
free rate to buy more of the market's optimal portfolio.
This
relationship
is
expressed
in
the
accompanying
Figure 2 on the following page.
Referring to
Figure 2, Rf indicates
asset, i.e. an asset that
nominal
became
return
the
addition
over a
foremost
to
those
has no risk associated with a
finite
period
assumption in
of
the risk free
Markowitz'
Sharpe's additional assumptions
of time.
Sharpe's
This
CAPM
portfolio
in
theory.
are summarized below in
sequence with Markowitz' from which they follow.
7.
There is a risk free asset and investors can
borrow and lend unlimited amounts at this
rate.
8.
Market imperfections do not exist. There are
no taxes, transaction costs, or restrictions
on short sales. Investors act to keep the
market in equilibrium.
9.
Total asset quantity is fixed, and all assets
are marketable and divisible.
The recognition
of the possibility of
asset had major implications
frontier.
to the Markowitz efficient
By combining this risk free asset with assets
further out
overall
a risk free
on the
efficient frontier,
efficient frontier
between Rf
elevated from its position from
increase, when
say at
and M
M, the
would be
A to M. The incremental
integrated from 0
to M, provides
a new
efficient frontier for portfolios that is referred to as
FIGURE 2
RISK /
RETURN SPACE
MPT and CAPM Efficient Frontiers
EXPECTED
RETURN
E(R)
Sharpe's
Capital Market Line
Rm
-
Markowitz'
Efficient Frontier
-0
Rp
RPf
Low
(Standard Deviation)
I
Tm
RISK
the capital market line (CML).
Another important
Sharpe's
model was
devised out of
advancement that was
the
idea that
their expected
the market portfolio and as
overall
for a
of
No
and
way to
place it
point 0)
This
is called
assets
on
the
of assets
can provide
derive benefits.
the efficient frontier (from
the portfolio by
no other
The only
return for incrementally
is to leverage
whose
efficient
efficiency, because
from which to
that is beyond
had some risk
investment
other combination
obtain more
be
such it represents the full
risk
better return/risk
asset exists
returns.
collective,
return
frontier.
index could
all possible assets which
involved with
complement
an
made under
more risk
point M to
borrowing at
Rf.
The
development
portfolio
First
was
was
the market
significant
that
risk
covariability of
market's
of
from
could
index
several
now
be
Secondly,
this
for more facility in
myriad
covariances that
under
number of
the Markowitz
additional
higher
compensation for
risks,
they
compensation (reward)
such
as
portfolios
theory.
positioned
can
along
restricted
require
on investments
require
for risk that can
diversification
significant
Since investors
won't
the
calculating the
were so
taking
as
relation to the
first
attribute allowed
market
standpoints.
defined
an asset's returns in
returns.
or
any
additional
be eliminated,
accomplish
the CML.
of
In
by
this
having
sense
investors will
only be
compensated for
by the full risk of the
risk of the overall market, not
asset.
This
provides
the systematic
incentives
for
the
portfolio
manager to be as
efficiently diversified as the market,
M, will provide.
This compensation that an investor can
hope to
termed
receive for
the
risk
this efficient
premium.
diversification is
From
Figure
2
it
is
graphically denoted as RP,
or the difference between Rp
return) and Rf (risk free return).
(expected portfolio
Lastly,
the development
mathematical
of
the CAPM
explanation of
the
allowed for
the
portfolio return
and
risk through comprehendible, graphical terms.
The expected returns
i.e. one that
from any efficient portfolio,
lies along the CML,
could be represented
by:
E(Rj)
('
where
to that
the
=
E(Rf)
+ [E(Rm)
- E(Rf)]
*a"'
Q'm
is the volatility of an asset in the portfolio
J
of the overall market.
linear
relationship
This formula indicates
under
Markowitz and Sharpe between
the
assumptions
of
the expected return of the
portfolio and the risk free
rate, as well as the market
rate of return.
assets behave linearly with
Individual
respect
to their
market
riskiness
individual riskiness
and
to
the
overall
to the
market
overall
return
according to this general formula.
E(R ) = oC+
where:
Bc
3 i(Rm)
+
E
is the unique rate of return of asset
j,
/i
is asset j's riskiness to the overall
movement within the market, and
is the specific error term associated
with asset j.
This
/3 , or beta coefficient, is defined as a
normalized covariance in the following regard:
manner:
Pnj
=
covariance (R, 9
variance (Rm)
Sharpe defined the
or
specific
m, or overall market beta as 1.0,
Thus, if/3j =
an identity.
portfolio
of
synchronization with
less
1, then
assets
the overall
than one,/3 < 1, would
moved
)
in
complete
market.
A
beta less
mean that the asset
volatile
with
or
moves
the
or portfolio
underlying
/
Conversely, a beta greater than one,
indicate an
the asset
market.
>1, would
asset or specific portfolio
of assets with
greater systematic risk than the underlying market.
CAPM
has
frameworks
become
for
one
asset
of
the
investment
throughout the 1970's and 80's.
it has
been the most
most
and
its
relied upon decision
a plethora of academically
basic assumptions
used
allocation
This is not to say that
across the investment spectrum, however.
part to
widely
making tool
This is due in
sound criticisms of
(Harrington (20)
pp.24-47).
It
was for the latter reason, however, that academe pursued
other theories
many
in order to
assumptions.
considerable
One
prominence
relieve the reliance
of
these
in
the
Arbitrage Pricing Theory (APT).
that
has
literature
on so
gained
is
the
Ross first
Stephen A.
introduced the
concept of
APT in 1976.5 In the 1980's the theory gained in stature
as Ross teamed with
Richard Roll in supplying empirical
evidence that strengthened the theory. 6 Whereas the CAPM
is an equilibrium
"factor", that
the
pricing
explanation
factors.
theory of asset pricing
being "the market", APT
issue
of
pricing
In essence
of the factors
is
based on one
recognizes that
multi-dimensional
behavior
from
there is no limit
seeks
and
a
number
of
to the quantity
that might be considered,
for which the
following generalized equation pertains.
E (Rj)
= Rf +P/j1 [E(R 1 ) - Rf] + ...
where: E( )=
+Pjz [E(Rz)
- Rf]
an expected variable
j = an asset
z = a factor
R. = return on an asset j
R3 = risk free rate of return
Rz = return on a portfolio with an average
z
sensitivity to a factor z, that
systematically affects all returns
3 = sensitivity to a particular asset j to a
particular factor z
In comparison
the
APT
borrows
to the nine assumptions
four
(numbers
1,2,7,
under CAPM,
and
9)
from
Markowitz' theory and CAPM, and sets down two of its own
(Harrington {20} p.193).
See Stephen A. Ross, "The Arbitrage Pricing Theory of
Capital Asset Pricing," Journal of Economic Theory, 13
(December 1976), pp.341-360.
6 Their two works that have been most influential
are
"An Empirical Investigation of the Arbitrage Pricing
Theory," Journal of Finance, 35 (December 1980),
pp.1073-1104; and "The Arbitrage Pricing Theory Approach
to Strategic Portfolio Planning," Financial Analysts
Journal, 40 (May - June 1984), pp.14-26.
The
10.
The number and identity of factors that are
significant to the systematic pricing are
shared by all investors, and
11.
There are no riskless arbitrage opportunities.
theory has
been
solely on
tested
stock-equities
market data, and has produced anywhere from four to nine
systematic risk.
factors of
most significant
and Roll in their
deduced by Ross
ones, as
The four
1983 study
dealt with:
a) Inflation
b) Industrial production
c)
Risk premiums of bonds
d) Term structure of interest rates.
While the exact
does bring
thesis, it
that previous
significant to this
factors are not so
to the forefront
the perception
have been lacking
theories may
in their
ability to provide for making ex-ante decisions based on
anything other
single, ex-post factor,
than a
the trend of
the S & P 500 index.
APT
thesis, however,
to this
ex-post data
is only
under an
for
The significance of
recognition that
is the
useful to ex-ante
decisions when
produce that data are fully
the underlying factors that
understood.
such as
made on
investments
economic scenario yesterday, have
no validity
similar
Otherwise, decisions
decisions
under
a
different
scenario
tomorrow.
The
entered
one
the
last
fold
model
of asset
(keeping
"modern"
through the
pricing.
As an option is
modern
pricing
that
portfolio
evolutionary process)
has
theory
is options
the right of an asset's owner
36
to buy or
sell that asset over any
the theory is that such
the underlying principle behind
can
a right
in producing
efficiency
In
be monetized.
future time period,
so
income is
doing, an
asset's
increased, as
some
marginal liquidity is squeezed from the asset at a point
in
time
where its
overall effect
price
is to
volatility
is pegged.
dampen the trading
The
volatility of
the asset's price (which would consume large amounts of
capital
if
stripping
trading
bought
the right
it
(which
capital that
and Scholes
model
entire
outright)
again
markets
futures
consumes
but a
favor
or sale
small
Developed
of Wall
market
application
Street.
has
continued
the United States to
in
and
of
by Black
1972, the
to
As
of
portion
seminal article in
sought
inefficiencies
in
future ownership
underpins the value).
particularly in
market
of
sold
{6} in their
once
efficient
or
the
more
a result,
to
an
develop
take advantage of
expectations.
The
five
underlying components to the asset's value are:
1.
2.
3.
4.
5.
The current market price of the asset,
The length of the option's temporal
duration,
The exercise price at the end of option
period,
The risk free interest rate, and
The variance of the asset's price over
the option period.
In theory once the asset's price can be determined along
with its
volatility, then the option
aid in achieving better
frontier.
pricing model can
positioning along the efficient
to fulfill
pricing models serve
the asset
All of
this last goal in search of the objective for maximizing
terminal wealth.
In a sense they all come back to roost
on Markowitz' original work
with its core assessment of
integrated risk and reward, and the optimization of that
assessment through the mechanism of portfolio diversity.
To the extent
that various asset classes,
class, can be
benefit,
modern portfolio
determining how
reach
the
portfolio,
ultimate
the issues
when dimensions must
type of
combined to yield this
the same
for
or assets of
to do
theory offers
However,
so.
level of
an
a methodology
in order
optimally
regarding the
to
allocated
what, where,
and
be comparatively understood within
each asset class as well as between the classes.
CHAPTER 3
MPT APPLICATION TO REAL ESTATE
Investment literature is
replete with criticism of
the pricing models and portfolio theories, in large part
because of
not
of
their underlying
concern
to
this
stock-equity markets
cogent to
class of
assumptions.
thesis
why
While
the
bond
find disagreement with MPT,
understand the
real estate.
differences within
To
this end, a
it is
and
it is
the asset
comparison with
the other two capital markets is unavoidable.
Certainly
real
estate
is not
a
normal
capital
market, partly because investment literature assumes the
stock-equities market
real estate
is the normative
is arguably the third
market.
Today,
most important asset
class for institutional investors because of traditional
asset
allocation (MMD
evidence in terms of
to the
(38) p.xx).
However, there
is
real estate's overall contribution
nation's wealth
portfolio, that
would indicate
that under MPT, real estate investments should occupy at
least a
plurality of
an efficient
and Siegel (27) p.224; Miles
(44)
p.2; Webb
there has
and
community (academe
years to explain
is
to
(50) p.466).
Therefore,
effort by the
real estate
and practitioners) over the
real estate, as an
terms understood by the
it
(36) p.71; Ross and Zisler
Ruebens
been a tremendous
portfolio (Ibbotson
determine
last 20
investment, in the
major money managers, whose job
the
appropriate
allocations
to
the
From Friedman's (15) first suggestion
real
on
(54)
and Cambon
Zerbst
of
study
composite
the
investing to
real estate
in
of MPT
the use
more
can be
assets
different
in which
facility
readily compared.
for
only comes about through
Such understanding
portfolio.
mixed-asset
a
within
classes
investment
various
estate's comparable returns and associated risk measures
stocks and
real
estate community
matching up
closer an
The
differences.
Another
way of
for
was
bias
the
and bond markets,
then the
the
results.
explaining
that
real
the better
the equities
was in comparison to
estate's performance
were in
of the model,
this is
saying
stark
had
assets
the
with
asset's qualities
to the assumptions
greater
assets'
to compare
assumptions
same
underlying
the
that
knowledge
the
under
performances
sought
has
periods, the
several time
bonds over
with
the less credible were
the models of
MPT to account for the inherent differences between real
estate and the comparative assets.
the
Perhaps
single
estate in comparison to bonds
market
The
efficiency.
real
of
biggest shortcoming
and stocks is the idea of
underlying assumptions
of the
equilibrium theories of Markowitz, Sharpe, and Ross were
enumerated
in
the previous
relative agreement
aggregated in
Theory
1970.
with the
chapter,
conditions that
"Efficient Capital
and Empirical
Work,"
and
Markets: A
Journal
all are
in
Fama {13}
Review of
of Finance,
May
The
begins
case
against
the issue
with
regionalized
at
increased
these
costs,
certain
investors
market.
This is in contrast
stock-equities
consolidation
of
information
any
from
Real
faster
highly
lead
to
inhibit
perhaps
fully
in
the
to the national market for
which
and
readily
provides
markets
that
are
economic
that various
participating
bonds
Such
information.
markets
from
and
very least
regional
informational
efficiency
estate markets
the
is
The implication
within
market
real
that
best, and
at
localized.
factors
real estate
allows
diverse
geographic
the
transactional
available
investors
all
for
and
current
access
to
the
location.
estate transactions,
however, are
much less
than most of those found
frequent and much more complex
This latter difference points
in other capital markets.
up another significant variation, e.g. the heterogeneity
the heterogeneity of the firms
of the product.
Despite
underlying the
stocks and
markets,
the
homogenized.
other hand
bonds traded in
product
investment
The real
is a
estate
much less
investments
of the
the
not a
Such transactions are
and twos, not
This brings in the issue of the
asset, which
to offer, other
(e.g.
that is
the basis of ones
thousands and millions.
nonetheless
product on
deal-based transaction
discrete selections on
divisibility
is
equity
structured, "clean" transaction.
the capital
for real
than hybrid forms
REITs,
Real
Estate
estate has
of equity
Limited
Partnerships,(RELPS),
stake
in
terms
on capital
of
flows
relative
this
from
indirectly
result
could
At
the constraint
efficiency is
market
that
etc.).
For institutional grade properties such
indivisibility.
indivisibility of interests could translate to sizeable,
nominal
capital being
amounts of
As
participation.
{16) has
Gau
could
very
competition
and
greater
such
market
less
market
to
inefficiency.
estate
real
concerning
period
holding
the
influences
investment
noted,
market
issue
divisibility
The
market
lead
well
segmentation
required for
investment
decision as well, which for real estate is recognized to
be a long-term investment from the initial commitment of
monies.
Not
horizons,
however.
finite until
period,
cash flow,
With
periods,
such
the
segmentation
and
could
with
and lease-up
similar
of
20, or
40
10,
expectations
lead
assets are
to
results
to be
sustaining year
still others
real estate
This
that horizon
second,
variable
the same
differently.
may hold
of the construction
the end
others until
positive
years.
Some
time
identical
share
investors
all
a
of
holding
thus priced
further
market
those
argued
to
previosly.
Perhaps most
significant in terms of
the CAPM, is
the issue that real estate has no nationally accessible,
composite index.
provision of
As
was pointed out in
Chapter 2, the
that allowed for
the systematic
the CAPM
risk component of
an asset (the risk
premium or market
price of
risk, to be
that an overall
be computed.
computed in the first
market basket of return
place) was
and risk could
Referring to Figure 2, this indicates that
Rm can be found along the
capital market line at a Beta
equal to 1.0, since the relative risk of the market is:
Covariance
Rm)
Variance (Rm)
The use of such a
MPT to
Variance
Variance (
=
significantly reduce
order to
assess
overall portfolio.
under fire
)
the computational
Only in
contribution to
through a
However, the CAPM itself
number of
scholarly works,
the issue of
Harrington ({20),
p.75) for example, cites
and
contends
that
the
this way can the efficiency
particularly over
Roll 7
load in
on a particular asset
its marginal
of the portfolio be optimized.
came
1.0
=
market index allowed practitioners of
conducting an investment analysis
in
)
this idea of
since a
true
an index.
the work of
market
index
contains all assets, the ability to collect such data is
impossible.
In
addition, testing such
in an expectational model
results.
Thus,
market line may
risk
free return
possibly
historical data
will yield only disappointing
in a mixed-asset portfolio
be more shallow, the
higher,
non-linear.
and
the capital
intercept for the
the efficient
Therefore,
can a
frontier
specific asset
class, particularly one such as real estate equity where
the
market inefficiencies
are at
least taken
at face
Richard Roll,"A Critique of the Asset Pricing Theory's
Tests, Part 1: On Past and Potential Testability of the
Theory,"Journal of Financial Economics, March 1977.
value, ever hope to be explained by MPT? The answer lies
insights that
theory to provide
ability of the
in the
aid the portfolio manager in the decision-making process
and
allow
to
theory
the
of
flexibility
the
for
adaptation.
real estate portfolio management
The research into
has
portfolio,
but rather
of a
component
1970s
and
development
emphasis
of
MPT
application
Stock
performance is compared.
the S
& P
for real
500, have spawned
estate, such
market basket
Strategically,
mixed
not only
similar indices
and Liquidity
Ballard, Biehl & Kaisor (BB &
and
and real
equities, attempts to
of institutional
portfolio analysis
asset level
asset classes.
equity indices, such as
stocks, bonds,
of U.S.
10% of foreign
weighted
portfolio
This latter fund, consisting of about
K) index as well.
well as
seen in the
which
as the FRC/NCREIF
Fund, but the mixed asset
30% each
to
indices
market
bonds,
or
securities
of this can be
Manifestation
of
evolution
real
stock-equities
by
governed
fixed-income
and
secondarily.
appropriateness of
on the
been
has
that
primarily,
estate
real
the
the
historically, MPT-generated, mixed-asset
estate into an
portfolio
to
on
been
not
has
the
but rather
portfolio,
Throughout the
mixed-asset portfolio.
80s
integral
as an
real estate
on
estate
the real
on
focused
not been
ironically
work lower
The benefits of MPT
estate, as
define a
grade assets.
should begin
into the
at the
separaate
consciousness have
come to real estate through association and accomodation
within the mixed asset portfolio.
The
results of
present an
this
research, summarized
historical rationale
equity should
have been
mixed-asset portfolio
as to why
included into
of the past.
below,
real estate
the theoretical
Real
estate equity
investment has:
0 Offered higher returns and lower, composite risk
than stock equities and bonds.
(Brueggeman, Chen
and Thibodeau (7); Ibbotson and Siegel (27); Zerbst
and Cambon (54)).
0 Offered diversification through negative
correlations with stock equities and bonds.
(Brueggeman, Chen and Thibodeau (7); Hartzell,
Hekman and Miles {22); Miles and McCue (37); Ross
and Zisler (44); Webb and Ruebens (50) and (51)).
0 Offered a significant inflation hedge, well in
excess of stock equities and bonds.
(Brueggeman,
Chen and Thibodeau (7); Hartzell, Hekman and Miles
(23); Rubens, Bond and Webb (50)).
0 Been understated in its risk component
(variability of returns) in relation to stock
equities and bonds due to the differences in
valuation methods (i.e. appraisal functions versus
auction market prices).
(Friedman (15); Gilberto
(17); Hartzell (21); Webb and Ruebens (50)).
Largely because these studies were done to convince
mixed-asset
portfolio
significant
allocation
concurrent
benefits of
the
studies
managers
to
were
real
portfolios.
an efficient
The
the
limitations
benefit
estate
undertaken
different subclasses
concept of
of
investment,
to
of real
assess
the
estate under
frontier for
of the
of
real estate
nature
of
real
estate for consideration of a direct application of MPT,
were well recognized by Ricks
(15) in
1970.
Yet over
(41) in 1969 and Friedman
17 years later, Gau
45
was still
exhorting his
colleagues to
"...look to
variations of
these pricing models (CAPM, APT and MPT) for real estate
rather than
based on
This
explore alternative
any perceived inefficiency."
would indicate
there
theoretical approaches
still
reluctance
to the
exists
to buy
(Gau
most casual
some
kind
into MPT
of
as an
{16) p.10).
observer that
institutionalized
aid to
real estate
portfolio management.
Nonetheless,
one of
the significant
evolutionary
outgrowths of attempting to apply MPT to real estate per
se,
was the
index.
formulation of
national
originally begun as an index to both serve as an
industry
benchmark
performance
managers,
and
for
an
aid
its data
closest surrogate
The index
and
a representative
commercial
in the
base now
for a
real estate
consisted
income-producing,
$594.4 million.
and
rating
of
serves as
commenced tracking on
originally
real
portfolio
the industry's
equity portfolio.
the last day
of
nonfarm
236
unlevered,
properties
Today the portfolio has
of 1977,
valued
still
nonfarm
based
unlevered,
properties
portfolios.
quarterly
Estate
on
The
that
data
by members
Investment
are
is
of the
Its data
income-producing,
held
aggregated
in
and
tax-exempt
and
National Council
Fiduciaries
at
grown to over
1220 properties valued at over $ 15.9 billion.
is
estate
(NCREIF)
reported
of Real
in
components:
1) Net operating income, and
2) Quarterly change in market value (per appraisals).
two
The data is further segmented, mutually exclusive, as
follows:
Geographic Region
East
Midwest
South
West
Property Type
Office buildings
Office/Showrooms/R & D
Warehouses
Retail buildings
the
While
management fees, it
does
index
FRC/NCREIF
portfolio
deduct
does not reflect fees
estate advisory firms and consultants.
paid to real
Despite the many
base
has
progressively grown under consistent restrictions.
This
of
restrictions
index,
the
as real estate researchers
standard has been important,
able to
have been
within the
between
practice of
focus the
MPT theories
real estate equity,
asset class of
the asset
data
the
classes
as well
previously discussed.
The
concept of a standard index also helps to alleviate some
of
the major
real estate
over the
concerns
Two of
supposed inefficiency.
market's
these sited by Jaffe and
Sirmans ({28} p.383) are poor data sources and a lack of
generality of market behavior.
the largest
the
of its kind
ability to
diversity.
grow
on all-equity,
in real estate, and
in relation
In addition
estate indices8,
The FRC/NCREIF index is
there are
only one of
to
has shown
its content
several other
and
real
which, the EAFPI, is based
tax-exempt commingled real
estate funds
(CREFs).
8 Ross, Firstenburg and Zisler {45) site two: the EAFPI
from Evaluation Associates and the Unlevered Equity REIT
Index (ULREIT) from Goldman Sachs & Company.
Brueggeman, Fisher and Stone (8) site three additional
ones from the National Association of REITS (NAREIT):
the Equity REIT Share Price Index (EREIT); the Mortgage
REIT Share Price Index; and the Hybrid REIT Index.
With these indices researchers began a long process
of
return and
reconciling the
estate
those
with
equities
Zerbst
indices
from comparable
Cambon
{54)
work
from real
of
stock
culminated with
This effort
and bonds.
and
risk results
which
summarized
the
the
individual efforts of the past, while also attempting to
normalize
those
results
investment spectrum.
allocation in
across
the
The issue of
the context of
institutional
optimal mixed-asset
MPT was the
next logical
area for research.
However,
incredible results
were being
generated
from this exercise, which showed that real estate should
be dominate any portfolio
along the efficient frontier.
Brueggeman, Fisher and Stone (8} derived a portfolio for
the lowest coefficient of variation that consisted of 0%
stocks,
9%
bonds, 10%
T-bills,
and
81% real
equity as represented by the FRC Index.
and Rubens (50)
tax-bracket
Similarly, Webb
derived the optimal portfolio
investor
as
0% bonds,
(NYSE), 6% common stocks
commercial real estate.
estate
0%
for a 0%
common
stocks
(small), 11% farmland, and 83%
Two
years later, in 1988, Webb
and Rubens (51) again showed that by using standard risk
measures
on
restricted
portfolios that
financial assets
and two
and residential)
from 1967
appropriate allocation to
have been
studies
on the order of
served to
real estate
include
four
assets (farmland
to 1982 that
real estate's
mixed-asset portfolios should
79% to 90%!
reinforce the
These
feeling in
types of
the mixed
asset portfolio management community that:
1) They had probably missed a good opportunity by
not being invested in real estate from 1967 to
1982,
2) Something was wrong in the way returns and
risks for real estate were measured,
3) There must be significant differences in the fundamenta
of real estate that makes an apples-to-apples
comparison of it to other capital assets under MPT
meaningless.
4) Maybe there was further opportunity in real
estate, but since there is such differentiation
among real estate products, are certain products
better than others?
The last issue led
within the real estate
researchers to look for answers
asset class.
With MPT providing
the conceptual and analytical comparative framework, and
the
increasing capital
budgets of
large institutional
investors looking for diversified avenues of investment,
real estate researchers
to make a
began to look inward
contribution.
IMPORTANCE of DIVERSIFICATION
large
has been
asset allocation
If
modern
and
investors,
then
diversification
the
It
issue.
strategic
been
has
perspective,
ultimate investment
downward to
thinking for
in
the
the
quantifiable
of
terms
the solution
has become
analysis/rationale
theory
portfolio
the efficient construction of
mechanism that allows for
one,
issue of
the major
pointed
out
goals that
to address
that
flow
objective are driven from
the asset classes.
This
from
a
an
the top,
type of strategic
real estate investment decisions
49
from
has only
recently
come to
and
(Furstenburg
Thus,
The converse way of
portfolio to likewise be
then allows for an
This bottoms-up approach
in practice
However,
classes in theory.
various asset
the
investment into
funds for
allocation of
in order
of portfolios
efficient frontier
for the aggregated mixed-asset
unbiased
of
say that each asset class
describing this process is to
efficient.
portfolio
rationale
quantitative
diversifying within an asset class.
requires an
{18)).
Gordon
mixed-asset
the
of
the
requires
implicitly
(141, and
Wurtzebach
diversification
industry literature
in the
the fore
illiquidity, indivisibility, heterogeneity
the relative
and magnitude of real estate equity investment restricts
its
advantages.
diversification
development in the application of
of
intra-
significant
most
the
been
has
issue
the
Nonetheless,
MPT to real estate in
the last decade.
prior to 1980.
to
real estate
research for
intra-diversification
one
equity
cite two relating
Miles and McCue (37)
apartment buildings,
of
examples
few
a
only
are
There
farmland, two
with
with
residential real estate and farmland, one with REITs and
article
Ricks'{41}
seminal
financed by
loans from
authors cite
and
various
life insurance
the increasing influence of
their requirement
responsibly diversify.
within the
on
under
ERISA to
subclasses
companies.
The
pension funds
utilize MPT
to
At stake was the common practice
real estate community to
naively diversify.
This
practice
held that
distinct differences to
in
Chapter 1,
through
the
boundaries
would
melding
the
types.
analysis to
of
the
study
indeed lower
expected
while
an
but
(commercial,
also
because
it
lease structure as a suitable
showed that
inflation,
the
increasingly
diversification analysis.
risk, and
areas
significant in
subclass
buildings),
analyzed the dimension of
determinant for
geographic
The geographic
was not only
estate
income-producing
across
achieved
the same for microeconomic ones.
Markowitz'
real
could be
macroeconomic issues,
and McCue study
from
estate's
other asset classes, elaborated
and property
popular
of real
of properties
property type would do
drawing
virtue
that diversification
diversify
The Miles
by
naive
was a
though
The results
diversification
very good
not
did
hedge against
against
unexpected
inflation (confirming work also done by Brueggeman, Chen
and
Thibodeau (7]
surprising
published in
result, however,
accounted for only 10 - 15%
estate
investment in
magnitude
below bonds
further credence to the
the same
was
issue).
that systematic
The
risk
of the total risk of a real
commercial properties,
and stock
equities.
orders of
This
gave
belief that the commercial real
estate market at least, and possibly all of real estate,
was
relatively
higher
inefficient,
risk index
variation)
investment
for
and thus
(the inverse
the
management
premium
of the
of
expertise.
51
could
offer
a
coefficient of
information
Thus,
and/or
broadly
naive
designed,
non-beneficial,
could
it
be counter-
productive,
as
Only through
for higher returns at possibly lower risk.
under the
a Markowitz analysis
opportunity
provide significant
however, could
market
be
within such an inefficient
Naive diversification
well.
only
not
might
diversification
MPT umbrella
would one
know.
in
work of Miles and McCue (37),
they built upon the basic
well
as
strategy,
leasing
However, they went
property
size
(SMSA),
as
property
a step further by
and
the metropolitan
of
components
of
and
type,
diversification.
elements of
dispersion as
geographic
as
a component
as
maturity
including lease
likewise
so doing
In
goal.
efficient portfolio
pursuit of
sub-asset class
of the real estate
exacting categories
more
sought
(22)
Miles
and
Hekman
Hartzell,
also modeling the
area
statistical
diversification.
Their
conclusions were very similar, if not the same to all of
those
previously discovered
Even
the low
once
the
data
the
geometrically smoothed (to
This confirmation of
and McCue
systematic risk
level of
for
by Miles
appreciation
was confirmed,
component
account for appraisal bias).
for the additional determinant
components of diversification that were considered.
later,
Hartzell,
marginally improved
was
intra-real estate diversification,
however, was significant
years
(37).
Schulman and
upon the geographic
Wurtzebach
Two
(24)
determinant by
analyzing the effects of dividing the United States into
eight,
to
continuing
in
important
MPT's
comprehending
coefficients
lower
produced
to
validity
real
was a
eight regions
as all
modelling representation,
better
was
factors
the
indicated that this
the results
Again,
estate.
of
for refinement
search
work
later
this
anyway,
issues
macroeconomic
for
surrogate
as
provided
was
diversification
naive
of
concept
the
under
component
geographic
the
Since
areas.
related
economically
more
than
of correlation
the
previous four, arbitrarily assigned classifications.
to some researchers was
Still troublesome
Hekman and
any
it only
then
naively
stands
or specific
unsystematic
across
a
those components.
is
diversified portfolio
further minimize
to
the
naively diversifying
risk by
if the
However,
i.e. specific risk is high,
risk is low,
risk within
For if systematic
Miles (22).
component of
large,
confirmed by Hartzell,
first shown, and later
data had
and McCue (37)
risk that the Miles
level of systematic
the low
systematic
then the cost
of diversifying across components might not be worth the
effort.
is because the real
This
largely project
the
locale
intensity.
and
estate investment is
specific and requires
an
Rather,
inordinate
if there
expertise within
amount
is such a
of
managerial
large specific
risk component, then there are bound to be opportunities
for
exploiting
geographic
Cole,
the
market
area, property
Guilkey, Miles
inefficiencies
type, lease
and Webb
within
a
structure, etc.
(9) tackled
this issue
head
on by
data,
first reviewing
then
variance
establishing
to
the
properties in
property
This
indicated that
(East,
West,
South,
They
total
of
the
North,
individual
(geographic and
resulting low
in all
subcategories
Industrial,
> 80%)
from
property
still others
the
of ten,
traditional
type
others
and
unsystematic or
upon the development
descriptions,
the
The
of diversification.
descriptions, and
portfolio
the
Office,
independent
versus
subcategories
risk
(37)
represented
total risk.
thus set
(i.e.
geographic
of
then
largely (
in fact
geographic
ratio
to the
ratios
independent
and McCue
each diverse subcategory
systematic risk
specific.
a ratio
average variance
type).
Retail) was
the Miles
categories)
Some included
only
only
property
a combination
type
of both.
All were developed from an intuitive sense for how
a real estate portfolio manager
classifications (i.e.
Oil sensitive,
Trade Restrictions, Yuppieland,
again,
the Markowitz
an
results showed
efficient
better
predict
to
frontier of
a composite
subcategories
methodology,
from other
define
than
works;
broadly
derive
portfolios.
to
The
and negative
The conclusion is as one
namely,
multiple,
diversifying
to
Once
in order
of high, low,
one's own
for
employed to
of correlation
correlations across the board.
might
Benefitting from
New South, etc.).
analysis was
mean/variance/coefficients
construct
might think of property
and
and
that it
is
discriminating
abide
blindly
by
a
diversify
naively and thus further risk inefficiency.
There is
past
ample evidence
MPT has
20 years,
over the
that shows that
progressively been
gaining in
stature among real estate academicians, as the composite
theory itself is adapted, manipulated and evolved.
how
MPT
has
utilized
been
decisions of the industry's
however,
chapters.
remains
to
be
for
real
estate
Just
equity
newest and largest players,
analyzed
in
the
following
CHAPTER 4
MPT SIGNIFICANCE TO INSTITUTIONAL REAL ESTATE INVESTORS
Institutional
recommendations and/or
are
managers
defend
to
forced
being
increasingly
asset
estate
real
their
asset allocations
positions for
within the mixed asset portfolios, according to multiple
sources in attendance at the first annual PREA Institute
{33}
on the
June, 1990.
management
portfolio
allocations
Pensions
as
portfolios, and as references,
managers
normative.
& Investments
performance of
managers.
in
By most accounts benchmark portfolios serve
as surrogates of optimal
lead
estate portfolios
of real
into
As
accepting
certain
example,
consider
an
(41} approach
the universe
of U.S.
to modeling
the
tax-exempt asset
As reported in their annual survey (Ring {42)
p.1) effective 1 January
1990, the aggregated portfolio
and associated benchmark portfolio
looked as follows in
Figure 3.
FIGURE 3
AGGREGATED PORTFOLIO vs. BENCHMARK PORTFOLIO COMPOSITION
for U.S. Tax-Exempt Money Managers
01 January 1990
AGGREGATED PORTFOLIO
48% Common Stocks
29% Bonds
12% Cash
6% Real Estate Equity
BENCHMARK PORTFOLIO
48% S & P 500 Stock Index
30% Shearson-Lehman-Hutton
Government/Corporate
Bond Index
16% 90 day T-bill Return
6% FRC/NCREIF Property
Index
only grew 15.5% over the
year, the aggregated portfolio
same period.
by the top 100 grew 13.8%,
The amount run
anyway, given that
For 1989
500 by 14.9%.
and the top
over the
benchmark portfolio grew 21.2%
While the
the standard volatility of the overall market represents
explains
MPT
1.0,
of
a beta
and
insight,
supposed
their
from
comes
abilities
added value
managers whose
the money
implications for
to
has major
This
used.
strategies were
diversification
whatever
under
investing
than
performance
yielded better
basket would have
representative market
the
in
investing
how
knowledge,
professional
on
capitalize
market
inefficiencies.
performance is
asset
its
declined
quarter
ten-year
that
FRC/NCREIF
throughout the
of 1989
its
1980's,
returns were
treasuries for
the first
history (Institutional Real Estate
portfolio acquisition
a
plan's funds might
then more of the
the
Thus, if
while the FRC/NCREIF
logically be invested in real estate.
understands
performance of an
market's index.
estate return was 8%,
index showed 5.8%,
portfolio's
tax-exempt
typically made on the
class against
plan's real
the
of
analysis
An
However, when one
has
index
and that
steadily
actually less
time in
4th
in the
than
the index'
Letter {3} p.3), the
manager needs to
reevaluate such
decisions against the return/risk ratio of other assets.
It is incumbent upon
to
be
able to
the real estate portfolio managers
defend
the
maintenance, increase,
or
decrease of their allocations in terms understood by the
MPT
assets.
competing
of
managers
portfolio
other
provides for this common language.
While the benchmark provides a test of performance,
it
the
to be
sought
ERISA
p.15).
catastrophic
minimum necessary
to
in the
through the
loss partially
pension plans to invest no
portfolio
of
limitation of
amount to
A truly
investments
the wealth portfolio on a
or even global level.
this would
(26)
incidence
estate.
consider
would
probabilistically in terms of
regional, national,
any
more than 10% of plan assets
employer's securities and real
efficient
stated
the
minimize
to carry
(Hemmerick
diversification
for
effect
positive
generally
class is
one asset
any
allocation in
considered
in this regard.
perhaps suffers the most
estate equity
the
Real
the various asset classes.
allocation of funds to
A 5%
rationale for
a misguiding
serve as
can also
a plurality
As has been
of any
U.S.
portfolio's real estate equity holding of between 40 and
50%
(Miles
(36).
Most recently a
commonly referred to
allocation of 10 to 15% has been recommended for such an
allocation.
At the
PREA Institute,
most participants
that a 10%
allocation for
agreed with
the observation
real estate
equity was commonly used,
purely by taking
the average
of a subjectively minimal
allocation of 5%
to a subjectively maximum (that anyone would believe) of
15%.
The fact is that there is little in the literature
that
supports
these
figures.
Real
estate
equity
of
aid in
ultimately
MPT can
where the use
This is one area
strategically derived.
than
rather
into"
"backed
been
has
allocation
decisions of
portfolio
acquisitions.
require
thus
{54},
and effort by Zerbst and
Institute
observed that
conducted
that truly
that is so, then real
afford not
MPT is
their real estate
not afford to have
tool for
the
and conversely,
in its usage,
managers operating
portfolio
Again,
estate portfolio managers can ill
to be versed
plan sponsors can
If
{16)).
comparison (Gau
of such
the promise
offer
a
that can
the framework
MPT is
feeling that
pervasive
an
in
nonetheless
is
There
fashion.
apples-to-apples
mortgages)
or
real
bonds, and
treated stocks,
securities,
(equities,
estate
a study
never been
there has
PREA
the
at
researcher
prominent
one
asset classes.
the various
Despite the encompassing study
Cambon
be
to
disciplines
strategic
same
the
tactically across
utilized
MPT will
decision making employing
Such strategic
in
a structural
the
vacuum.
the
construction of
structure.
It
has been
pointed out
in the
previous chapter
that researchers in the real estate field throughout the
1970's concentrated
of
real estate's
large
also
their efforts largely on
contribution to
asset
(institutional) mixed
been
throughout
reviewed
the
that
1980's
their
has
been
the issue
the efficiency
portfolio.
primary
on
of a
It
has
contribution
the
issue
of
efficiency
within
particularly
as
development
such
of
Throughout
the
real
research
strategies
these
two
estate
has
aided
for
decades, MPT
portfolio,
in
diversification.
has
provided
researcher with the tool for structured analysis.
further issue arises, however,
the transferability
academe to
the
of the
researchers
research from the
capitols.
have
pulsed
the
Yet a
that calls into question
the corridors of investment
financial
the
halls of
managers within
Fortunately,
the
trend of
several
MPT
usage
at
selective points over the last twenty years.
The
dawning
argument of the
of
the
1970's
brought
efficiency of real estate
market (Friedman (15) and Fama (13)).
of
this
issue
however,
of
been
particular
Pellatt's
(39)
utilizing
a
Advocating
the
structure of
have
proposal
Monte
use
the
as a capital
The pros and cons
discussed
in
Chapter
of
of
estate
investments
simulation
technique.
this
real
that
era
2;
interest
Carlo
of
forth
within
technique
Markowitz portfolio theory, he
was
the
noted that
as of 1972:
The most overwhelming conclusions ...
after
reviewing both the literature and the practice of
real estate investment analysis are twofold:
1. Almost all methods of analysis rely upon
general industry 'rules of thumb' calculations ...
Almost no analytical methods employ present value
calculations.
2.
Virtually no methods of analysis ...
sophisticated computational techniques or
statistical tests of validity.
60
apply
previously, Wiley
Two years
the
investment
Pellatt
practices,
apparently
referred
to a
1964.
which
did
not
in
respondents
reported using
value (NPV)
measure of
his
refer.
bibliography
Rather
study by
Wiley's
statements,
institutional
of
from
less ambitious
Nonetheless,
Pellatt's
surveys
comprehensive
first
one of
(53) had conducted
Ricks (41)
conclusions
that
an
only
Pellatt
supported
of
Wiley's
after-tax, net
present
analysis.
7%
in
Similarly,
only 18%
reported using an after-tax measure of the internal rate
of return.
The before-tax figure
less than convincing
for NPV was
32%, and the IRR
still a
was not surveyed
in the before-tax regard.
A
decade after
the Wiley
Webb (49}
proposal,
again
survey and
surveyed the
the Pellatt
institutional
market (life insurance companies
and pension funds) for
perceptible
sophistication in
analysis
of
signs of
real
increased
estate
acquisition.
the
Citing
the
increasingly dominant role of
these institutions in the
real
their
estate
market
due
to
large
amounts
of
perpetual capital
influx, Webb tested a
akin to this one.
Webb's implicit reasoning was that if
the largest institutional actors
relatively
real estate
equity
similar thesis
were not employing the
sophisticated techniques
of
MPT for
portfolios (particularly their
investments), then
used elsewhere, as
MPT was
their
real estate
probably not
being
smaller institutional investors were
significantly more restricted in
their ability to enter
the
market
in any
significant
way.
Because of
the
latter issue, Wall Street had responded with a number of
investment vehicles,
real
estate equity
mutual
funds
which could wring out
benefits
(CREFs),
securities (FNMA,
in terms
securities
GNMA), limited
and regular mortgage pools.
options for
pros
and
of real
(REITs),
of
mortgage
Edwards (11) detailed such
each
in
Regardless,
numerous studies
vehicle has
replicated the
sense of a
estate
partnerships (RELPs),
institutional investors and
cons
some of the
a
summarized the
qualitative
have shown
that no
performance in
direct equity investment in
fashion.
such
a Markowitz
real estate, in
terms of its portfolio contribution.
In
addition
to
the
survey
of
the
sophistication in
real estate analysis, Webb
provided
a track
as to
previous
studies
on
surveys
1982-83.
relevant
of
this level
similar,
institutional
His analysis
to
this
terms
of
showed two
thesis.
complementary
assessing
issue of
The
dealt with
through indirect
risk,
own, these
first
1972
was
that
However,
it did
on
not appear
and
the
the
that
whole, or pension managers
of MPT,
adjustments to returns.
previous
identical,
clearly been on the rise
risk in terms
treatment of the successive
his
not
four
significant results
returns.
institutional investors as a
in part,
by comparing
though
of
(49) also
investors between
practice of MPT principles had
in
level
but rather
Given Webb's
surveys up to and including
surveys will
not be
further
dealt with here.
The momentum gained from
did not stop in
real estate research
The
desire
make ex-ante
to
utilizing MPT
the
decisions
research
unexpected opportunity presented
Webb (25) involving
of
investment
data, has
and
community;
one
itself to Hartzell and
the stock market crash
in the U.S.
Finding themselves in the midst of a survey of
in 1987.
institutional investors
of real
the early 1980's.
testing ex-post
principles in
enticed
always
the application of MPT to
on their
expectational factors
stock market lost
estate equity investors, the
over 20% of its market capitalization in one day, as the
Dow
Jones
Industrial
Average lost
authors were quick to spot
change in
this
508
The
the opportunity to gauge the
expectations of real estate
tremendous
points.
exogenous occurrence.
investment given
Their
results
have significant support to this thesis.
Among the 236 institutions surveyed by Hartzell and
Webb, 110
responded (46.6%).
Of
these 42 of
56 (75%)
were from real estate consultants and advisors, but only
19 of 100 were from
pension fund sponsors.
The reasons
that were given for the lack of pension responses were:
a) that as sponsors they didn't participate in
surveys,
b) didn't manage their real estate decisions
(consultants or advisors did), and/or
c) didn't have enough expertise to comment.
The
was
response
third
given
the
the marketplace.
funds in
of the
increasing plurality
unexpected
quite
However, the article indicates that 41 of 42 real estate
advisors and 18 of 19 pension sponsors actually answered
the
of
questions,
involved
which
MPT principles
the
of
major
portion
Markowitz (total
heavily
returns,
volatility of those returns, and cross correlations with
other asset classes).
This indicates that 60 out of 156
pension sponsors, consultants,
at
least using
the
and advisors (38.5%) are
rudiments of
MPT, otherwise
they
would not have been able to fill out the survey.
One last conclusion that
data
is
that
conservative
pension
in their
is ascertainable from the
sponsors
are
expectations
slightly
more
than either
their
or consultant/advisor kin.
institutional life insurance
The sponsors' expectations of total return, appreciation
potential,
and
institutional
inflation
investors
all
of
other assets
and inflation were more
directly
The
group.
closer
a
that fiduciary might
market
is
fiduciary
investment capital
recent
correlation
Although the
apparent, it
below
surveyed.
expectations
any other
cross
were
the
other
Likewise,
their
coefficients
conservative than
reason for this
nonetheless not
is
to
with
the
is not
surprising.
source
of
the
(i.e. their own), the
more cautious
be expected to be.
Also, as more
participants,
pension
funds
might
shown to
have
logically proceed with greater caution.
Modern
portfolio theory
has
been
the
investment
in
Markowitz'
initial
usage.
Hartzell
degree
that
equity
are
three
theory
and Webb
institutional
marginally
spanning
in
techniques
The degree to which
committed
to these
of
survey
have confirmed to
investors
between
decades
and Webb's
utilizing the
also
their expectations.
have
estate equity
intensive use in real
found increasingly
its
a certain
real
estate
to
assess
pension funds
techniques
Webb's study is assessed in the following chapter.
since
CHAPTER 5
RESULTS AND ANALYSIS OF A SURVEY:
REAL ESTATE PORTFOLIO ACQUISITION CRITERIA
in the U.S. PENSION FUND INDUSTRY
THESIS OBJECTIVE AND HYPOTHESES
This chapter
presents the
the U.S pension community's
criteria.
to
If
modern
results of a
real estate decision making
the level of sophistication
portfolio
corresponding
theory
change
sophistication
in
would
survey of
is
the
also
rising,
then
a
and
level
of
expected.
Such
an
types
be
with respect
undertaking requires a benchmark for comparison, and the
Webb {49} study of 1982-3 provides such a vehicle.
thesis
gauges
the
marginal
sophistication by the application
techniques
found in
level
of
This
technical
of the principles and
modern portfolio
theory.
Whereas
Webb concerned his study with real estate investments in
equity, mortgages,
considers
and construction loans,
only the
real
estate
this thesis
equity investment
in
consideration of its uniqueness as a portfolio asset.
The survey responses shown herein were generated by
a questionnaire
to
419
pension
consultants, and advisory firms,
plan
sponsors,
who by nature of their
size and/or business could be expected to manage pension
portfolios that include real estate equity.
nature
then, the
survey was
entities in the pension
dealt
with in
the
the questionnaire
By its very
biased toward
fund population.
following section.
and the cover letter
the larger
This issue is
The format
of
that introduced
its purpose are shown in
Appendix A, and the results of
the survey that follow,
refer to the question numbering
of the survey.
The
was
survey
the primary
responses that
from the
infer
to
test
a
number
together would either support,
hypotheses that
to support,
designed
were both
thesis.
or fail
The
questions sought
factual and
attitudinal, and
responses descriptive statistics were
generalized conclusions.
all flow from a
of
used to
The hypotheses
tested
generalized hypothesis that the changes
in the industry will
have manifested themselves in more
sophisticated techniques than found
in the Webb survey.
This general hypothesis is expressed specifically as:
1.
from a
Real estate
portfolio
managers have
shifted
bottoms-up, deal-based, tactical mentality
to a
strategic, top-down approach in allocating funds.
2.
Real estate portfolio managers have become more
sophisticated in their diversification strategies.
3.
Real estate
portfolio
managers have
adopted
more sophisticated techniques for return measures.
4.
Real estate
portfolio
managers have
adopted
more sophisticated techniques for risk measures.
5.
Real estate
performance
portfolio managers
against both
mixed asset
measure their
and real
estate
market indices.
6.
Real
estate holding periods have
the face of several
last seven years.
increased in
negative market conditions over the
7.
have increased
estate portfolio managers
Real
searching and investing in
their investment horizons by
a global real estate market.
METHODOLOGY AND INHERENT BIAS
From 18 - 20 June
1990, the Center for Real Estate
Development at the Massachusetts Institute of Technology
hosted
the
first
annual
Institute
for
Real
Estate
Portfolio Management, that was
sponsored by the Pension
Real Estate Association (PREA).
In preparation for that
instruction the survey found
in Appendix A was prepared
so
Institute
that
students
appreciation
within
for
their
the
the
state
field.
questionnaires
pension
of
plan
were
In
advisory firms.
to
Pensions & Investments' (5)
September 1989.
of
portfolio
organizations
Selection of
pension plan sponsors
portfolio
mid-Spring
sent
sponsor
of
might
and
have
an
management
1990
survey
managers
real
the former was
at
estate
based on
survey of the 1,000 largest
whose data was reported
as of 30
Selection of the latter was based on an
earlier survey, also by Pensions & Investments (26), for
data as of 30 June 1989.
The
419 questionnaires
sponsors and 101 advisory
were
selected based
asset poirtfolio.
tax-exempt
Pensions
assets
&
on
were
firms.
mailed
to 318
plan
The 318 plan sponsors
the magnitude
of their
mixed
Those which had $1 billion or more of
under
Investments
management,
(5),
68
were
as
reported
selected
for
by
the
survey.
These
318 sponsors out of
total,
control $1.584
$2.174
trillion
in
an estimated 39,375
out
trillion
pension
tax-exempt
estimated
of the
This
funds.
equates to 0.8% of the sponsors controlling 72.9% of the
pension asset population.
funds that
least
$1
Pensions &
million
Of those defined contribution
Investments singled out
in
real
estate
equity,
with at
all
were
included in this survey.
Of those defined benefit funds
with at least $4 million
in real estate equity, all lie
in the top
survey
200 and therefore were
went
to
an
unreasonable to
$1
118
funds,
expect that all sponsors
million in
representing
addition
surveyed.
equity real
estate were
a significant
It is also assumed that
segment of
Since the
it
is
not
with at least
surveyed, thus
the population.
given the barriers to investing
in real estate equity, $1
million is not an unrealistic
figure
to real
as an
example, a
allocation
$1 million real estate
portfolios where 5% or 10%
would indicate a mixed
estate equity.
For
equity investment in
is allocated to real estate,
asset portfolio size between $20
and $10 million, respectively.
The distribution of questionnaires and responses is
in
shown
Table
1.
The
survey
yielded
an
overall
response that was better
both in nominal and percentage
terms than
and nominally
than
Webb's (49),
the focused
Elebash
and
survey of
Christianson
somewhat better
state pension
{12}.
The
sponsors of
latter
survey
claimed an impressive 82% for the targeted audience.
69
TABLE 1
DISTRIBUTION OF QUESTIONNAIRES AND RESPONSES
TYPE
SURVEYED
RESPONDED
% RESPONSE
Sponsors
318
83
26.1 %
Advisors
101
42
41.6 %
Total
419
125
29.9 %
Not all of the
in
their
because
respondents held real estate equity
portfolios.
only
(equity or
those
This
funds
feedback
investing
mortgages) were asked to
the questionnaire.
All others
was
in
important,
real
estate
continue answering
were asked to send their
responses back in self-addressed envelopes, so as not to
adversely impact the response
rate.
the distribution of responses
that reported having real
Table 2 summarizes
estate in their portfolio, then breaks this distribution
further, by indicating the
number of explicit responses
for amounts of equity and mortgages in the portfolios.
TABLE 2
DISTRIBUTION OF RESPONSES REPORTING REAL ESTATE
AND FURTHER SUBDIVIDED BY MANAGERS
REPORTING SPECIFIC AMOUNTS OF EQUITY & MORTGAGES
TYPE
RESPONSE
WITH R.E.
SPECIFIC RESPONSES FOR
EQUITY
MORTGAGES
Sponsors
83
61
56
29
Advisors
42
41
39
19
125
102
95
48
Total
70
2 shows that there were 23
A comparison of Tables 1 and
did not have
respondents who
portfolios,
these
or 18.4%
of
were sponsors,
didn't possess
any tax-exempt
results.
in
in their
responses.
the total
while one
was from the combination
subsequent
any real estate
was an
22
of
advisor, which
real estate
equity.
It
of these 102 respondents whose
data provided
for
the
remainder of
these
Nonetheless, the percentages that will be used
describing
the
descriptive tests
in
the
RESULTS
section, are based on the total sample size of 125.
Tables 3 & 4 provide the statistical composition of
the respondents.
when
reviewing
utilize
manage
there
A significant caveat to
Table
the expert
3
services of
their portfolios.
is double
is that
Thus,
counting of
many
bear in mind
plan
sponsors
the advisory
firms to
the possibility
fund assets
that
is extremely
high.
TABLE 3
STATISTICAL SUMMARY OF EQUITY AND MORTGAGE MEANS
(Dollar figures are in Millions)
EQUITY
MORTGAGE
RESPONSES
AVERAGE
AVERAGE
TOTAL
THOSE
REPORTING
REAL ESTATE
125
$ 1,183
$ 888.3
102
$ 1,449
$ 1,089
TABLE 4
COMPOSITION OF REAL ESTATE PORTFOLIOS
(Dollar Figures are in Millions)
EQUITY
|
MORTGAGES
TYPE
RESPONSES
|
RESPONSES
TOTAL
I
TOTAL
(MEAN)
|
{MEAN}
------------------------------------------------SPONSORS
56
$
42,586
($
ADVISORS
39
TOTAL
95
j
760)
29
$
|
$105,286
|
{$2,700}
|
$147,872
|
19
$
of
the
sample
institutional
48
$111,036
obviously
biased
targeted
population.
an
average
portfolio
138
have
while
of
an
$1.94
billion,
mean
of
mortgage
$174
estate
200
securities
pension
bias.
sample
of
estate
equity
Thirty
nine
92
for
respondents
lumped
average
to
this
72
along
and
$90.145
billion
survey,
of
only
Real
the
reported
a
with
considered.
{26)
holding
of
reports
demonstrated
Investments
an
equity
"mortgages"
together,
are
held
that
sponsors
mortgages
mortgages
firms
reports
Investments
pure
$760
estate
in
responses
such
of
Similarly,
&
are
advisors'
&
real
holding
when
only
Pensions
in
Pensions
backed
if
(5)
was
reported
equity
million.
portfolio
billion
million
estate
is
that
sponsors
assets
$343
it
since
Investments
with
$1.60
investors,
example,
real
&
whereas
representative
portfolios
of
average
be
portfolio
For
of
to
large
funds
average
reported
estate
Pensions
the
an
considered
toward
the
million,
(($2,313)
is
real
54,930
{$2,891}
($1,557)
While
56,107
($1,935}
same
that
in
$980
however,reported
million.
a
real
total holdings of $105.286 billion or an average of $2.7
mean, and
sample
overall
real
reporting
indicate
that the
means
industry
averages
for
the
Therefore,
sample
mean for
sample
the
their
in
estate
both the
interest is that
result of
Another
billion.
those
holdings,
portfolio
substantially above
are
both
and
equity
to be
appears
the
mortgages.
biased
to
the
industry's largest portfolios, and thus conclusions from
the
may not
study
To the
portfolios.
measure the rate
survey, this
of
increases in
extent
since the Webb
could
Conversely, one
expect
that
first in
take place
sophistication might
a fund is
to
to an overestimation
With a greater amount of assets,
hired, and/or the
expert management can be
the best in
smaller
objective is
that the
sample bias may lead
the larger portfolios.
more able
inferred to
be
of change in attitudes
change.
that
logically
to conduct its own
research.
The
competition to provide effective services in this regard
drives
the
analysis higher.
compete for
of
level
for
sophistication
investment
Further, larger portfolios are able to
educated human
capital that
can implement
sophisticated investment techniques.
RESULTS
Several
of
the
survey
significance
to
presented by
Louargand (32}
{33}.
Some
results
industry practioners
of the
at the
analysis in
and
were
their
previously
MIT/PREA Institute
this section
draws on
that paper, however, much of it is de novo.
one
any
to
germane
Questions
is best
This
out the questionnaire.
scattered through
were
hypothesis
illustrated in the first hypothesis.
HYPOTHESIS 1:
Real estate portfolio managers have shifted from
to
tactical mentality
deal-based,
bottoms-up,
strategic top-down approach in allocating funds.
posed subliminal ideas as
of the survey
the
was
It
hypothesis.
as the
key
that
after
hoped
of
tests
the
respondent
a
oriented
technically
more
earlier,
the
reviewed
designed
were
survey
and
at the latter half of
Questions 16 and 20
forecasting.
to strategy in
diversification,
risks,
returns,
of
terms
the front-end
that were delivered at
Several questions
a
a
and honest answer would
questions, a more introspective
result for the two tests.
The second to the last question of the survey asked
formal, written
whether a
investing.
real estate
and 68% of those
answered
of 54%
responding).
portfolio
estate,
the
will be
these
similarly referred
to in
(of the total)
was used
affirmative
and [68%]
asked whether
Further, when
model
(Subsequently,
affirmative.
response percentages
the manner
total respondents,
of the
54%
respondents who answered the question,
the
in
used for
strategic plan was
to
allocate
response
was
(of those
any optimal
funds to
26%
real
[34%].
However, when asked if such a model was used to allocate
funds
estate asset
across real
13% [17%]
types, only
Only two respondents went on to provide a
indicated so.
model, while very
of the
descriptive title
than an unnamed
they used anything more
indicated that
few others
in-house model.
one
Certainly
of
basic,
the
implementing a strategic
initiatives in
professional
methodology of
investing is to formulate what your objective(s) is in a
descriptive market, what the
complex but
immediate and
strengths play in your favor,
long term goals are, what
your way.
and what barriers stand in
in this regard are encouraging,
While the results
one would also expect a
higher usage of quantitative, decision-making aids, such
as an optimal
portfolio model, to make
such as investing millions
very quantitative decisions,
of
dollars for
of various
a stream
what amounts to
cash flows.
ratios of the results are particularly interesting.
the allocation
optimize
real estate within
of funds to
Still
only half again use
their intra-real
provide further
to aid in
half again use a model
Only
asset portfolio.
One
the respondents utilize a written
half to two thirds of
strategic plan.
The
estate
a model to
holdings.
proof that the level
a mixed
This
may
of sophistication
in analysis of real estate in the portfolio context lags
that of stock equity and bond analysis.
literature
does not
reveal any
compare this test.
75
A search of the
benchmark in
which to
As a subset of
the strategic planning process, the
motivational goals for investing
of
the
pension
funds,
To
construct
contained
also
the
further
theory to real estate
this picture,
Question
14
represented goals, and respondents
posed a selection of
were asked to
in real estate equity.
but
applicability of modern portfolio
portfolios.
the
ascertain
understanding not only the strategic
This is helpful in
focus
to
attempted
also
questionnaire
rank all seven of them.
in Table
5,
and indicate
The results are
that real
estate
investments are driven by yields, with the most frequent
number one choices being
total expected return and cash
flow from operations.
TABLE 5
PERFORMANCE GOALS FOR THE REAL ESTATE EQUITY PORTFOLIO
(Listed in descending order by results)
Please rank your goals and/or preferences for your
equity real estate portfolio.
( 1 = most important ............
7 = least important )
Criterion
1
Total Expected 50
Return
Cash Flow
22
From Operations
Inflation
8
Hedging
Low/ Negative 18
Correlation with
Stock Returns
Potential for
5
High Appreciation
Residual Value 3
2
Ranking
3
4
17
21
8
1
0
1
1
22
16
7
10
7
9
2
22
14
14
12
19
4
3
11
11
7
5
9
30
6
9
15
19
21
10
12
6
10
15
19
18
20
8
6
5
6
Cum.
Rank
7
Risk Aversion
5
11
11
15
18
13
17
7
Other
2
0
1
1
0
0
1
8
76
estate ability
real
to be
that while researchers had found
anticipated inflation,
case for
the
primary goal of
survey showed that a
Nonetheless, this
real
unanticipated inflation.
lackluster against
estate was
In
against inflation.
hedge
to
Chapter 3 it was clear
this
has focused on
the most recent literature
Much of
the pension portfolio managers was this hedging ability.
of the literature
While much
estate's impact on a
was ranked
goal
respondents, but
two
importance
categories.
may reflect
That
returns.
29
the bottom
39 respondents in
also by
or
low
categories by
highest two
in the
This
achieving
of
stock market
correlation with
negative
on real
mixed asset portfolio, respondents
the
on
mixed
were
has also focused
the issue
that the
firms where the real estate
respondents are from larger
portfolio manager might not be as integrally involved in
asset allocation.
the decisions of mixed
The remaining
three characteristics show a fairly even distribution of
responses that show these goals to be important, but not
Perhaps most representative of
primary characteristics.
as
recognized
pension funds are
the fact that although
this group is
the
risk
most
averse
among
group
institutional investors, risk aversion is important, but
clearly takes a back seat
from the
under
to an overall expected return
investment itself.
OTHER,
versatility
of
most
the
Of those
sought
investments
significant goal.
77
responses listed
diversification
as
their
top
and
or
HYPOTHESIS 2:
become
managers have
Real
estate portfolio
sophisticated in their diversification strategies.
more
Diversification techniques have been the subject of
considerable
survey
in
study
1984,
indicates the
since
as
the
publication
discussed
desire on
real estate community to
in
of
Chapter
the part of
Webb's
3.
This
the institutional
further understand the concept
of an optimal portfolio that is efficiently diversified.
The application
of the
considered naive,
concept has
as portfolio
traditionally been
managers needed
not to
have "run any numbers" to know that property investments
in
different
regions
structures would
and
by different
uses
of
by definition be diversified.
the
As was
referred to in Chapter 3, Brueggeman, Chen and Thibodeau
(7)
along with
showed
that
Miles
there
unsystematic
risk
property types,
both
that perhaps
a
other region
or
levels
region
and
made a strategy
costly than
it needed to
of
within
of naive
be.
If
be found within
could certainly be found in
between regions.
my observation
any additional
quantitatively
enough
of unsystematic risk could
emerged from
were
high
within
any given region, then they
any
McCue {37),
were
diversification more
high levels
and
criteria
An issue
of this was
that should
that
whether there
be or
were
being used to more efficiently diversify the portfolio.
The issue
{49} study,
fact
had some basis for
comparison in Webb's
wherein respondents indicated that
diversified
by
geographic
78
region
they in
(61.9%)
and
property
on the
limitation
to
make
no
to the
amounts allocated
While
criteria of investment.
systematic
form of
used some
while 38.1%
type (61.1%),
different
a whopping 38.8% claimed
attempt
to
diversify,
the
sub-sample of just pension managers reported this figure
The latter was based on a small sample of
as only 5.9%.
17, however.
Table 6 shows the survey's unrestricted choice from
a set of
diversification criteria.
of geographic
and property criteria were
results are listed in
of
pension
A more
diverse set
offered.
The
comparison with Webb's sub sample
managers.
Respondents
could
select
any
number of the criteria that they felt they utilized.
TABLE 6
EXPLICIT DIVERSIFICATION CRITERIA IN EQUITY PORTFOLIOS
(Percentages are affirmative responses)
Do you use any of the following as explicit criteria for
diversification in your equity real estate portfolio?
Criterion
Webb
('82-83)
Survey Results
('90)
Property type
88.2%
85.3%
Property size
NA
69.6%
Property age
NA
16.7%
Tenant type or business
32.4%
Lease Terms
NA
30.4%
Fixed allocation
47.1%
4.9%
Region
94.1%
69.6%
State
NA
21.6%
37.3%
NA
Metropolitan area
Metropolitan sub-market
24.5%
Economic location
NA
39.2%
Other
NA
12.7%
No systematic
diversification
criteria are used
5.9%
There is
7.8%
a much larger group
property type,
and a smaller
concepts of metro
total
little change
lack
of
this category.
change in
terms of
and
This is
it
is closely
in the
must
be
38.1% who
in diversifying
followed
location
While
the most significant
the sophistication
using economic
recent concept
among pension managers
Webb's overall result showed
fell into
those
the recent
and economic location.
diversification criteria,
remembered that
portfolios,
group who use
and sub-metro differentiation, tenant
and lease diversification
there was
who diversify across
by
the size
criteria, a
in the literature, as
of
relatively
well as financial
diversification techniques.
Once
area of
interest, they were
top five
shown
portfolio managers
in
Table
7
along
with
These
the
to this
rank their
rankings are
raw
frequency
The results indicate that respondents are
between economic
appropriate way
Offered
later asked to
diversification criteria.
distribution.
divided
were conditioned
location
to achieve
a similar
set of
and
region as
the
locational diversification.
choices for
80
differentiating
between
properties,
Tenancy
characteristics
secondary or
large
they
for
but
constraints
this
as
property
property
size
as any
as
of
as
a fairly
a
portfolio
concepts
type.
strength
There was also
may reflect
much
with
demonstrated
lower criteria.
response
criteria,
stuck
secondary
allocation
performance
diversification.
TABLE 7
FREQUENCY DISTRIBUTION AND RANKING
OF DIVERSIFICATION CRITERIA FOR EQUITY PORTFOLIOS
(Listed in descending order by results)
Please rank your top five criteria
for diversification
in your real estate portfolio.
( 1 = most important ..............
5 = leastimportant)
Ranking
No
Cum.
Criterion
1
2
3
4
5
Response Rank
------------------------------------------------Property type
22
9
5
0
6
1
Economic
location
Region
.3
17
21
32
3
.2
32
14
74
3
Metro area
7
11
11
55
4
Property size
0
12
16
71
5
Tenant type
1
5
11
29
6
State
0
1
6
72
7
Lease terms
2
3
8
40
8
Metro submarket
Property age
1
6
6
50
9
1
3
3
59
10
Other
8
1
2
81
11
None
2
0
0
90
(Don't use any criteria for diversification.)
12
81
It appears that the concepts raised in the literature in
few years are
the past
across financial and occupancy
fairly fast
diversification
attention to
increased
If so,
rate.
being adopted at a
variables may be a trend
for the future that has already begun.
HYPOTHESES 3:
adopted
portfolio managers have
Real estate
sophisticated techniques for return measures.
more
It was pointed out under the first hypothesis that
returns.
To
comparisons.
after
tax
invoked for
once again
Webb compared both
a
that
tax
the after
of
pattern
clearer
its historical
before tax, as well as
reasoned
measures and
showed
measures
hypothesis, Webb's
assess this particular
{49} is
survey
are targeted at
of the pension funds
the primary goals
progressive
sophistication of techniques away from rules of thumb to
the more quantitative comparability of net present value
For the purposes of this
and internal rates of return.
hypothesis, no tax distinctions were made, but the wider
variety
of choices
reflect
Webb's
additional
in Question
after
tax
derivatives of
17e, were
measures as
designed to
those measures.
strictly comparable, the results
as
well
some
Though not
in Table 8 demonstrate
a marginal improvement in the level of sophistication in
the
intervening
particularly true,
years
since Webb's
if it can
study.
be assumed that
This
is
users of
partitioned IRR's, FMRR's, and Annualized Holding Period
Returns
(HPR's)
have
at
least
the
same
level
of
comprehension as
that for
the Internal Rate
of Return
(IRR).
TABLE 8
TECHNIQUES FOR MEASURING REAL ESTATE RETURN
(Grouped in descending order of results)
What attributes do you use in monitoring your real
estate performance?
PERCENT RESPONSE
Survey Results
MEASURE
WEBB
Internal Rate
of Return (IRR)
65%
61%
Holding Period
Return (HPR)
NA
10%
Risk Adjusted
Return
NA
5%
Partitioned IRR
NA
3%
Financial Managem't NA
Rate of Return (FMRR)
1%
Cash on Cash
63%
45%
Net Present Value
48%
11%
Payback Period
26%
1%
Discounted Payback
NA
3%
Broker's Rate of
Return
21%
2%
If the
this sample
previous assumption
can be
shows that
such measures
80% use
versus 65% in the early 1980s.
in the
fact that only
cash compared to 63% in
45% of
accepted, then
of IRR,
A parallel shift is seen
the sample uses
cash on
Webb's sample; and that only 2%
reported using a Brokers Rate
of Return (After Tax Cash
Flow +
Equity Buildup / Ini tial
sample reported
the
Equity) whereas Webb's
A sim ilar decrease
21%.
the Payb ack
statistic for
Period.
is evident in
These
changes
indicate an increasing level* of sophistication the part
of real
estate
estate managers, anid a tendency to
performance in
the
financial analysts look at
same
treat real
way that
traditional
portfolios of securities and
bonds, or capital budgeting projects.
HYPOTHESIS 4:
Real estate
portfolio managers have
adopted
sophisticated techniques for risk measures.
In
order to
question was
test
this
replicated.
more
hypothesis, Webb's
exact
An interesting aspect
of his
study was the division of statistics reported separately
for pension
managers and
well as compositely.
this
survey, and
with
Webb's
life insurance
Table 9
Table 10
companies, as
reports on the results of
consolidates these
results, both
overall
and
results
for just
the
pension managers.
There were
two additional
questionnaire that
measures added
directly relate to
theory: Mean/Variance and
in this
modern portfolio
Beta coefficients.
Taken all
together, there are two striking changes in the results.
The first
is the
significantly consistent lack
specific
adjustment
managers.
There
population
which treats
for
appears
risk
to
return
84
by
be a
one
out
component
and risk
of any
of
in
five
the
intuitively.
TABLE 9
RISK ADJUSTMENT TECHNIQUES IN EQUITY PORTFOLIOS
(Percentages of Affirmative Responses)
How do you adjust for riskiness in your analysis of
equity real estate investments?
(Respondents checked only those that applied.)
TECHNIQUE
OFTEN SOMETIMES
Adjust upwards the
return req'd
from the project
43.1
12.7
Adjust downward the
benefits expected
16.7
from the project
SELDOM
NEVER
2.9
5.9
10.8
10.8
8.8
0.0
5.9
14.7
Use Sensitivity
analysis
48.0
Use Probability
distributions
4.9
13.7
6.9
21.6
Use Mean/Variance
analysis
6.9
2.9
11.8
28.4
Use Beta
coefficients
2.9
2.0
3.9
38.2
Other
8.8
No explicit risk
adjustment is made
22.5
TABLE 10
COMPARATIVE RESULTS OF RISK ADJUSTMENT TECHNIQUES
TECHNIQUE
WEBB
SURVEY RESULTS
TOTAL
PENSIONS
PENSIONS
Increase Return
71%
82.3%
55.8%
Decrease Benefits
40%
52.9%
31.4%
29.4%
56.8%
Sensitivity Analysis 21%
Probability Distr.
18%
5.9%
Mean/Variance
NA
NA
9.8%
Beta Coefficients
NA
NA
4.9%
No risk adjustment
21%
5.9%
No response
18.6%
22.5%
43.1%
85
Another
as a viable tool for
acceptance of sensitivity analysis
Responses that this technique was used
risk adjustment.
this
one.
of these
answer any
on
for
risk; and
the
adjustments
(i.e.
choices
in this survey
were used
results are
perhaps even
for
the
also indicate
MPT practices.
of some implementation of
the beginning
The
reliance
adjusting
question) that
Certainly these
stronger
methods in
quantitative
additional
much
not to
those chose
question at all.
a
indicate
results
Many of
real estate.
with equity
these
of 102 respondents
based on the sample
percentages are
out that
be pointed
should also
It
48% in
survey to
13% in Webb's
from about
OFTEN rose
the
1980's is
the
during
perceptible change
given the
more dramatic
large part of the sample that chose not to answer any of
the questions.
HYPOTHESIS 5:
Real estate portfolio managers measure their performance
estate market
mixed asset and real
against both
indices.
This hypothesis represents an expectation that
is based
performance measurement
(CAPM), and
pricing model
the
application
estate.
13 and
In
of
on the
thus is further
modern portfolio
order to test this,
17, were surveyed
capital asset
evidence of
to
theory
real
two questions, numbers
which would indicate
the use
and reliance on significant investment indices.
A
robust
monitored their
83.5%
of
the
respondents
said
real estate performance against
86
they
a real
a mixed
7.2% used
used, and
index was
stock equities
27.8% indicated that a
#1.
more credence to Hypothesis
even
plan, providing
strategic
under their
benchmark
written
formal,
a
done against
was
monitoring
such
followed by 49.5% who indicated
This was
estate index.
asset index like the B B & K to monitor performance.
particularly
it was
mind
in
these results
With
surprising to discover the results of Question 13, which
respondents believed that
asked whether
the FRC/NCREIF
Index approximates
the actual volatility of
estate portfolios.
Only 30.5%
said
said it did, while 17.9%
This
all.
index at
use the
they didn't
their real
latter
figure is relatively consistent
with the results in the
However, a
full 51.6% indicated an
previous paragraph.
explicitly
managers
index
response.
(most of
that
whom
indicated it
the majority
such
an
7
about
If
results against
monitor their
one), and
faith
negative
out of
a real
was the
8
estate
FRC/NCREIF
of the respondents
have little
their
portfolios'
index
models
volatility, then the industry still has data problems to
sort out,
if it
uses a
doesn't match its needs.
standard of
performance which
Nonetheless, the data clearly
shows that the important concept
of a market index as a
tenant of modern portfolio theory, has gained widespread
use throughout the industry.
Two additional questions were
asked that relate to
the hypotheses on diversification, risk, and this one on
performance
evaluation.
Questions
87
18 and
19 surveyed
the
of
attitudes
relative risk
equity
real estate
managers
and diversifying benefits of
compared to
indices.
portfolio
the
more
The results which are
on
real estate
widely recognized
stock
listed in Tables 11 and
12 indicate that the vast majority of portfolio managers
feel
that
correlated
their
portfolios
with stock
are
low
market returns,
than a market index of
stocks.
to
negatively
and less
risky
This is consistent with
the finding of Elebash and Christiansen (12) that 79% of
state
pension
funds
find
real estate
equity
to
be
attractive because it adds diversification benefits to a
mixed asset portfolio.
TABLE 11
RELATIVE CORRELATION OF REAL ESTATE TO A STOCK RETURNS
(Percentages of Affirmative Responses)
Negatively Correlated
30.9%
Not
Correlated
40.2%
Mildly
Correlated
32.0%
Highly
Correlated
0.0%
TABLE 12
RELATIVE RISK OF REAL ESTATE EQUITY PORTFOLIO
TO A STOCK MARKET INDEX
(Percentages of Affirmative Responses)
Much Less Risky
24.0%
Somewhat Less Risky
55.2%
About As Risky
8.3%
Somewhat More Risky
Much More Risky
11.5%
1.0%
88
HYPOTHESES 6:
Real estate holding periods have increased in the
face of several negative market factors over the last
seven years.
The financial
late
markets in the United
1980's witnessed
experienced prior
been
a
a
to that
period
of volatility
time.
significant change
in
States in the
Since 1986
the
seldom
there has
capital gains
tax
regulations, two seismic collapses of the stock equities
market, a
the
significant faltering
result of
yielding,
low
significant,
of the bond
proper regulatory
grade
"junk"
market as
intervention in
bond
multi-regional real
financing,
estate bust
high
and
a
that has
resulted in a financial debacle in the banking industry.
One of
the benefits
of real estate
equity investments
that rewards
investors for its relative
the inherent
shelter from dramatic capital
occur with
While not
have
financial dislocations.
all of these recent,
negative market factors
real estate,
estate
swings that
sudden economic and
necessarily impacted
grade
illiquidity is
it
all
types of
has given
portfolio managers
to
pause
reassess
institutional
to many
some of
real
their
underlying assumptions about the various types of assets
they hold.
One
holding
of these
period which
confirmed.
Whereas
possibilities
increased
assumptions
the
of
every study
Webb
longer
number
has been
was
holding
of choices
the ten
up through
concerned
periods,
to
reflect
year
Webb has
with
and
the
thus
holding
periods
out to
answer open
that
in
40 years,
ended.
Rationally
holding periods
light
of
markets.
Of
the
this questionnaire
would
it would
have appeared
have marginally
extreme volatility
the 88
left the
who responded
in
increased
the
to Question
capital
10, 53
chose a single figure, the distribution for which looked
as follows:
5 years .....
3
7 years .....
2
10 years ..... 46
15 years .....
2
Of
the 36
who reported
period, the distribution is
shows the
mean for the
years, with a
a range
for the
catalogued in Table 12.
front end
of the range
median of 7 years and a
At the
back end of
with a
mode and
the range,
mode of
holding
as 6.5
mode of 5 years.
the mean is
10 years.
It
11.4 years
Graphically, this
conveys the idea that perhaps holding periods have begun
to
decrease for
indeterminate reasons.
The range
significant between 6.5 and 10 years.
TABLE 12
FREQUENCY DISTRIBUTION OF HOLDING PERIODS
FOR THOSE RESPONDENTS SPECIFYING A RANGE
YEARS
FRONT END
RESPONSES
YEARS
FAR END
RESPONSES
----------------------- I---------------------1
1
|
5
1
3
2
|
7
2
5
13
|
10
21
7
11
|
15
10
10
8
20
1
90
is
As was
periods
pointed by
a few respondents,
vary depending
on the
type of
the holding
property held.
While this is certainly true enough, it is of particular
interest that 20 years
and it
was from
observations
it
marginally begun
could
be
was the maximum figure mentioned
only one
respondent.
appears
that
to decline.
that this
sample
maintain
"core"
"trophy"
properties, has
tracking the
are
holding
One
of
properties,
Thus,
from all
periods
have
possible explanation
larger investors,
often
referred
who
to
as
become more
sophisticated in
cyclical nature of their
core markets and
responding
to
that
cycle
accordingly
interests of
profits and increasing
is, however,
no data from
in
efficiency.
this survey to
the
There
support this
contention.
HYPOTHESIS 7:
Real estate portfolio managers have increased their
investment horizons by searching and investing in a
global real estate market.
For this
final hypothesis Webb again
baseline of data for
results
Again,
of this
his
comparison.
survey,
results
Table 13 provides the
along with
are
supplies the
tabulated
those of
in
an
Webb's.
overall
institutional sense, as well as for the pension managers
separately.
91
TABLE 13
INTERNATIONAL REAL ESTATE EQUITY INVESTMENTS
(Frequency of Explicit Responses)
SURVEY RESULTS
PENSIONS
WEBB
COUNTRY
PENSIONS
TOTAL
N.AMERICA
CANADA
MEXICO
PUERTO RICO
14
2
0
1
0
0
9
1
1
EUROPE
UNITED KINGDOM
FRANCE
BELGIUM
ITALY
SPAIN
OTHER
2
2
0
0
0
0
0
0
0
0
0
0
5
1
1
1
1
1
PACIFIC RIM
AUSTRALIA
JAPAN
HONG KONG
SINGAPORE
4
0
0
0
0
0
0
0
2
1
1
1
the results do show a
Considering the sample size,
substantial increase in
estate
since
investment.
the survey,
toward the
102, only
interest for international real
This
as
is
particularly
pointed out
largest portfolios.
earlier, is
Of this
13 indicated they held
noteworthy
biased
population of
property or mortgages
in other countries, while 86 explicitly stated that they
did
not.
However,
of the
86 that
did not
invest in
property elsewhere, 18, or 21%, indicated that they were
actively considering that possibility.
Webb
cited
several
internationally was not
reasons
attractive.
why
investing
These included the
issues
of political
risk,
foreign exchange
problems,
legal problems, lack of expertise, and tax consequences.
He
felt
also speculated
that
there
that
were
institutional investors
plenty of
real
estate
also
equity
opportunities right here in the
U.S., that they did not
do business internationally, or
that rent controls were
stricter elsewhere, thereby limiting the opportunity for
increased cash flow (#2 investment criteria).
was made
in this questionnaire to
between the decision to
An effort
test the correlation
invest overseas and maintaining
a business office there.
There were
they
30 different respondents
either held
property
considering doing
they
had
a
so.
physical
overseas
Of those, 15,
presence
affiliation in those countries.
wrote personal
notes on
or
who indicated
or were
actively
or 50%, indicated
formal
ownership
Many of the respondents
the return
questionnaire that
indicated this was indeed significant in their decision.
It is also noted that
cited by Webb,
many of the reasons formerly
are similar to those heard
for the lack
of significant investment in equities and bonds overseas
between a decade
and two decades ago.
indication
of
techniques
of analysis
the
general
investment communities.
lag
in
between real
This is another
adoption
estate and
of
new
other
CHAPTER 6
CONCLUSIONS
The
rate
management
of
attitudes
instantaneous.
information
into
change
the
about
Only
arrive
and
is
theoretical
become
in
adjust to
expectations.
This survey
managers
adopted
real
from
does
absorbed
time.
new ways
ways of
estate risk and performance
far
markets
illustrates that
new
portfolio
homgeneously
process
longer to
have
institutional
real estate
in
expectations
markets take
in
Real
of forming
portfolio
looking
at
during the 1980s.
real
The rate
at which they have made
these changes is perhaps slower
than might be expected,
but the change demonstrates the
process of maturation and sophistication taking place in
the institutional real estate industry.
The
eighty three
pension sponsors
and forty
two
advisory management firms that
responded to this survey
represent
of
the
for
real
a
cross
section
participants
in
investment.
The results
show that
implement
their real
substantially
in
a
strategic
property
determined
within
the
sense,
the
by
the
structure.
attention, however,
Naive
although
real estate
largely
individual deal
terms of
market
to the
of
estate
estate
the
portfolio
are paying
analysis of these
the
equity
real
investment
acquisition
attractiveness
They
capable
portfolio managers
refinements in techniques
diversification
most
is
of
still
of
the
much more
deals in
of diversification.
estate
portfolio
by
solely
tenant type,
such as
other considerations
yielding to
are
region
geographic
and
type
property
property size and economic location.
Real estate portfolio managers have also noticeably
improved upon the level of refinement for assessing both
The use of the
return and risk, separately and jointly.
of the internal rate of
basic and more complex variants
along
return,
quantitatively
in
significant
this
more
are far
analyses,
and sensitivity
mean/variance
of
simulations
type
Monte Carlo
with
regard
than
the
subjective adjustments of returns to compensate for risk
that
considered
jointly,
respondents
are
used in
been
prevalently
had
results
the
demonstrates a
When
show -that
most
estate
real
in terms of market indices,
portfolio's return and risk
which
their
analyzing
past.
the
clear conceptual
leap, if
not a
practical one, to a major tenant of portfolio theory.
There are nonetheless some surprises in the results
that run counter to certain expectations as the industry
emerged
from the
Despite
1980s.
the extremely
short
term volatility of the national capital markets, wherein
held to be
for real estate were
longer holding periods
virtuous, respondents indicated a slight change in their
horizons from
more
likely between
investors in
have
for
a longer, 10-plus year
7
to 10
fixed income
looked increasingly
further benefits
of
years.
preference to one
While
securities and
to the
portfolio
stock equity
international markets
diversification, real
95
estate
portfolio
nonetheless that
results show
ivestment in the
begun to
eight
belief
that
market
is
investors
may
This
years.
the
sufficiently
It may just
to
lend further
evidence to
real
inefficient, so
as
lag
to
the
estate
allow
reaping profits
necessity of looking elsewhere.
also demonstrate another factor
twenty year
the last
global market over
opportunities for
without the competitive
have
pension funds
multi-faceted, domestic
plenty of
to
arena to any significant degree.
participate in such an
The
committed
apparently not
have
managers
condition within
of the ten
the real
estate
community toward adopting
more sophisticated techniques
of analysis in comparison
with other capital markets on
Wall Street.
96
APPENDIX A
MASSACII LUS ETTS INST1ITUTE OF TE()I:II"(INoIDGY;N
CENTER FOR REAL ESTATE DEVELOPMENT
Building W31-310
Cambridge, Massachusetts 02139
Telephone: (617) 253-4373
Fax: (617) 258-6991
May 1, 1990
Dear Investment Professional:
We are conducting survey research into the current state of real estate portfolio
management. The Center for Real Estate Development in conjunction with the
Pension Real Estate Association (PREA) is undertaking an annual Real Estate
Institute to be staged here at MIT each June. This year's curriculum focuses on
real estate portfolio management. We ask that you participate by returning the
enclosed questionnaire to us by May 31, 1990. All responses will be used in
aggregate form only, and no organization or firm will be identified in any way. No
data will be reported in a form which would allow identification of its source. In
addition to its use in our curriculum, we expect that our survey results will be
reported in a journal widely circulated in the industry.
The questions are designed to replicate part of the survey done by James Webb in
1982 in which you may have participated. We hope to be able to identify the
evolution of portfolio management practice by comparing these results over time.
We have selected you as the person in your organization most likely to be able to
provide the answers to our questions. If you believe that someone else could
respond more fully, please pass the survey on to them and ask that they return it
to us. Feel free to call me at either of the numbers below if you have questions
about the survey. You may fax the completed survey to me at my fax number
shown below or return it in the enclosed envelope.
We would appreciate your firm or organization identification on our survey form
so that we can track our responses. We reiterate that no information will be used
in any way which could identify your organization in the presentation of our
results. We will return a summary of our results to you by the end of June if you
identify your organization.
Thank you very much for helping us to gain insight into current portfolio
management practices.
Sincerely,
Marc Louargand
617-253-3988
508-371-1169
508-371-1169 FAX
MIT CENTER FOR REAL ESTATE DEVELOPMENT
INSTITUTIONAL PORTFOLIO SURVEY
Organization Name:
1.
Is your organization a: pension plan sponsor _
_
other
2.
investment advisory firm _
specify)
no
If not, please stop here and return the survey in
Do you hold real estate in your portfolio? yes _
the envelope provided. Thank you very much for your participation.
the approximate value of your real estate portfolio?
3. What is
4.
(please
$
equity $_mortgages
Do you use any of the following as explicit criteria for diversification in your equity real estate
portfolio?
a.
a.
h.
k.
m.
property type
_
f.
state
b. property age _
g.
_
metropolitan area
_
c.
property size _
d. region _
metropolitan area sub-market
j. lease terms
i. tenant type or tenant business
economic location
1. no systematic diversification criteria are used
fixed allocation by category
other
5.
Do you now hold property or mortgages on property in other countries?
property:
yes_
no __
mortgages: yes _ no _
6.
If you answered "no" above,
property: yes_
no
7.
If you answered "yes" to question 5, in what countries do you have investments?
property:
mortgages:
8.
If you answered "yes" to question 5 or 6, does your organization maintain a physical presence or a formal
ownership affiliation in any other country? (e.g., branch office, sdbsidiary, joint venture partnership
If yes, in which countries?
no
entity, etc.) yes_
9.
How do you adjust for riskiness in your analysis of equity real estate investments? (check those that
apply)
Never
Seldom
Often Sometimes
a. Adjust upwards the return
are you actively considering acquisitions in other countries?
mortgages: yes _ no _
required from the project
b. Adjust downwards the benefits
expected
c.
from the project
Use sensitivity analysis
d. Use probability distributions
e.
Use Mean/Variance analysis
f. Use Beta coefficients
g.
Other
methods
(
please
specify)
h. No explicit risk adjustment is made
10. When evaluating equity real estate investment proposals, on what holding period ("time horizon") do you
years
usually base your analysis?
11. Do you use formal forecasts of GNP growth, inflation, and other macroeconomic activity in your investment
decision-making process? (please check those that apply)
a. In-house economist's forecasts
b.
D.R.I.
c.
WEFA
d. Other service (please identify)
e. No formal forecasts are used
12.
Do you use any real estate market forecasting services?
a.
13.
yes
_
b.
please identify
Do you believe that the Frank Russell Company Index (FRC)
estate portfolio? a. yes
_
b. no
e.don't
no
approximates the actual volatility of your real
use the FRC Index
over +
14. On a relative scale, please rank your goals and/or preference@ for your equity real estate portfolio. (rank
from 1 - most important to 7 - least important)
a. cash flow from operations
b. residual value at end of holding period
c.
d.
expected return
total
inflation hedging
a. risk aversion
f. low or negative correlation with stock market returns
g. potential for high appreciation
h.
(
other
please
specify)
15. Please rank your top five criteria for diversification in your real estate portfolio. (1 = most important
5
least important)
a. property type
b. region
c. state
d. metropolitan area
e.
metropolitan area sub-market
f. economic location
g. age of property
h. size of property
i.
J.
tenant type or tenant business
lease terms ( maturity, etc.)
k.
other
(please
specify)
1. don't use any criteria for diversification
16. Do
a.
b.
If
17.
you use any "optimal portfolio model" to help you:
yes
no
Allocate funds to real estate
yes __ no
Allocate funds across real estate asset types
so, does the model have a name or descriptive title?
How do you monitor your equity real estate portfolio's performance? (please check all that apply)
(S&P500, Wilshire 5,000 etc.)
a. versus stock market indeg
(FRC, Liquidity Fund, etc.)
b. versus real estate index
(BB&K, etc.)
c. versus mixed asset index
d. versus strategic plan benchmarks (formal written targets)
e. versus performance attributes:
discounted payback
payback _
broker's rate of return _
cash-on-cash return
Net Present Value
Internal Rate of Return (IRR)
Financial Management Rate of Return (FMRR)
annual holding period return (HPR) _
_
partitioned IRR _
risk-adjusted performance measure
18. Do you think that your equity real estate portfolio returns are:
negatively correlated with stock market returns
not correlated with stock market returns
mildly correlated with stock market returns
highly correlated with stock market returns
19. Do you think that your equity real estate portfolio is:
much less risky than a market basket of stocks (an index portfolio)
somewhat less risky than a market basket of stocks
about as risky as a market basket of stocks
somewhat more risky than a market basket of stocks
much more risky than a market basket of stocks
20. Do you have a formal (written) strategic plan for real estate investing?
yes _
no
21. What is your primary source of strategic advice for real estate investing?
a.
in-house staff
b. investment advisory firm _
c.
consultants
d.
other
please specify)
please return to Marc Louargand/ MIT-CRED/ W31-310/ Cambridge, MA 02139
or fax both sides to 508-371-0521 Thank you for your response.
REFERENCE BIBLIOGRAPHY
{ 1) Anon.
Mega-Shifts. The Institutional Real Estate
Letter, Vol 1, #12, December 1989, pp.1-9.
{ 2) Anon.
"Over There". The Institutional Real Estate
Letter, Vol 2, #3, January 1990, pp.1-9.
{ 3) Anon.
The Trouble with Real Estate. The
Institutional Real Estate Letter, Vol 2, #4, April
1990, pp.1-7,18-20.
{ 4) Anon.
Special Issue: The Largest Money Managers.
Pensions & Investments, Vol 18,#10, 21 May 1990,
pp.1-96.
{ 5) Anon.
Special Report: The 1,000 Largest Pension
Funds. Pensions & Investments, Vol 18,#2, 22
January 1990, pp.16-68.
{ 6) Black, F. and Scholes, M. The Valuation of Options
Contracts and a Test of Market Efficiency.
Journal of Finance, May 1972, pp.399-417.
The
{ 7) Brueggeman, W.; Chen, A.H.; and Thibodeau, T.G.
Real Estate Investment Funds: Performance and
Portfolio Considerations. AREURA Journal, Fall
1984, pp.333-345.
{ 8) Brueggeman, W.; Fisher, J.D.; and Stone, L.D.
Estate Finance, 8th ed.
Chapter 23.
Real
Boston:Irwin, 1989,
{ 9) Cole, R.; Guilkey, D.; Miles, M.; and Webb, B. More
Scientific Diversification Strategies for
Commercial Real Estate. Real Estate Review,
Spring 1989, pp.59-66.
{10)
Conroy, R.; Miles, M.; and Wurtzebach, C.H. A
Practical View of Real Estate and Modern Portfolio
Theory. Industrial Development, Vol 155, May/June
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