The Tale of Two Markets:
A Comparison of Performance between Class A Properties in Secondary Markets and
Class B Properties in Primary Markets
by
Omer Katz
M.B.A. in Finance, 2009
B.A. Accounting & LL.B. in Law, 2007
Tel-Aviv University
And
Kailash Gupta
M.S. Accounting & Taxation, 2008
B.S. Accounting, 2006
Florida Gulf Coast University
Submitted to the Program in Real Estate Development in Conjunction with the Center for Real Estate in
Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate Development
at the
Massachusetts Institute of Technology
September, 2014
©2014 Omer Katz and Kailash Gupta
All rights reserved
The authors hereby grant to MIT permission to reproduce and to distribute publicly paper and electronic
copies of this thesis document in whole or in part in any medium now known or hereafter created.
Signature of Author_____________________________________________________________________
Omer Katz
Center for Real Estate
July 30, 2014
Signature of Author_____________________________________________________________________
Kailash Gupta
Center for Real Estate
July 30, 2014
Certified by____________________________________________________________________________
Walter N. Torous
Senior Lecturer, Center for Real Estate
Thesis Supervisor
Accepted by___________________________________________________________________________
Albert Saiz
Chairman, Interdepartmental Degree Program in Real Estate Development
The Tale of Two Markets:
A Comparison of Performance between Class A Properties in Secondary Markets and
Class B Properties in Primary Markets
by
Omer Katz
&
Kailash Gupta
Submitted to the Program in Real Estate Development in Conjunction with the Center for Real Estate on
July 30, 2014 in Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate
Development
ABSTRACT
As the number of investors in real estate expands and current investors increase their target allocations,
we can expect to see a substantial increase in the investment pace in real estate for institutions. Investors
seeking high yields have been shifting their focus away from core investments due to high prices and
resulting low yields, and have started to look beyond core properties and core markets for opportunities.
This thesis examines the historical performance of Class A buildings in secondary markets and Class B
buildings in primary markets from 2005 to 2013. Historical performance data is used from NCREIF, and
the CoStar database is used to classify each property as Class A or Class B. Through this study we hope
to shed some light on the importance of location and asset type (Class A or Class B buildings) as
determinants of returns in commercial real estate investments.
An analysis of our empirical findings, on an aggregated basis of an entire real estate cycle (2005-2013),
indicates that while office and multifamily properties have demonstrated similar behavior throughout the
cycle, this has not been the case for industrial properties. In the case of office and multifamily properties,
Class B buildings in primary markets have outperformed Class A properties in secondary markets and the
NCREIF NPI. As opposed to these distinct results, in the case of industrial properties, Class A buildings
in secondary markets have outperformed Class B properties in primary markets and the NCREIF NPI.
One explanation for this unpredictable behavior might be associated with the substantial economic and
physical differences of industrial properties, specifically when compared to office and multifamily
properties. Another possible explanation of this result has to do with the relatively small size of NCREIF
data on industrial properties, and, consequentially, the industrial property data in this thesis was
comprised of merely 93 industrial properties.
Based on the overall empirical findings of our study, a savvy real estate investor, who is dedicated to
maximizing his long run returns, would be better off investing in office and multifamily properties in
primary markets, and in industrial properties in secondary markets.
Thesis Supervisor: Walter N. Torous
Title: Senior Lecturer, Center for Real Estate
The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 2 Real Estate Development TABLE OF CONTENTS CHAPTER 1: INTRODUCTION ................................................................................................................... 4 CHAPTER 2: LITERATURE REVIEW ............................................................................................................ 7 MODERN PORTFOLIO THEORY ............................................................................................................................. 7 DIVERSIFICATION WITHIN REAL ESTATE ............................................................................................................... 10 CHAPTER 3: METHODOLOGY AND DATA ............................................................................................... 14 NCREIF DATABASE .......................................................................................................................................... 14 COSTAR DATABASE ......................................................................................................................................... 15 CLASS A AND CLASS B BUILDINGS ....................................................................................................................... 16 PRIMARY AND SECONDARY MARKETS ................................................................................................................. 17 TIME PERIOD ................................................................................................................................................. 18 PROPERTY TYPES ............................................................................................................................................ 18 CHAPTER 4: PORTFOLIO CONSTRUCTION .............................................................................................. 19 CHAPTER 5: DATA ANALYSIS ................................................................................................................. 22 OFFICE BUILDINGS: ANALYSIS OF PERFORMANCE .................................................................................................. 23 Growth Phase (2005-­‐2007) ................................................................................................................... 24 Trough Phase (2008-­‐2010) ................................................................................................................... 28 Recovery Phase (2011-­‐2013) ................................................................................................................ 32 Combined Period (2005-­‐2013) .............................................................................................................. 36 MULTIFAMILY BUILDINGS: ANALYSIS OF PERFORMANCE ......................................................................................... 37 Growth Phase (2005-­‐2007) ................................................................................................................... 38 Trough Phase (2008-­‐2010) ................................................................................................................... 42 Recovery Phase (2011-­‐2013) ................................................................................................................ 46 Combined Period (2005-­‐2013) .............................................................................................................. 50 INDUSTRIAL BUILDINGS: ANALYSIS OF PERFORMANCE ............................................................................................ 51 Growth Phase (2005-­‐2007) ................................................................................................................... 52 Trough Phase (2008-­‐2010) ................................................................................................................... 55 Recovery Phase (2011-­‐2013) ................................................................................................................ 58 Combined Period (2005-­‐2013) .............................................................................................................. 61 CHAPTER 6: SUMMARY AND CONCLUSION ........................................................................................... 62 LIMITATIONS AND SCOPE FOR FURTHER RESEARCH .............................................................................. 64 BIBLIOGRAPHY ...................................................................................................................................... 65 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 3 Introduction: A recent survey by Kingsley Associates and Institutional Real Estate, Inc. noted that institutional investors who invest in real estate target an average of 10.3% of their portfolio to the sector in 2014, as compared to 9.8% in 2013, and 8.8% in 2012. In 2014, the overall target allocations to real estate are expected to increase by an average of 52 basis points (bps). Approximately 38% of institutions expect to increase their target allocations in 2014, and on average these institutions expect to increase their target allocation by 157 bps. (Cornell University and Hodes Weill & Associates, LP) A recent survey by Cornell University and Hodes Weill & Associates, LP indicated that apart from institutional investors increasing their overall portfolio allocation to real estate investments, most institutions are currently under-­‐invested relative to their overall target allocation. There has also been an increase in the number of real estate investors in the form of Real Estate Investments Trusts (REITs), sovereign wealth funds, pension funds, insurance companies, and high net worth individuals. Therefore, we can expect to see a substantial increase in the investment pace in real estate for institutions over the coming years as the number of investors in real estate expands and current investors increase their target allocations. Since the Global Financial Crisis, investors seeking high yields have been shifting their focus away from core investments due to high prices and resulting low yields, and have started to look beyond core properties and core markets for opportunities, which can offer higher risk adjusted returns over the long run. This study aims to provide guidance to institutional real estate investors in answering the question: Are there core markets and core asset types? We will do so by comparing the performances of Class A buildings in secondary markets and Class B buildings in primary markets. Furthermore, this study will establish the importance of location (defined as primary or secondary markets) and asset type (Class A or Class B buildings) as determinants of returns in commercial real estate investments. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 4 Diversification of real estate is typically achieved by blending properties across different geographic regions and property types. However, we believe that a well-­‐diversified portfolio of real estate should mix properties across these two broad categories. The main focus of this study is to determine if there are differences in returns between the two strategies (investing in Class A buildings in secondary markets and investing in Class B buildings in primary markets) and if investment managers should prefer one strategy to the other based on the impact of location and asset type on long run investment performance. For this, we will create two sets of custom portfolios consisting of Class A properties in secondary markets and Class B properties in primary markets. However, by comparing the historical returns of these custom portfolios alone will provide no insight related to investment decisions, as returns should never be viewed separately from risk (Pai and Geltner). To address this issue, we will use the historical property level data from NCREIF and compare their performance by calculating their Sharpe ratios. The Sharpe ratio, named after William F. Sharpe, who shared the Nobel Prize for portfolio theory, is the risk premium of an investment divided by the risk (volatility), and is considered a natural measure of risk-­‐adjusted returns. Capital Asset pricing models (CAPMs) allow investors to more accurately measure investment performance by adjusting portfolio returns to control for risk (Geltner and Miller). Beta represents the systematic risk, which cannot be diversified away and which determines the risk-­‐adjusted returns of an investment. In general it seems to be more difficult to apply the CAPM within asset classes than across them. This is true not only for real estate, but also for the stock market. The CAPM does not explain much of the variation in ex-­‐post returns across portfolios of individual stocks within the market (Geltner & Miller). Eugene Fama and Kenneth French expanded the traditional CAPM to include in addition to the market beta factor, two new risk factors as determinants of the expected return. In this study we shall follow Fama and French by introducing two factors, i.e., location (primary or secondary market) and The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 5 asset type (Class A or Class B) to better understand the correlation between the two factors and the long run return performance of real estate investments. This thesis begins with the description of the relevant literature of concepts and theories applied within this paper and specifies the objective of this study in more detail. The next section introduces the various sources of data and the data itself along with the methodology used to create the custom portfolios. This section also discusses and concludes on the results of the performances of the custom portfolios by comparing, among others, their Sharpe ratios. The last section summarizes and concludes the study describing the relevance of the various investment strategies and the impact of factors such as location and asset type on long run investment performance. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 6 Literature Review: Modern Portfolio Theory began in 1952 with the publication of an important article by Harry Markowitz. Markowitz was the first researcher to prove the old saying, “Don’t put all your eggs in one basket”. Markowitz introduced how we could measure the benefits of diversification. He was the first to develop a specific measure of portfolio risk and to derive the expected return and risk of a portfolio. The Markowitz model generates the efficient frontier of portfolios and investors are expected to select a portfolio, which is most appropriate for their risk and return preferences, from the efficient set of portfolios available to them. Sharpe (1966) developed a computationally efficient method, the single index model, where returns on an individual security are related to the returns on a common index. The single index model can be extended to portfolios as well. This is possible because the expected return on a portfolio is a weighted average of the expected returns on individual securities. In 1966, Sharpe introduced the Sharpe ratio, which measures the portfolio performance on a risk-­‐adjusted basis. The Sharpe ratio is calculated by dividing the risk premium by the risk or volatility. The numerator of the Sharpe ratio measures the investor’s compensation for risk, and the denominator is the amount of risk in the investment as measured by its standard deviation. Mathematically, the Sharpe ratio is calculated as below: Sharpe, W. F. (1966). Mutual Fund Performance. Journal of Business SRi = (ui – rf ) /si Where, •
SRi = Sharpe Ratio of portfolio •
ui = Average return on the portfolio •
rf = Risk free rate of return •
si = Standard deviation of the excess return on portfolio The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 7 Investors face two kinds of risk in investing: diversifiable and non-­‐diversifiable. Diversifiable risk or idiosyncratic risk can be reduced, if not eliminated, when held in combination with other assets. Non-­‐
diversifiable risk or systematic risk is the risk inherent to investing in a particular investment/portfolio, and is compensated by the capital markets, accordingly. The expected return commensurate for a security’s systematic risk is provided by the Capital Asset Pricing Model (CAPM), which was introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner (1965) and Jan Mossin (1966). Since most investments are valued by discounting their future cash flows by a “discount rate”, the CAPM is used to determine an appropriate required rate of return of an asset. The CAPM attempts to use volatility and risk to estimate expected returns. The CAPM suggests that an investment’s opportunity cost of capital is determined by its Beta. A beta of 1 means that the security or portfolio is neither more risky nor less risky than the whole market. A beta of more than 1 indicates greater systematic risk and a beta of less than 1 indicates less. The Beta is calculated as follows: 𝐶𝑜𝑣 (𝑅𝑖, 𝑅𝑚)
𝛽=
σ! m
where, •
Cov (Ri,Rm) is the covariance between the asset and the market return. •
𝜎 ! 𝑚 is the variance of the market return. The CAPM conveys the equilibrium notion that securities are priced such that their expected returns will compensate investors for their systematic risks. Once the Beta is calculated, the expected rate of return of an individual security in relation to its systematic risk can be determined as follows: 𝐸 𝑅𝑖 = 𝑅𝑓 + 𝛽{𝐸 𝑅𝑚 − 𝑅𝑓} Where, •
E(Ri) is the expected return on the investment The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 8 •
Rf is the risk free rate of return •
𝛽{𝐸 𝑅𝑚 − 𝑅𝑓} is the Beta times the market risk premium A growing number of studies find that the cross-­‐sectional variation in returns cannot be explained by the market beta alone and showed that fundamental variables such as size (Banz, 1981), book to market value (Chan, Hamao and Lakonishok, 1991), and the price to earnings ratio (Basu, 1983) account for a portion of the cross-­‐sectional variation in expected returns. Eugene Fama and Kenneth French (1995) expanded the current CAPM to include three factors as key determinants of expected returns. Factors such as: market factor, size factor, and value or book to market factor were incorporated to create the “Three Factor Model”. The Fama-­‐French Three Factor Model can be represented as follows: E (Ri) = Rf + β1 {(Rm) – Rf} + β2 SMB + β3 HML Where, •
E(Ri) is the expected return on the investment •
Rf is the risk free rate of return •
𝛽1 {𝐸 𝑅𝑚 − 𝑅𝑓} is the Beta times the market risk premium •
SMB is the difference in the returns between "small" and "big" stock portfolios. •
HML is the difference between stocks with "high" book-­‐to-­‐market ratio and stocks with a "low" book-­‐to-­‐market ratio. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 9 Diversification within Real Estate: Several studies have attempted to answer the question, as to how much real estate is in an optimal Portfolio? These studies have used various data over various periods of time. The results have been varying. Several studies including Fogler (1984) concluded that a minimum of 15% -­‐ 20% of an investor’s portfolio should be invested in real estate. This conclusion was supported by numerous other studies over the next few years. Fogler, H.R., “Twenty Percent in Real Estate: Can Theory Justify It?” Journal of Portfolio Management 10 (1984):6–13 Having determined that real estate should be part of any multi-­‐asset portfolio, the next question is how to diversify within the real estate sector. Several aspects of diversification are available to real estate investors, such as: •
Property type: Multifamily, Hotel, Office, industrial and Retail •
Location: National Vs. International and Primary Vs. Secondary •
Asset type: Class A, Class B and Class C buildings. •
Strategy: Core, Value-­‐Added and Opportunistic. Miles and McCue (1982) compared the diversification benefits that could be achieved by using geographic areas vs. property types. They concluded, based on six years’ worth of data that diversification by property was more effective than by geographic region. However, Hartzell et al. (1987) argued that diversification within real estate portfolio should be done considering exacting categories such as area growth rate, property type and lease maturity. They extended the length of the data to ten years and concluded the opposite that, geographic diversification taking into account the property type, the growth rate and lease maturity offer more efficient diversification within the real estate portfolio. Miles, M.,McCue, T., “Diversification in the Real Estate Portfolio.” Journal of Financial Research 7 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 10 (Spring 1984):57–68. Hartzell, D., Hekman, J., Miles, M., “Diversification Categories in Investment Real Estate.” Journal of the American Real Estate and Urban Economics Association 13 (Spring 1985):32–47. Firstenberg et al. (1988) demonstrated the diversification benefits from selecting different property types from different geographic locations. Viezer (2000) compared 13 different diversification strategies along with the dimensions of geographic locations, property type and economic region, and concluded that economic diversification was superior to geographic diversification. Furthermore, his study concluded that the best diversification method overall was the four property types in four geographic regions. Firstenberg, P.M., Ross, S.A., Zisler, R.C., “Real Estate: The Whole Story.” Journal of Portfolio Management 14 (Spring 1988):22–34. Viezer, T.W., “Evaluating ‘Within Real Estate’ Diversification Strategies.” Journal of Real Estate Portfolio Management 6 (2000):75–95. Viezer (1999a) further did an interesting study, whereby he combined the portfolio allocation process with the opportunistic nature of real estate. He proposed the calculation of a “Diversification Hurdle Rate”, a rate of return per deal, determined by its risk, which increases the current Sharpe ratio. Lower diversification rates for certain properties and/or markets would imply that the weights for those properties should be increased in the current portfolio. Similarly, only those properties whose expected returns exceed the diversification hurdle rates should be acquired. Viezer, T.W., “Building Real Estate Portfolios One Deal at a Time, With an eye on Diversification.” Real Estate Finance (Fall 1999a):1-­‐11. Ziering and McIntosh (1999), explored the effect of property size as an explicit diversification criterion for portfolio performance. They divided properties into 4 categories: less than $20 million, $20 million to $ 40 million, $40 million to $100 million, and $ 100 million and above. The results of the study showed that “large properties” perform differently than smaller commercial real estate assets and that The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 11 property size is positively correlated with risk-­‐return levels size across a relatively broad continuum. They concluded that the greater the portfolio’s exposure to large properties, the greater the potential for higher returns, but at the price of increased portfolio volatility. Our study will expand on the study done by Ziering and McIntosh, as the sales price factor used by them will be one of the criteria by which we will differentiate between Class A and Class B buildings. Ziering, B, McIntosh, W., “Property Size and Risk: Why Bigger is not Always Better”. Journal of Real Estate Portfolio Management. 1999. Pai and Geltner (2007) relied on an equilibrium asset-­‐pricing model using the Fama-­‐French like factors such as property size and MSA tier to conclude that those factors explained about 90% of the long run historical cross-­‐section of core property portfolio returns. They also concluded that unexpectedly the city “tier” factor gives an expected return premium to upper tier cities. Their thesis was an extension of Li and Price (2005), which concluded that a single factor CAPM accurately modeled the cross-­‐section of long run total returns across the major asset classes, including real estate. They also noted that a multi-­‐factor model explained a high percent of variation. In some ways, our study is an extension of Pai and Geltner and Li and Price, whereby we shall be using a multi-­‐factor model to further determine the impact of location factor and an asset type factor on real estate portfolio returns across various property types. Esrig and Hudgins (2011) expanded the work of Pai and Geltner by comparing the performance of properties across four quadrants: primary and secondary markets and large and non-­‐large properties. They found that size, not location was the primary determinant of performance. In the two sectors analyzed, they found that large assets in both the primary and secondary markets outperformed non-­‐
large assets in both locations on an absolute and risk-­‐adjusted basis. (Esrig D, Hudgins M, and Cerreta, J. Revisiting the impact of Large Assets on Real Estate Portfolio Returns. Journal of Portfolio Management 35 no.5 (October 2011): 125-­‐136.) The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 12 The unique aspect of our study is the investigation of the long run performance of real estate investments when accounting for property characteristics and location. In our thesis, we shall compare the performance of the two investment strategies under study, i.e., investing in Class A buildings in secondary markets and investing in Class B buildings in primary markets using the performance data provided by the National Council of Real Estate Investment Fiduciaries (NCREIF). Previous studies referred to above, have validated that multi-­‐factor models do work when applied to real estate markets. These studies also included various factors such as property size, property type, geographic location, growth rate, and lease maturity within the models to observe their impact on real estate. In our study, we will specifically dig into two of the factors: geographic location and property type, but we will define it slightly different to capture its impact on the performance of assets based specifically on the criteria mentioned before. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 13 Methodology and Data: The main objectives of the thesis are to first compare the past performances of two investment strategies, i.e. investing in Class A buildings in secondary markets and investing in Class B buildings in primary markets. Next, this thesis aims to determine the impact of location (primary vs. secondary) and property type (Class A vs. Class B buildings) on long run investment performance. For these purposes, we will use data provided by the National Council of Real Estate Investment Fiduciaries (NCREIF), which includes both previously sold and currently owned properties over the 2005-­‐2013 period. NCREIF returns are calculated assuming 100% equity and no debt financing, which enables to understand how properties perform irrespective of their financial structure. We will also use the CoStar database to determine the classification of the properties between Class A and Class B. NCREIF Database: The National Council of Real Estate Investment Fiduciaries (NCREIF) is an association of institutional real estate professionals who share a common interest in the real estate industry. NCREIF is a not-­‐for-­‐profit trade association that serves its membership, and the academic and investment community's need for improved commercial real estate data, performance measurement, investment analysis, information standards, education, and peer group interaction by collecting, processing and reporting data in a secure environment and by producing performance measurement indices. The NCREIF Property Index (NPI) is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only. The Index is set at 100 starting fourth quarter of 1977. Calculations are based on quarterly returns of individual properties before the deduction of portfolio-­‐
level management fees, but inclusive of property level management fees. Each property's return is weighted by its market value (value-­‐weighted). Index values are calculated for income, capital value and total. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 14 CoStar: CoStar is a provider of information, analytics, and marketing services to the commercial real estate industry in the United States and United Kingdom. The Company’s suite of online service offerings includes information about space available for lease, comparable sales information, tenant information, information about properties for sale, internet marketing services, analytical capabilities, information for clients' websites, information about industry professionals and their business relationships, data integration, and industry news. Its service offerings span all commercial property types, including office, industrial, retail, land, mixed-­‐use, hospitality and multifamily. The CoStar “Property Database” offers a full market inventory of properties and spaces -­‐ available as well as fully leased -­‐ searchable by market and submarket, with hundreds of details on each one. We will use the Property Database to research the buildings within the NCREIF database to determine the classification of a particular building, Class A or B, that will then be our basis for creating separate portfolios. From the dataset we will create two distinct portfolios, one representing Class A buildings in secondary markets and the other one representing Class B buildings in primary markets. In order to create portfolios representing these attributes, we will need to first clearly define the terms: class A buildings, class B buildings, primary markets, and secondary markets. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 15 Class A and Class B buildings: Even though there are no defined objective standards for determining whether a building is Class A or Class B, most industry participants agree that the determination is based on certain essential characteristics including: age of the building, location of the building, building amenities, and tenant mix. Class A buildings are more prestigious buildings competing for premier office users with rents above average for the area. Class A buildings are relatively recently built, have high quality standard finishes, state of the art systems, exceptional accessibility and a definite market presence. Class A buildings are generally located at or near the Central Business District (CBD) of the city with easy access to public transportation. On the other hand, Class B buildings are buildings competing for a wide range of users with rents in the average range for the area. Class B buildings are generally a bit older than the Class A buildings, building finishes are fair to good for the area and systems are adequate, but the building does not compete with Class A at the same price. CoStar has defined Class A buildings as “In general, a class A building is an extremely desirable investment-­‐grade property with the highest quality construction and workmanship, materials and systems, significant architectural features, the highest quality/expensive finish and trim, abundant amenities, first rate maintenance and management; usually occupied by prestigious tenants with above average rental rates and in an excellent location with exceptional accessibility. They are most eagerly sought by international and national investors willing to pay a premium for quality and are often designed by architects whose names are immediately recognizable. A building meeting this criteria is often considered to be a landmark, either historical, architectural or both. It may have been built within the last 5-­‐10 years, but if it is older, it has been renovated to maintain its status and provide it many amenities. Buildings of this stature can be one-­‐of-­‐a-­‐kind with unique shape and floor plans, notable architectural design, excellent and possibly outstanding location and a definite market presence”. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 16 Similarly, Co-­‐Star has defined Class B building as “a building that offers more utilitarian space without special attractions. It will typically have ordinary architectural design and structural features, with average interior finish, systems, and floor plans, adequate systems and overall condition. It will typically not have the abundant amenities and location that a class A building will have. This is generally considered to be more of a speculative investment. The maintenance, management and tenants are average to good, although, Class B buildings are less appealing to tenants and may be deficient in a number of respects including floor plans, condition and facilities. They therefore attract a wide range of users with average rents. They lack prestige and must depend chiefly on lower price to attract tenants and investors. Typical investors are some national, but mostly local.” Primary and Secondary Markets: We will further expand the portfolios based on its geographic location: Major or primary cities and secondary cities. Institutional real estate investors claim that the metropolitan “tier” where the property is located is an important factor to them. The industry in general defines “major” or “primary” markets to include: New York, Los Angeles, Chicago, San Francisco, Washington DC, and Boston. These top tier cities disproportionately attract foreign capital, are relatively constrained in their physical supply and may be more liquid for large investors. The industry further defines “secondary” markets that are also major targets for institutional real estate investors. For the purpose of this study, “secondary” markets include: Atlanta, Miami, Dallas, Houston, Phoenix, Denver, San Diego, Seattle, Minneapolis and Philadelphia. All other markets are categorized as “tertiary” markets, which are outside the scope of this study. It is important to note that in the investment property performance results of recent decades, the metro tier factor stands out. In other words, properties located in the major markets outperform the properties in the secondary and tertiary markets (Geltner and Miller). The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 17 Time Period This thesis focuses on the performance of the properties for the time period from 2005 through 2013. After the analysis of the dataset from NCREIF, the lower number of observations of the specific properties needed for our study during the period prior to 2005 made us select a start period of 2005. This period gives us about 9 years of data through a complete real estate cycle, with the period 2005 – 2007 representing the growth phase, period 2008-­‐2010 representing the trough phase, and recovery phase being represented by the period from 2011-­‐2013. Property Type Out of the four main property types namely -­‐ office, multifamily, industrial, and retail, our study focuses on office, multifamily, and industrial property types. Not enough data for retail was available for our study, and the fact that CoStar did not classify retail properties as either Class A or Class B made us ignore the retail sector for the purpose of our study since we did not want to base the classification of the buildings based on subjective criteria, which would be inconsistent with the methodology used for the other property types. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 18 Portfolio Construction: Using the property level data from the NCREIF database that represents approx. 6,000 properties across the US, we constructed two main portfolios based on the location (primary or secondary markets) and asset type (Class A or Class B). We then constructed three sub-­‐portfolios within these main portfolios to represent the asset types covered within this study: office, multifamily, and industrial. For the purpose of building these portfolios we first sorted the NCREIF database by the two main criteria of our study, i.e., primary and secondary markets. Once the data was initially sorted, we further sorted it by property type relevant to our study (office, multifamily, and Industrial). In order to further sort the data by the third criteria of our study (Class A or Class B), we had to determine each property’s classification. However, the NCREIF database does not classify the properties based on Class A or Class B. To achieve this classification we matched each property address of our portfolio thus far to the Property database from CoStar. The CoStar Property Database gives detailed information regarding each property including the Class A or Class B classification of the properties. Once the classification for each property was determined, we constructed our portfolios representing Class A buildings in the 10 selected secondary cities and Class B buildings in the 6 Primary Markets. A graphical representation of the portfolio structure is provided below. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 19 Since we intend to calculate annual returns, we then analyzed the properties on a yearly basis and discarded any property that was not owned (sold off) for the entire 4 quarters in any given year for that particular year. Based on the sorting of the data by our criteria, we were able to narrow down to a total portfolio of about 300 properties spread between primary and secondary markets and across the three property types and classified as Class A or Class B properties. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 20 The distribution of properties by property type, location, and class is shown in the tables below. Market
New-York
Chicago
Washington-DC
Boston
San-Francisco
Los-Angeles
Total
Market
Denver
Philadelphia
Minneapolis
Phoenix
Miami
Atlanta
Houston
Dallas
SanBDiego
Seattle
Total
Market
New-York
Chicago
Washington-DC
Boston
San-Francisco
Los-Angeles
Total
Market
Denver
Philadelphia
Minneapolis
Phoenix
Miami
Atlanta
Houston
Dallas
SanBDiego
Seattle
Total
2005
2006
2
2
2
2007
1
Primary-Markets-2-Office
Number-of-Properties
2008
2009
2010
7
6
7
2
2
2
2
2
7
5
11
2
18
16
19
30
29
1
9
4
4
8
3
5
2
2
8
3
7
8
5
10
2005
5
1
4
4
3
3
5
7
1
2006
6
1
5
2
3
2
7
4
1
2007
9
1
5
2
3
1
5
5
4
38
35
2005
1
8
8
8
1
8
2
2006
5
8
8
8
1
8
6
2005
/
/
/
1
4
2
/
3
5
2006
/
/
/
1
4
3
/
3
4
2
17
2
7
5
12
2
31
31
26
28
2011
2012
2013
5
2
3
6
6
1
6
1
4
6
5
1
6
6
4
6
5
1
4
1
1
6
2
5
5
1
6
4
6
6
5
34
33
30
33
29
28
2011
2012
2013
8
1
6
1
8
8
8
8
2
3
2
3
12
1
1
1
1
3
14
12
19
2011
/
2012
/
2013
/
1
2
/
/
1
6
1
4
/
/
/
/
3
2
3
5
1
4
4
34
2007
5
1
8
8
1
2
9
Primary-Markets-2-Multifamily
Number-of-Properties
2008
2009
2010
5
8
7
1
1
8
8
8
8
8
8
8
1
3
1
3
3
3
10
15
11
2007
/
/
/
2
4
1
/
Secondary/Markets/3/Multifamily
Number/of/Properties
2008
2009
2010
/
/
/
/
/
/
/
/
/
2
2
2
4
5
3
/
/
/
/
/
/
4
1
3
4
1
16
15
2007
2
1
2
2
2
2
3
Market
Denver
Philadelphia
Minneapolis
Phoenix
Miami
Atlanta
Houston
Dallas
SanBDiego
Seattle
Total
2005
/
/
/
/
/
2
/
/
/
/
2
2006
/
/
/
/
/
2
/
/
/
/
2
2007
/
/
/
/
/
2
/
3
/
/
5
7
2
9
5
7
2
1
3
5
3
2006
2
1
2
2
1
2
4
2013
8
2
8
4
6
2
1
4
6
1
2005
2
2
2
2
1
2
3
2012
8
2
8
4
11
2
Secondary0Markets040Office
Number0of0Properties
2008
2009
2010
8
7
5
1
6
1
3
3
4
2
1
1
3
5
4
1
1
1
5
5
5
1
Market
New-York
Chicago
Washington-DC
Boston
San-Francisco
Los-Angeles
Total
2011
/
3
4
4
3
3
4
3
3
4
1
2
4
1
2
4
3
17
18
15
16
14
23
2011
2012
2013
2
2
2
2
2
5
2
2
2
2
2
6
2
2
2
2
2
6
7
8
8
2011
/
/
/
/
2012
/
/
/
/
2013
/
/
/
/
4
Primary.Markets.7.Industrial
Number.of.Properties
2008
2009
2010
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
4
5
5
6
7
7
Secondary/Markets/3/Industrial
Number/of/Properties
2009
2010
/
/
/
/
/
/
/
/
2008
/
/
/
/
1
3
/
/
/
/
4
1
3
1
2
1
4
1
4
1
5
/
/
/
1
1
2
/
/
5
/
/
4
/
/
7
/
/
/
/
5
/
/
/
/
6
Total
44
1
72
38
73
0
228
Total
57
8
35
12
37
12
38
18
33
44
294
Total
57
6
1
1
13
20
98
Total
0
6
2
15
39
7
0
27
37
18
151
Total
0
14
0
0
2
37
53
Total
0
0
0
0
6
27
0
7
0
0
40
The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 21 Data Analysis As mentioned above, the NCREIF property level data is used for this thesis. The NCREIF database also provided us with the “Income Return”, “Appreciation Return” and “Total Return” based on the data submitted by contributing members. Per NCREIF, the returns were calculated as follows: Income Return: 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
1
1
1
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 + 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑚𝑝𝑟𝑜𝑣𝑒𝑚𝑒𝑛𝑡𝑠 − 𝑃𝑎𝑟𝑡𝑖𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 − 𝑁𝑂𝐼
2
2
3
Appreciation Return: 𝐸𝑛𝑑𝑖𝑛𝑔 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 + 𝑃𝑎𝑟𝑡𝑖𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑚𝑝𝑟𝑜𝑣𝑒𝑚𝑒𝑛𝑡𝑠
1
1
1
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 + 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑚𝑝𝑟𝑜𝑣𝑒𝑚𝑒𝑛𝑡𝑠 − 𝑃𝑎𝑟𝑡𝑖𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 − 𝑁𝑂𝐼
2
2
3
Total Return: Total Return = Income Return + Appreciation Return Based on the returns calculated as stated above, we calculated the mean and median of the total return for each portfolio on a yearly basis. However these returns for the portfolios created would be out of context without the related risk associated with these portfolios. For this reason, we also calculated the Sharpe ratio, which is a measurement of the return earned in excess of that which could have been earned on an investment that has no diversifiable risk. The higher the Sharpe ratio, the better the performance of the portfolio under analysis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 22 Office Buildings: Analysis of Performance In this section we analyze the performance data related to the Class A office properties in secondary market and the Class B office properties in the primary market. Even though our analysis is based on total return, the tables provided show the breakdown by income return and appreciation return. We have broken down the time period into three distinct periods: Growth (2005-­‐2007), Trough (2008-­‐2010), and Recovery (2011-­‐2013). The distribution of the properties per the distinct periods is provided below. Market
New,York
Chicago
Washington,DC
Boston
San,Francisco
Los,Angeles
Total
Market
Denver
Philadelphia
Minneapolis
Phoenix
Miami
Atlanta
Houston
Dallas
SanBDiego
Seattle
Total
Primary-Markets-2-Class-B-Office
Number-of-Properties
2005$2007
2008$2010
2011$2013
1
20
23
1
$
$
25
22
25
10
15
13
16
33
24
$
$
$
53
90
85
Secondary0Markets040Class0A0Office
Number0of0Properties
2005$2007
2008$2010
2011$2013
20
20
17
3
2
3
14
10
11
8
4
$
9
12
16
6
3
3
17
15
6
12
3
3
5
11
17
13
17
14
107
97
90
Total
44
1
72
38
73
0
228
Total
57
8
35
12
37
12
38
18
33
44
294
The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 23 Growth Phase (2005-­‐2007) The growth phase covers the period from 2005 to 2007, which represented a period of high appreciation and total returns across the entire real estate sector in the US. The performance of the properties under observation is summarized in the following tables. Table 5.1.1 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2005 In 2005, we observed the performance of 18 Class B buildings in primary markets and of 38 Class A buildings in secondary markets. As depicted by the table above, in 2005 Class A buildings in secondary markets significantly outperformed Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 24 Table 5.1.2 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2006 In 2006, we observed the performance of 16 Class B buildings in primary markets and of 35 Class A buildings in secondary markets. As depicted by the table above, in 2006 Class B buildings in primary markets significantly outperformed Class A buildings in secondary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 25 Table 5.1.3 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2007 In 2007, we observed the performance of 19 Class B buildings in primary markets and of 34 Class A buildings in secondary markets. As depicted by the table above, in 2007 Class B buildings in primary markets significantly outperformed Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 26 Summary: During the growth period (2005-­‐2007), Class A office buildings in secondary markets provided an average total return of 16.96%, compared to the average total return of the NCREIF portfolio of 19.71%. Comparatively, Class B office buildings in primary markets provided an average total return of 19.14%, almost similar to the NCREIF portfolio return. The primary markets outperformed the secondary markets by 218 basis points on a total return basis during that time period. During the growth period we would have expected to see primary markets outperform other markets as increased capital flows would result in significant appreciation gains. However, it is interesting to see that the same holds true even for Class B buildings in primary markets when compared to the performance of Class A buildings in secondary markets. Table: 5.1.4 Total Return Mean for the period from 2005-­‐2007 2005 12.32% 18.22% 19.47% PRIMARY SECONDARY NCREIF 2006 22.34% 14.73% 19.15% 2007 22.75% 17.94% 20.51% Table: 5.1.5 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 24.00% 22.75% 22.00% 22.34% 20.00% 19.47% 18.00% 18.22% 19.15% 20.51% 17.94% PRIMARY SECONDARY 16.00% NCREIF 14.00% 12.00% 14.73% 12.32% 10.00% 2005 2006 2007 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 27 Trough Phase (2008 – 2010) The trough phase covers the period from 2008 to 2010, which represented a period of negative appreciation and total returns across the entire real estate sector in the US mainly due to the Global Financial Crisis. The performance of the properties under observation is summarized in the following tables. Table 5.1.6 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2008 In 2008, we observed the performance of 30 Class B buildings in the primary markets and of 34 Class A buildings in the secondary markets. As depicted in the table above, in 2008 the returns on Class B buildings in primary markets fell more sharply than those of Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 28 Table 5.1.7 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2009 In 2009, we observed the performance of 29 Class B buildings in primary markets and of 33 Class A buildings in secondary markets. As depicted in the table above, in 2009 the returns on Class B buildings in primary markets fell more sharply than those of Class A buildings in secondary markets. However, as a result of the high variability of the secondary markets portfolio returns, the Sharpe ratio indicates that primary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 29 Table 5.1.8 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2010 In 2010, we observed the performance of 31 Class B buildings in primary markets and of 30 Class A buildings in secondary markets. As depicted in the table above, in 2010 Class B buildings in primary markets recovered more sharply than Class A buildings in secondary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 30 Summary: During the trough period (2008-­‐2010), Class A office buildings in secondary markets resulted in an average total return of -­‐4.31%, compared to the average total return of the NCREIF portfolio of -­‐
4.88%. Comparatively, Class B office buildings in primary markets resulted in an average total return of -­‐
5.40%. The secondary markets outperformed the primary markets by 109 basis points on a total return basis during that time period. This data suggests that the Class B buildings in the primary markets are more vulnerable to a market downturn than the Class A buildings in the secondary markets. Table: 5.1.9 Total Return Mean for the period from 2008-­‐2010 2008 2009 2010 PRIMARY -­‐8.90% -­‐19.04% 11.75% SECONDARY -­‐3.21% -­‐17.94% 8.22% NCREIF -­‐7.29% -­‐19.10% 11.74% Table: 5.1.10 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 15.00% 11.75% 11.74% 10.00% 8.22% 5.00% 0.00% -­‐5.00% -­‐10.00% -­‐15.00% -­‐20.00% 2008 -­‐3.21% 2009 2010 PRIMARY SECONDARY -­‐7.29% NCREIF -­‐8.90% -­‐17.94% -­‐19.04% -­‐19.10% -­‐25.00% The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 31 Recovery Phase (2011-­‐2013) The recovery phase covers the period from 2011 to 2013, which represented a period of rising appreciation and total returns across the entire real estate sector in the US mainly due to the opening up of capital markets. The performance of the properties under observation is summarized within the following tables. Table 5.1.11 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2011 In 2011, we observed the performance of 31 Class B buildings in primary markets and of 33 Class A buildings in secondary markets. As depicted in the table above, in 2011 Class B buildings in primary markets outperformed Class A buildings in secondary markets. However, as a result of the high The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 32 variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. Table 5.1.12 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2012 In 2012, we observed the performance of 26 Class B buildings in primary markets and 29 Class A buildings in secondary markets. As depicted in the table above, in 2012 Class B buildings in primary markets outperformed Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 33 Table 5.1.13 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2013 In 2013, we observed the performance of 28 Class B buildings in the primary markets and 28 Class A buildings in secondary markets. As depicted in the table above, in 2013 Class B buildings in primary markets outperformed Class A buildings in secondary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 34 Summary: During the recovery period (2011-­‐2013), Class A office buildings in secondary markets resulted in an average total return of 10.43%, compared to the average total return of the NCREIF portfolio of 11.4%. Comparatively, Class B office buildings in primary markets resulted in an average total return of 14.56%, much higher than both the secondary markets and the NCREIF portfolio as a whole. The primary markets were the first to recover and recorded better performance than the Class A buildings in secondary markets. This could be in part because investors remained cautious about re-­‐entering the secondary markets due to lack of liquidity and available capital. Table: 5.1.14 Total Return Mean for the period from 2011-­‐2013 2011 2012 2013 PRIMARY 16.59% 11.12% 15.97% SECONDARY 10.47% 9.49% 11.33% NCREIF 13.76% 9.49% 9.86% Table: 5.1.15 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 18.00% 16.00% 14.00% 16.59% 13.76% 12.00% 10.00% 15.97% 10.47% 11.12% 11.33% 9.86% 9.49% 8.00% PRIMARY SECONDARY NCREIF 6.00% 4.00% 2.00% 0.00% 2011 2012 2013 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 35 Combined Period (2005 – 2013) As depicted in the graph below and explained in earlier sections, Class B buildings in primary markets have outperformed the overall market during the period from 2005 to 2013, Class A buildings in secondary markets included. However, the performance fell more sharply than the secondary markets during the trough period primarily due to the capital crunch and an oversupply of space within the primary markets. Class B buildings in the primary markets also rebounded at a much higher rate during the recovery period. Class A properties in secondary markets have historically performed below the primary markets as well as the NCREIF NPI, however during the trough, the properties in the secondary markets were not as vulnerable as the Class B properties in the primary markets. Unsurprisingly, their recovery has also lagged behind and has not been so robust. In summary, office buildings located in a primary market is a powerful moderator of performance, most likely due to very positive supply/demand fundamentals and an increase in the demand for space by institutional tenants. Table 5.1.16 Total Return Mean for the period from 2005-­‐2013 2005 2006 2007 2008 2009 2010 PRIMARY 12.32% 22.34% 22.75% -­‐8.90% -­‐19.04% 11.75% SECONDARY 18.22% 14.73% 17.94% -­‐3.21% -­‐17.94% 8.22% NCREIF 19.47% 19.15% 20.51% -­‐7.29% -­‐19.10% 11.74% 2011 16.59% 10.47% 13.76% 2012 11.12% 9.49% 9.49% 2013 15.97% 11.33% 9.86% Table: 5.1.17 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% -­‐5.00% -­‐10.00% -­‐15.00% -­‐20.00% -­‐25.00% PRIMARY SECONDARY 2005 2006 2007 2008 2009 2010 2011 2012 2013 NCREIF The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 36 Multifamily Buildings: Analysis of Performance In this section we analyze the performance data related to the Class A multifamily properties in secondary markets and the Class B multifamily properties in the primary market. Even though our analysis is based on total return, the tables provided show the breakdown by income return and appreciation return. We have broken down the time period into three distinct periods: Growth (2005-­‐2007), Trough (2008-­‐2010), and Recovery (2011-­‐2013). The distribution of the properties per the distinct periods is provided below. Market
New,York
Chicago
Washington,DC
Boston
San,Francisco
Los,Angeles
Total
Market
Denver
Philadelphia
Minneapolis
Phoenix
Miami
Atlanta
Houston
Dallas
SanBDiego
Seattle
Total
Primary-Markets-2-Class-B-Multifamily
Number-of-Properties
2005$2007
2008$2010
2011$2013
11
20
26
1
2
3
$
$
1
$
$
1
3
5
5
2
9
9
17
36
45
Secondary/Markets/3/Class/A/Multifamily
Number/of/Properties
2005$2007
2008$2010
2011$2013
$
$
$
$
$
6
$
$
2
4
6
5
12
12
15
6
$
1
$
$
$
9
11
7
13
12
12
4
9
5
48
50
53
Total
57
6
1
1
13
20
98
Total
0
6
2
15
39
7
0
27
37
18
151
The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 37 Growth Phase (2005-­‐2007) The growth phase covers the period from 2005 to 2007, which represented a period of high appreciation and total returns across the entire real estate sector in the US. The performance of the properties under observation is summarized in the following tables. Table 5.2.1 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2005 In 2005, we observed the performance of 2 Class B buildings in the primary markets and of 17 Class A buildings in the secondary markets. As depicted by the table above, in 2005 Class B buildings in primary markets significantly outperformed Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 38 Table 5.2.2 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2006 In 2006, we observed the performance of 6 Class B buildings in primary markets and of 16 Class A buildings in secondary markets. As depicted by the table above, in 2006 Class B buildings in primary markets significantly outperformed Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 39 Table 5.2.3 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2007 In 2007, we observed the performance of 9 Class B buildings in primary markets and of 15 Class A buildings in secondary markets. As depicted by the table above, in 2007 Class B buildings in primary markets significantly outperformed Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 40 Summary: During the growth period (2005-­‐2007), Class A multifamily buildings in secondary markets provided an average total return of 17.54%, compared to the average total return of the NCREIF portfolio of 15.72%. Comparatively, Class B multifamily buildings in primary markets provided an average total return of 24.46%, almost similar to the NCREIF portfolio return. The primary markets outperformed the secondary markets by 692 basis points on a total return basis during that time period. During the growth period we would have expected to see primary markets outperform other markets as increased capital flows would result in significant appreciation gains. However, it is interesting to see that the same holds true even for Class B buildings in primary markets when compared to the performance of Class A buildings in secondary markets. Table: 5.2.4 Total Return Mean for the period from 2005-­‐2007 PRIMARY SECONDARY NCREIF 2005 21.63% 16.73% 21.16% 2006 27.40% 24.47% 14.63% 2007 24.35% 11.42% 11.36% Table: 5.2.5 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 30.00% 25.00% 20.00% 27.40% 21.63% 24.47% 24.35% 21.16% 14.63% 15.00% 16.73% PRIMARY 11.42% 10.00% 11.36% SECONDARY NCREIF 5.00% 0.00% 2005 2006 2007 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 41 Trough Phase (2008-­‐2010) The trough phase covers the period from 2008 to 2010, which represented a period of negative appreciation and total returns across the entire real estate sector in the US mainly due to the Global Financial Crisis. The performance of the properties under observation is summarized in the following tables. Table 5.2.6 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2008 In 2008, we observed the performance of 10 Class B buildings in primary markets and of 17 Class A buildings in secondary markets. As depicted in the table above, in 2008 the returns on Class B buildings in primary markets fell more sharply than those of Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 42 Table 5.2.7 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2009 In 2009, we observed the performance of 15 Class B buildings in primary markets and of 18 Class A buildings in secondary markets. As depicted in the table above, in 2009 the returns on Class B buildings in primary markets fell more sharply than those of Class A buildings in the secondary markets. However, as a result of the high variability of the secondary markets portfolio returns, the Sharpe ratio indicates that primary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 43 Table 5.2.8 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2010 In 2010, we observed the performance of 11 Class B buildings in primary markets and of 15 Class A buildings in secondary markets. As depicted in the table above, in 2010 Class A buildings in secondary markets recovered more sharply than Class B buildings in primary markets. However, as a result of the high variability of the secondary markets portfolio returns, the Sharpe ratio indicates that primary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 44 Summary: During the trough period (2008-­‐2010), Class A multifamily buildings in secondary markets resulted in an average total return of 1.35%, compared to the average total return of the NCREIF portfolio of -­‐2.20%. Comparatively, Class B multifamily buildings in primary markets resulted in an average total return of -­‐2.02%. The secondary markets outperformed the primary markets by 337 basis points on a total return basis during that time period. This data suggests that the Class B buildings in the primary markets are more vulnerable to a market downturn than the Class A buildings in the secondary markets. Table: 5.2.9 Total Return Mean for the period from 2008-­‐2010 2008 2009 2010 PRIMARY -­‐4.97% -­‐19.83% 18.75% SECONDARY -­‐2.14% -­‐14.31% 20.49% NCREIF -­‐7.30% -­‐17.50% 18.21% Table: 5.2.10 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 25.00% 20.49% 18.75% 18.21% 20.00% 15.00% 10.00% PRIMARY 5.00% 0.00% -­‐5.00% -­‐10.00% -­‐15.00% -­‐20.00% -­‐25.00% -­‐2.14% 2008 -­‐4.97% -­‐7.30% SECONDARY 2009 2010 NCREIF -­‐14.31% -­‐17.50% -­‐19.83% The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 45 Recovery Phase (2011-­‐2013) The recovery phase covers the period from 2011 to 2013, which represented a period of rising appreciation and total returns across the entire real estate sector in the US mainly due to the opening up of capital markets. The performance of the properties under observation is summarized within the following tables. Table 5.2.11 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2011 In 2011, we observed the performance of 14 Class B buildings in primary markets and of 16 Class A buildings in secondary markets. As depicted in the table above, in 2011 Class A buildings in secondary markets significantly outperformed Class B buildings in primary markets. However, as a result of the high variability of the secondary markets portfolio returns, the Sharpe ratio indicates that primary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 46 Table 5.2.12 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2012 In 2012, we observed the performance of 12 Class B buildings in primary markets and 14 Class A buildings in secondary markets. As depicted in the table above, in 2012 Class B buildings in primary markets outperformed Class A buildings in secondary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 47 Table 5.2.13 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2013 In 2013, we observed the performance of 19 Class B buildings in primary markets and 23 Class A buildings in secondary markets. As depicted in the table above, in 2013 Class B buildings in primary markets outperformed Class A buildings in secondary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 48 Summary: During the recovery period (2011-­‐2013), Class A multifamily buildings in secondary markets resulted in an average total return of 14.17%, compared to the average total return of the NCREIF portfolio of 12.37%. Comparatively, Class B multifamily buildings in primary markets resulted in an average total return of 13.11%, which is a bit lower than the results for the secondary markets, but is still higher than the returns of the NCREIF portfolio as a whole. The results indicate that with respect to multifamily buildings, the secondary markets were the first to recover and recorded better performance than the Class B buildings in primary markets. This could be in part because of the relatively small size of investments required in secondary markets and institutional investors cautiousness about re-­‐entering into real estate investments in primary markets following the Global Financial Crisis. Table: 5.2.14 Total Return Mean for the period from 2011-­‐2013 2011 2012 2013 PRIMARY 11.79% 16.36% 11.19% SECONDARY 16.64% 15.57% 10.30% NCREIF 15.45% 11.24% 10.41% Table: 5.2.15 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 18.00% 16.00% 16.64% 15.45% 14.00% 12.00% 10.00% 11.79% 16.36% 15.57% 11.24% 11.19% 10.41% 10.30% PRIMARY 8.00% SECONDARY 6.00% NCREIF 4.00% 2.00% 0.00% 2011 2012 2013 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 49 Combined Period (2005 – 2013) As depicted in the graph below and explained in earlier sections, Class B buildings in primary markets have outperformed the overall market during the period from 2005 to 2013, Class A buildings in secondary markets included. However, the performance fell more sharply than the secondary markets during the trough period primarily due to the capital crunch and an oversupply of space within the primary markets. Moreover, in the case of multifamily buildings, Class A buildings in the secondary markets rebounded at a higher rate during the recovery period. Class A properties in secondary markets have historically performed below the primary markets as well as the NCREIF NPI, however during the trough, the properties in the secondary markets were not as vulnerable as the Class B properties in the primary markets. Nevertheless, and as opposed to our initial expectations, their recovery seems to be more robust. One hypothesis for this unpredictable behavior might be related to the significant impact of the Global Financial Crisis specifically on class B multifamily buildings in primary markets. Table 5.2.16 Total Return Mean for the period from 2005-­‐2013 2005 2006 2007 2008 2009 2010 2011 2012 2013 PRIMARY 21.63% 27.40% 24.35% -­‐4.97% -­‐19.83% 18.75% 11.79% 16.36% 11.19% SECONDARY 16.73% 24.47% 11.42% -­‐2.14% -­‐14.31% 20.49% 16.64% 15.57% 10.30% NCREIF 21.16% 14.63% 11.36% -­‐7.30% -­‐17.50% 18.21% 15.45% 11.24% 10.41% Table: 5.2.17 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 30.00% 20.00% 10.00% PRIMARY SECONDARY 0.00% 2005 -­‐10.00% 2006 2007 2008 2009 2010 2011 2012 2013 NCREIF -­‐20.00% -­‐30.00% The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 50 Industrial Buildings: Analysis of Performance In this section we analyze the performance data related to the Class A industrial properties in secondary market and the Class B industrial properties in the primary market. Even though our analysis is based on total return, the tables provided show the breakdown by income return and appreciation return. We have broken down the time period into three distinct periods: Growth (2005-­‐2007), Trough (2008-­‐2010), and Recovery (2011-­‐2013). The distribution of the properties per the distinct periods is provided below. Market
New,York
Chicago
Washington,DC
Boston
San,Francisco
Los,Angeles
Total
Market
Denver
Philadelphia
Minneapolis
Phoenix
Miami
Atlanta
Houston
Dallas
San@Diego
Seattle
Total
Primary0Markets070Class0B0Industrial
Number0of0Properties
2005$2007
2008$2010
2011$2013
$
$
$
2
6
6
$
$
$
$
$
$
2
$
$
6
14
17
10
20
23
Secondary1Markets131Class1A1Industrial
Number1of1Properties
2005$2007
2008$2010
2011$2013
$
$
$
$
$
$
$
$
$
$
$
$
$
3
3
6
8
13
$
$
$
3
2
2
$
$
9
$
$
13
$
$
18
Total
0
14
0
0
2
37
53
Total
0
0
0
0
6
27
0
7
0
0
40
The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 51 Growth Phase (2005-­‐2007) The growth phase covers the period from 2005 to 2007, which represented a period of high appreciation and total returns across the entire real estate sector in the US. The performance of the properties under observation is summarized in the following tables. Table 5.3.1 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2005 In 2005, we observed the performance of 3 Class B buildings in primary markets and of 2 Class A buildings in secondary markets. As depicted by the table above, in 2005 Class B buildings in primary markets outperformed Class A buildings in secondary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. Table 5.3.2 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2006 In 2006, we observed the performance of 3 Class B buildings in primary markets and of 2 Class A buildings in secondary markets. As depicted by the table above, in 2006 Class A buildings in secondary The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 52 markets outperformed Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. Table 5.3.3 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2007 In 2007, we observed the performance of 3 Class B buildings in primary markets and of 5 Class A buildings in secondary markets. As depicted by the table above, in 2007 Class A buildings in secondary markets significantly outperformed Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 53 Summary: During the growth period (2005-­‐2007), Class A industrial buildings in secondary markets provided an average total return of 12.12%, compared to the average total return of the NCREIF portfolio of 17.41%. Comparatively, Class B industrial buildings in primary markets provided an average total return of 5.69%, which is significantly lower than the return of the NCREIF portfolio. The secondary markets outperformed the primary markets by 643 basis points on a total return basis during that time period. During the growth period we would have expected to see industrial buildings in secondary markets outperform primary markets as demand and increased capital flows would result in significant income and appreciation gains. However, it is interesting to see that the same holds true even for Class A buildings in secondary markets when compared to the performance of Class B buildings in primary markets. Table: 5.3.4 Total Return Mean for the period from 2005-­‐2007 PRIMARY SECONDARY NCREIF 2005 14.24% 10.19% 20.32% 2006 0.96% 9.33% 16.96% 2007 1.87% 16.84% 14.94% Table: 5.3.5 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 25.00% 20.32% 20.00% 15.00% 16.96% 16.84% 14.94% 14.24% 10.19% 9.33% PRIMARY SECONDARY 10.00% NCREIF 5.00% 0.96% 0.00% 2005 2006 1.87% 2007 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 54 Trough Phase (2008-­‐2010) The trough phase covers the period from 2008 to 2010, which represented a period of negative appreciation and total returns across the entire real estate sector in the US mainly due to the Global Financial Crisis. The performance of the properties under observation is summarized in the following tables. Table 5.3.6 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2008 In 2008, we observed the performance of 6 Class B buildings in primary markets and of 4 Class A buildings in secondary markets. As depicted in the table above, in 2008 the returns on Class B buildings in primary markets fell more sharply than those of Class A buildings in secondary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 55 Table 5.3.7 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2009 In 2009, we observed the performance of 7 Class B buildings in primary markets and of 5 Class A buildings in secondary markets. As depicted in the table above, in 2009 the returns on Class A buildings in secondary markets fell more sharply than those of Class B buildings in primary markets. However, as a result of the high variability of the primary markets portfolio returns, the Sharpe ratio indicates that secondary market portfolio performed better on a risk-­‐adjusted basis. Table 5.3.8 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2010 In 2010, we observed the performance of 8 Class B buildings in primary markets and of 4 Class A buildings in the secondary markets. As depicted in the table above, in 2010 Class A buildings in secondary markets recovered more sharply than Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 56 Summary: During the trough period (2008-­‐2010), Class A industrial buildings in secondary markets resulted in an average total return of -­‐2.99%, compared to the average total return of the NCREIF portfolio of -­‐4.75%. Comparatively, Class B industrial buildings in primary markets resulted in an average total return of -­‐8.13%. The secondary markets outperformed the primary markets by 514 basis points on a total return basis during that time period. This data suggests that the Class B buildings in the primary markets are more vulnerable to a market downturn than the Class A buildings in the secondary markets. Table: 5.3.9 Total Return Mean for the period from 2008-­‐2010 2008 2009 2010 PRIMARY -­‐11.12% -­‐12.67% -­‐0.61% SECONDARY -­‐3.28% -­‐13.65% 7.96% NCREIF -­‐5.77% -­‐17.85% 9.37% Table: 5.3.10 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 15.00% 9.37% 10.00% 7.96% 5.00% 0.00% -­‐3.28% 2008 -­‐5.00% -­‐10.00% -­‐15.00% -­‐20.00% 2009 -­‐5.77% -­‐11.12% 2010 -­‐0.61% PRIMARY SECONDARY NCREIF -­‐12.67% -­‐13.65% -­‐17.85% The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 57 Recovery Phase (2011-­‐2013) The recovery phase covers the period from 2011 to 2013, which represented a period of rising appreciation and total returns across the entire real estate sector in the US mainly due to the opening up of capital markets. The performance of the properties under observation is summarized within the following tables. Table 5.3.11 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2011 In 2011, we observed the performance of 7 Class B buildings in primary markets and of 7 Class A buildings in secondary markets. As depicted in the table above, in 2011 Class A buildings in secondary markets outperformed Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 58 Table 5.3.12 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2012 In 2012, we observed the performance of 6 Class B buildings in primary markets and 5 Class A buildings in secondary markets. As depicted in the table above, in 2012 Class A buildings in secondary markets significantly outperformed Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. Table 5.3.13 Performance of Class B Properties in Primary Markets and Class A properties in Secondary Markets in 2013 In 2013, we observed the performance of 8 Class B buildings in primary markets and 6 Class A buildings in secondary markets. As depicted in the table above, in 2013 Class A buildings in secondary markets significantly outperformed Class B buildings in primary markets. Moreover, the Sharpe ratios also support this conclusion. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 59 Summary: During the recovery period (2011-­‐2013), Class A industrial buildings in secondary markets resulted in an average total return of 17.47%, compared to the average total return of the NCREIF portfolio of 12.54%. Comparatively, Class B industrial buildings in primary markets resulted in an average total return of 6.66%, which is lower than both the secondary markets and the NCREIF portfolio as a whole. The secondary markets were the first to recover and recorded better performance than the Class B buildings in primary markets. This could be in part because of physical constraints in primary markets, which leads to excess demand in secondary markets, specifically upon reemergence from the Global Financial Crisis. Table: 5.3.14 Total Return Mean for the period from 2011-­‐2013 2011 2012 2013 PRIMARY 13.92% 5.23% 0.82% SECONDARY 15.49% 22.89% 14.03% NCREIF 14.58% 10.71% 12.32% Table: 5.3.15 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 22.89% 25.00% 20.00% 15.00% 10.00% 15.49% 14.58% 14.03% 12.32% 13.92% 10.71% 5.00% PRIMARY SECONDARY NCREIF 5.23% 0.82% 0.00% 2011 2012 2013 The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 60 Combined Period (2005 – 2013) As depicted in the graph below and explained in earlier sections, Class A buildings in secondary markets have outperformed the overall market during the period from 2005 to 2013, Class B buildings in primary markets included. However, the performance fell more sharply than the primary markets during the trough period primarily due to the capital crunch and an oversupply of space within the secondary markets. Class A buildings in the secondary markets also rebounded at a much higher rate during the recovery period. Class B properties in primary markets have historically performed below the secondary markets as well as the NCREIF NPI. Moreover, during the trough period, the properties in the secondary markets were not as vulnerable as the Class A properties in the primary markets, and even their recovery has been more robust. In summary, industrial buildings located in a secondary market is a powerful moderator of performance, most likely due to very positive supply/demand fundamentals and an increase in the demand for space by institutional tenants. Table 5.3.16 Total Return Mean for the period from 2005-­‐2013 2005 2006 2007 2008 2009 2010 2011 2012 2013 PRIMARY 14.24% 16.61% 1.87% -­‐11.12% -­‐12.67% -­‐0.61% 13.92% 5.23% 0.82% SECONDARY 10.19% 9.33% 16.84% -­‐3.28% -­‐13.65% 7.96% 15.49% 22.89% 14.03% NCREIF 20.32% 16.96% 14.94% -­‐5.77% -­‐17.85% 9.37% 14.58% 10.71% 12.32% Table: 5.3.17 Graphical representation of the performance of Class A buildings in Secondary markets, Class B buildings in Primary markets and the NCREIF NPI 25.00% 20.00% 15.00% 10.00% PRIMARY 5.00% SECONDARY 0.00% -­‐5.00% 2005 2006 2007 2008 2009 2010 2011 2012 2013 NCREIF -­‐10.00% -­‐15.00% -­‐20.00% The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 61 Summary and Conclusions: As articulated in chapter 1 of this paper, the theoretical incentive for this study is based, in broad strokes, on the rationale that has led Eugene Fama and Kenneth French in the 1990s to research and expand the number of explanatory factors in the traditional CAPM formula. Accordingly, in this empirical study we have utilized the aforementioned conceptual framework to research and identify explanatory factors in the real estate investments realm. This study has identified two important factors (determinants) that might provide us with better understanding of long run performance in real estate investments. The first factor is the location of the property (primary markets or secondary markets), while the second factor is the asset type (Class A or Class B). This study examined and compared the performance of three property types (office, multifamily, and industrial) classified as Class B properties in primary markets and Class A properties in secondary markets through a complete real estate cycle of nine years and three distinct phases -­‐ growth (2005-­‐2007), trough (2008-­‐2010), and recovery (2011-­‐2013). The results of our study indicate the following trends based on the performance throughout the entire real estate cycle examined (2005-­‐2013): Office -­‐ Class B buildings in primary markets have outperformed the NCREIF NPI, Class A buildings in secondary markets included. However, the performance of Class B buildings in primary markets fell more sharply than that of Class A buildings in secondary markets during the trough period, and, unsurprisingly, rebounded at a much higher rate during the recovery period. It should also be noted that in risk-­‐adjusted terms, measured by the Sharpe ratio, the performance of the portfolios consisting of Class B buildings in primary markets for the years 2006, 2010, 2011, and 2013, has been inferior to that of Class A buildings in secondary markets. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 62 Multifamily -­‐ Class B buildings in primary markets have outperformed the NCREIF NPI, Class A buildings in secondary markets included. However, the performance of Class B buildings in primary markets fell more sharply than that of Class A buildings in secondary markets during the trough period, but as opposed to our initial expectations and the results for office properties, the recovery of class A buildings in secondary markets was more robust. One hypothesis for this unpredictable behavior might be related to the significant impact of the Global Financial Crisis specifically on Class B multifamily buildings in primary markets. It should also be noted that in risk-­‐adjusted terms, measured by the Sharpe ratio, the performance of the portfolios consisting of Class B buildings in primary markets for the years 2012 and 2013, has been inferior to that of Class A buildings in secondary markets. Industrial -­‐ Class A buildings in secondary markets have outperformed the NCREIF NPI, Class B buildings in primary markets included. Unsurprisingly, the performance of Class B buildings in primary markets fell more sharply than that of Class A buildings in secondary markets during the trough period, but as opposed to our initial expectations, the recovery of class A buildings in secondary markets was more robust. One hypothesis for this behavior might be related to the fact that industrial buildings located in secondary markets are a powerful moderator of economic performance, but at the same time an operational necessity. Accordingly, their performance was less sensitive during the trough period, but reacted very positively to a strong demand for industrial space upon reemergence from the Global Financial Crisis. It should also be noted that in risk-­‐adjusted terms, measured by the Sharpe ratio, the performance of the portfolios consisting of Class A buildings in secondary markets aligns with our results on unadjusted risk terms. The overall empirical results of our study indicate that a savvy real estate investor, who is dedicated to maximizing his long run returns, would prefer to invest in office and multifamily properties in primary markets, and in industrial properties in secondary markets. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 63 Limitations and Scope for Further Research: Despite the succinct presentation of our overall empirical results, the conclusions of this thesis do have several limitations in scope that should be addressed by prospective research initiatives. The main limitations in scope of this thesis and associated issues, which should be further examined in depth in prospective research initiatives, are: •
This thesis has relied only on data provided by NCREIF. The NCREIF data is considered to be of prominent quality. However, it should be noted that the data collected by NCREIF represents only operating properties that were acquired on behalf of tax-­‐exempt institutional investors and that the total returns used in this thesis were calculated based on NCREIF’s methodology. Prospective empirical research should examine our results carefully based on several databases; •
The analysis in this thesis has focused only on one real estate cycle from 2005 to 2013. Prospective empirical research should examine our conclusions in several real estate cycles; •
The scope of NCREIF data available for industrial properties is relatively small, and, consequentially, the industrial property data in this thesis was comprised of merely 93 industrial properties. Also, due to lack of data, this thesis has not analyzed retail products. Prospective empirical research should examine the performance of industrial and retail properties in depth; •
This thesis analyzed only two explanatory factors (determinants) of long run performance in real estate. Prospective empirical research should examine and analyze the explanatory power of each one of these factors separately, along with exploring the explanatory power of other possible factors; •
Our research examined only the performance of properties located in primary and secondary markets in the US. Prospective empirical research should examine the performance of properties located in tertiary markets in the US and also examine our results in other developed markets around the world. The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 64 Bibliography: Sharpe, W. F. (1966). Mutual Fund Performance. Journal of Business Fogler, H.R., “Twenty Percent in Real Estate: Can Theory Justify It?” Journal of Portfolio Management 10 (1984):6–13. Miles, M.,McCue, T., “Diversification in the Real Estate Portfolio.” Journal of Financial Research 7 (Spring 1984):57–68. Hartzell, D., Hekman, J., Miles, M., “Diversification Categories in Investment Real Estate.” Journal of the American Real Estate and Urban Economics Association 13 (Spring 1985):32–47. Firstenberg, P.M., Ross, S.A., Zisler, R.C., “Real Estate: The Whole Story.” Journal of Portfolio Management 14 (Spring 1988):22–34. Viezer, T.W., “Evaluating ‘Within Real Estate’ Diversification Strategies.” Journal of Real Estate Portfolio Management 6 (2000):75–95. Viezer, T.W., “Building Real Estate Portfolios One Deal at a Time, with an eye on Diversification.” Real Estate Finance (Fall 1999a):1-­‐11. Ziering, B, McIntosh, W., “Property Size and Risk: Why Bigger is not Always Better”. Journal of Real Estate Portfolio Management. 1999. Esrig D, Hudgins M, and Cerreta, J. Revisiting the impact of Large Assets on Real Estate Portfolio Returns. Journal of Portfolio Management 35 no.5 (October 2011): 125-­‐136. Geltner, D. and N.G. Miller. Commercial Real Estate Analysis and Investments. Mason, OH: Thompson South-­‐Western, 2007. National Council of Real Estate Investment Fiduciaries website, <https://www.ncreif.org/property-­‐index-­‐
returns.aspx Black, T., Roy, “Real Estate in the Investment Portfolio”. Real Estate Issues 1 (Fall 2004). Black, F. “Beta and Return.” Journal of Portfolio Management: Fall 1993 Pai, Arvind and D. Geltner, “Stocks are from Mars, Real Estate is from Venus.” The Journal of Portfolio Management 33, no 5 (2007):134-­‐144. 2013 Institutional Real Estate Allocations Monitor, Cornell University and Hodes Weill & Associates (December 2013) The Tale of Two Markets: A Comparison of Performance between Class A Properties in Secondary Markets and Class B Properties in Primary Markets 65