1. Yale School of Management Global Real Estate Markets Cycles and Fundamentals Bradford Case William Goetzmann K. Geert Rouwenhorst

2. Yale School of Management Pension Plans and Real Estate “Pension-plan investment in real estate is extremely limited and much smaller than one would expect based on most mean- variance models” – Ciochetti et al. (1999) Target based on MV models: 15-20% Actual allocation: 3-4%

3. Yale School of Management Arguments for Real Estate Low correlation with other asset classes  Stocks and Bonds (Titman and Quan, 1999)  Regional Diversification (Goetzmann and Ibbotson 1990)  International Diversification (Eichholz 1996, Eichholz and Harzell, 1996), Liu and Mei, 1998, and others) Relatively high average return  Goetzmann and Ibbotson (1990), Provides a good hedge against inflation  Goetzmann and Ibbotson (1990), Titman and Quan (1999), Anari and Kolari (2002)

4. Yale School of Management Forms of Real Estate Investment Direct holdings in properties  Office  Industrial  Residential Investment though REITS – stock market

5. Yale School of Management Direct Investment versus Property Shares Returns on direct investment difficult to measure due to:  Appraisals  Taxes  Transactions Costs By comparison, share price data:  Behavioral biases

6. Yale School of Management Real Estate Market Integration Real estate is spacially immobile  Expect regional factors to predominate  Evidenced by diversification benefits 1991-1992: “Global” real estate crash  Important common component to real estate returns

7. Yale School of Management Global versus local factors Separate global from local factors in real estate returns Are national real estate markets correlated through a global or local GDP factor? Role for Shiller’s “macro futures”?

8. Yale School of Management Preview World real estate markets are correlated through common GDP effects A global real estate portfolio is a bet on trends in global production After controlling for global GDP, local effects are generally small.

9. Yale School of Management Data International Commercial Property Associates  Yields and cap-rates  Approximate effective rents Prime industrial, office, and retail real estate in 22 cities around the world,1987-1997 Converted to U.S. real dollars

10. Yale School of Management Total Returns Y = going in cap rate R = effective rent Assumes perpetuity formula holds

11. Yale School of Management A Decent Approximation? U.S. Industrial property;.84 correlation to NCREIF U.S. Office.54 correlation to NCREIF Little correlation to NAREIT An instrument for appraisal index

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14. CorrelationTest Test 1: Remove own GDP effect via regression. Examine change in avg. correlation Test 2: Remove global EW GDP effect via regression. Examine change in average correlation GDP factor = real $-valued percent change in annual GDP

15. Yale School of Management Removing GDP factors

16. Yale School of Management Global vs. Local Factors R 2 from TS regression on global vs. local & global (Chow test) Ratio: ) R 2 /global R 2 Measures incremental value of local over global What countries are driven by local GDP

17. Yale School of Management Local Factor Variance Ratio

18. Yale School of Management Time-Series Regressions Country-by-country regressions  GDP change, lagged GDP change and lagged return  Contemporaneous GDP factor significant U.S. regression  three lags of GDP change three lags of returns  Current GDP and lag-2 value significant

19. Yale School of Management Diversification Average percentage risk reduction by adding countries to portfolio Benefits to real estate diversification similar to equity markets Industrial has greatest benefit Office has least benefit

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21. GDP-Hedged Diversification How well does international diversification work if you could hedge GDP risk? Diversification limits:  Unhedged: 29.8%. (70.2% reduction)  Hedged against GDP risk: 8.6%. (>90% reduction) Robert Shiller: “Macro Markets”

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23. Conclusions Cross-border correlations of real estate captured by common exposure to world GDP Real estate is fundamentally local, but its covariance is global