McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. Chapter 22: Real Estate Investment Performance and Portfolio Considerations

22-2 Real Estate Investment Performance  Limited data –Private, negotiated transactions –Asset is non-homogeneous –Thinly traded market –Real estate specific data sources  NAREIT  NCREIF Property Index

22-3 Exhibit 22-2 Cumulative Total Returns REITs, S&P 500, NCREIF, Bonds, and T-Bill Indexes,

22-4 Real Estate Investment Performance  Holding Period Returns P T = End of period price P T-1 = Beginning of period price D 1 = Dividends

22-5 Real Estate Investment Performance  Example 22-1: –Purchase price $100 –Sales price $110 –Dividend received $5 –HPR = $15/$100 = 15%

22-6 Real Estate Investment Performance  Geometric Mean Return  Arithmetic Mean – a simple (non-compounded) average

22-7 Real Estate Investment Performance  Example 22-2 –Consider the following annual returns:  15%, 20%, -30%, 22% –Arithmetic mean = ( )/4 = 9.25% –Geometric mean =[(1.25)(1.2)(.7)(1.22)] –Geometric mean = 6.39%

22-8 Real Estate Investment Performance  Historical comparisons  Risk –Business risk –Default risk (from leverage) –Liquidity risk  Variability in asset returns & risk premiums

22-9 Real Estate Investment Performance  Coefficient of Variation –= Standard Deviation of Returns/Mean Return –Risk per unit of return –Also known as “risk-to-reward” ration  Portfolios –Asset efficiency: Does adding an asset to a portfolio add to returns while maintaining or lowering portfolio risk?  Portfolio Returns Where W’s are weights

22-10 Exhibit 22-8 Portfolio Returns of NCREIF and S&P 500 Stocks,

22-11 Exhibit 22-9 Efficient Frontiers

22-12 Real Estate Investment Performance  Example 22-3  Portfolio –Asset A: weight 30%, return 10% –Asset B: weight 40%, return 15% –Asset C: weight 30%, return 18%  Portfolio return –(.3x10)+(.4x15)+(.3x18)= 14.4%

22-13 Real Estate Investment Performance  Portfolio risk –Standard deviation  Not a weighted average  There is interaction between returns of assets  Covariance –Absolute measure of how two data series (such as asset returns) move together over time

22-14 Real Estate Investment Performance  Correlation –Relative measure of movement –Range of +1 to -1 –For example, as the correlation approaches +1, two series are said to move very closely together. The converse is also true.

22-15 Real Estate Investment Performance  Portfolio weighting –Efficient frontier  Maximum return for a given risk level  Diversification & real estate –Historical evidence –NCREIF Index & appraisal smoothing –Traded REITs & public markets risk

22-16 Exhibit NCREIF versus NAREIT (REITs) Quarterly Returns,

22-17 Real Estate Investment Performance  Diversification –Property Type & Location  Global diversification –Evolution of global REIT structures –CMBS markets –International Indices  Socially responsible property investing

22-18 Exhibit NCREIF Returns by Property Type, Four Quarter Rolling Total

22-19 Exhibit NCREIF Returns by Selected MSA, Four Quarter Rolling Total

22-20 Real Estate Investment Performance  Diversification & global cities  Risks of global investment –Currency risk –Incomplete information –Different tax laws & property rights –Political risk –Communication & culture differences

22-21 Exhibit Largest Commercial Real Estate Markets

22-22 Exhibit GDP Growth Rates for Different Global Cities

22-23 Real Estate Investment Performance  Derivatives –Derivatives allow investors to take a position in real estate without actually buying or selling properties. –Long & short positions –Overexposure & underexposure to property types