Real Estate Investment: Education & Practice: Do the Theories fit the Applications? Keith Lown & Michael White Nottingham Trent University

Most degree programmes include classes on investment analysis – Modern Portfolio Theory and The Capital Asset Pricing Model Real estate investment constitutes a major research area Theories used in equity markets usually taught in real estate degrees But how relevant are these theories for real estate investment? Investment Theory & Practice

Modern Portfolio Theory Modern Portfolio Theory (and its spin-off The Capital Asset Pricing Model) won Nobel Prizes for 3 famous financial economists: Harry Markowitz b University of Chicago - Modern Portfolio Theory (1952) John Lintner b.1916, d Harvard Business School - Capital Asset Pricing Model William F Sharpe b UCLA - A Simplified Model for Portfolio Analysis

The Market Model The expected return on an asset could be expressed as a linear function of the expected return on the market as a whole Expected Rate of Return Asset Specific variable β Beta value Expected rate of return on market Return on any asset related to a common index (the market as a whole) rather than on each other (as in MPT) The Capital Asset Pricing Model

Calculation of β Beta: Covariance of rate of return on the asset and portfolio Variance of the rate of return on the market β Beta Values β = 1asset/share rises and falls in line with the market β = >1asset/share rises and falls are more volatile than the market – Aggressive Asset β = <1asset/share rises and falls fluctuate less than market - Defensive Asset β = 0asset/share has no risk Used Extensively in Analysis of Equities Markets The Capital Asset Pricing Model

Equities Beta Calculations

CAPM Vocabulary has crept into Real Estate… Formula for the single asset portfolio including Beta

Theory and Practice Research Are these models used by real estate investors/fund managers? Can they be adopted? Should they be adopted? Clear limitations when considering the practicalities of investing in what is an imperfectly traded market with lumpy assets Is it appropriate only as top level asset allocation and not at sector selection?

Asset allocation Funds Real EstateBondsEquities Direct Indirect

Asset allocation Funds Real Estate BondsEquities DirectIndirect OfficesRetailIndustrialOther Indirect

Asset allocation Direct Offices RetailIndustrial Other City Centre Out of Town Business Parks High Street Retail Parks Shopping Centres LogisticsEstates Hotels Student Resi. Leisure Shopping Centres Regional Dominant Town Centre Suburban Town Centre Prime SecondaryTertiary

Where can MPT/CAPM be employed? MPT/CAPM?

Asset Allocation No consideration of international investment Is, can or should CAPM be used in determining allocations to direct real estate? If not, why teach it on real estate courses? Primary drivers for real estate investment = returns and liquidity not necessarily diversification

Research Methodology Quantitative Research Structured interviews with property fund managers Qualitative Research Is this even possible in that historic performance data for individual properties is not available in a format that can be useable?

Research Methodology Structured Interviews with Property Fund managers. Areas to be covered: The asset allocation process utilised? Structure characteristics of their funds? Decision Making Process Portfolio Allocation Role of Diversification Benchmarking provisions

The Pilot Study Early Indications from 3 UK Fund Managers The money coming into property is ever more sophisticated… We have to speak the right language Property is small beer compared to Equities There just isn’t the data to use CAPM properly CAPM can be another way of analysing real estate assets Property does not lend itself to such analysis We are more interested in risk management It is worthwhile teaching but… These tools are only used at a top level asset class allocation

Real Estate Investment Education & Real Estate Investment Practice: Do the Theories fit the Applications? Keith Lown & Michael White Nottingham Trent University Questions?