Public and Private Real Estate: ERES Milan 2010 The Benefits of Public and Private Real Estate Stephen Lee Cass Business School

Public and Private Real Estate: ERES Milan 2010 Introduction: There is extant literature showing that private real estate has a major part to play in the mixed-asset portfolio. There is also a good deal of evidence showing that REITs makes a substantial contribution to the mixed-asset portfolio. But only two studies have explicitly examined what risk/return benefits real estate actually offers the mixed-asset portfolio, i.e. is real estate is a return enhancer, diversifier or both? However, neither study examined whether real estate, either public or private, offers a benefit to the mixed-asset portfolio if such a portfolio already includes the alternative real estate vehicle.

Public and Private Real Estate: ERES Milan 2010 Introduction: This is important as Paglari et al (2003) argue that the public- and private-market vehicles should be viewed somewhat interchangeably. Thus, it is maybe that only one of them may be able to offer a positive benefit to the MAP if the other real estate vehicle is already present. Indeed, previous studies by Lee and Stevenson (2005) Chiang and Lee (2007) Lee, et al. (2007) Lee (2009) find that REITs have little place in the MAP if private real estate is already present.

Public and Private Real Estate: ERES Milan 2010 Diversification and Return Benefits: The simplest way to examine the benefit from holding a portfolio consisting of an allocation w in investment i and (1-w) in an existing portfolio is to calculate the difference in returns between the old and new portfolios. However, because the old and new portfolios have different risk characteristics the two portfolios cannot be compared directly. Liang and McIntosh (1999) therefore suggest using the risk- adjusted performance (RAP) measure developed by Modigliani and Modigliani (1997) to make the risks of the two portfolios comparable, which then allows the two portfolios to be compared on an equivalent basis.

Public and Private Real Estate: ERES Milan 2010 Diversification and Return Benefits: After some algebra Liang and McIntosh (1999) show that when the weight of the new investment tends to zero, the marginal benefit of investment i with an existing (old) portfolio can be shown by the following:

Public and Private Real Estate: ERES Milan 2010 Data: Data for the Private Real Estate market is represented by the MIT Transaction Based Index (TBI) Data for the public real estate market is represented by the Equity REIT (EREIT) index complied by the National Association of Real Estate Investment Trusts (NAREIT). The comparable stock and bond indexes are: Large Capital Growth Stocks (LCGS); Large Capital Value Stocks (LCVS); Small Cap Growth Stocks (SCGS); Small Cap Value Stocks (SCVS); Long-Term Government Bonds (LTGB) and Cash (TBs). The data for the growth and values stocks collected from the French website, while all the other data is collected from Ibbotson Associates (2010). The data is quarterly from 1984:1 to 2009:4

Public and Private Real Estate: ERES Milan 2010 Data The analysis conducted on the full sample period (1984:1 to 2009:4) and for three sub-periods 1984:1 to 1992:4; 1993:1 to 1999:4 and 2000:1 to 2009:4. The selection of the 1993 cut-off point is the same as that in Lee and Lee (2003); Clayton and Mackinnon (2003) and Lee et al. (2008) and reflects the structure change in the REIT industry following the introduction of the Revenue Reconciliation Act of The selection of the 2000 cut-off point corresponds to the enactment of the REIT Modernization Act 1999 and is the same as that used by Liu (2009).

Public and Private Real Estate: ERES Milan 2010 Table 1: Summary Statistics: Quarterly Data: 1984:Q1 to 2009:Q4

Public and Private Real Estate: ERES Milan 2010 Table 2: Annualised Overall, Diversification and Return Benefit of Private Real Estate:

Public and Private Real Estate: ERES Milan 2010 Table 3: Annualised Overall, Diversification and Return Benefit of Public Real Estate:

Public and Private Real Estate: ERES Milan 2010 Table 4: Annualised Overall, Diversification and Return Benefit of Private Real Estate to the MAP with and without REITs

Public and Private Real Estate: ERES Milan 2010 Table 5: Annualised Overall, Diversification and Return Benefit of REITs to the MAP with and without Private Real Estate

Public and Private Real Estate: ERES Milan 2010 Conclusion: Numerous studies have examined the allocation of public and private real estate in the MAP and find that a large allocation to both forms of real estate can be justified. But only two studies have explicitly examined what risk/return benefits real estate actually offers the MAP, i.e. whether real estate is a return enhancer, diversifier or both? However, neither study examined whether real estate, either public or private, offers a benefit to the MAP if such a portfolio already includes the alternative real estate asset class.

Public and Private Real Estate: ERES Milan 2010 Conclusion: Using quarterly data over the period from Q1:1984 to Q4:2009 and the method suggested by Liang and McIntosh (1999). The results show that private real estate generally offers a positive benefit to the alternative assets classes and the standard financial MAP, with or without REITs. The benefit of private real estate mainly coming from its diversification benefits rather than any return enhancement. Nonetheless, the results also indicate that the benefit of private real estate to the US capital market portfolio can show substantial changes through time.

Public and Private Real Estate: ERES Milan 2010 Conclusion: In contrast, REITs shows lower benefits to stocks and the standard financial MAP than private real estate, but a higher benefit to bonds. Additionally, the results show that like private real estate the benefits of REITs show substantial changes through time. Nonetheless, any benefit REITs did show to the MAP is eliminated if private real estate is also included. Thus, whether REITs can have a place in any future MAP largely depends on the relative return performance of REITs versus the alternative financial asset classes within the MAP and whether private real estate is already present.

Public and Private Real Estate: ERES Milan 2010 The Benefits of Public and Private Real Estate Any Questions?