1. ERES 2011 The Performance Gap in UK Property Returns Stephen Lee e-mail: stephen.lee.1@city.ac.uk

2. Introduction: When we talk of the performance of direct property in the UK we typically refer to an average buy-and-hold return, also known as time-weighted return, for some widely used market index like the Investment Property Databank Annual Index (IPDAI). However, the returns of the investors in these assets can be quite different. Investor returns are determined not only by the returns on the underlying assets but also by the timing and magnitude of their capital flows into and out of these investments. To account for the annual-to-annual variation in assets under management, a dollar-weighted return has to be calculated, which weights the returns by the level of assets at each observation point (Dichev, 2007). NB: Negative PG Values are Good

3. Introduction: Dichev (2007) shows that the difference between returns of the underlying stocks and investor returns, the so called performance gap; can be significant in the stock market. The author finds that there is a +1.3% per annum performance gap for equities traded on NYSE and AMEX exchanges and a +5.3% performance gap for NASDAQ stocks. The performance gap averages +1.5% for 19 major international stock markets and +1.3% for the UK stock market. Subsequent studies have found similar differentials for other stock markets across the world.

4. Why the Poor Performance Gap in Stock Markets? Stock market investors are generally characterised as: 1.Chasing past winners but fail to find persistence in superior performance and 2.Are unwilling to book losses in persistent under-performing stocks,

5. The Performance Gap in Direct Real estate: There is reason to believe that the performance gap in direct property is likely to be different from that in stock markets. This is because, while there is evidence that property investors chase returns and so may invest at the wrong time and that real estate results show evidence of persistence in inferior performance, as is the case in the stock market, which may explain the positive performance gap. Unlike the stock market real estate returns also show persistence in the superior performing properties for a considerable length of time. Thus, direct real estate investors may show a negative performance gap depending on the extent of their capital allocations into persistent winners.

6. Measurement of Returns and Cash Flows:

7. NB: Negative PG Values are Good

8. Data: IPD 45 Market Segments: 1981-2009 Table 1: Market Segments Summary Statistics: Annual Data 1981-2009

9. Table 2: Market Segment Performance Gaps: Annual Data 1981-2009 NB: Negative PG Values are Good

10. Table 3: Statistically Significant of Negative and Positive Performance Gaps

11. Cash Flows: Table 4: The Correlation of Cash Flows and Returns

12. Cash Flows: Table 4: Conditional Cash Flow and Returns

13. Performance Persistence: Table 5: Performance Persistence and the Performance Gap

14. Conclusions: This study provides the first evidence on the magnitude of the difference between returns to UK property investors and the returns achieved by the property assets, i.e. the performance gap. Using annual data over the period from 1981 to 2009 we find that the performance gap in UK property returns shows a number of features of interest. First, the results reveal that the simple-average and weighted- average performance gaps from 1981 through 2009 were -1% and -0.49% per annum, respectively. In other words, UK direct property investors as a group have shown greater returns than their underlying investments. That is, estimates of the performance of the UK property market based on time-weighted returns do not reflect the experience of actual property investors as a group.

15. Conclusions: Secondly, we provide evidence of a significant positive correlation between capital flows and lagged returns, which can be explained by the proclivity of investors to chase winners, which then prove disappointing and that investors display a distinct loss aversion. Lastly, we show that the persistence in superior (inferior) returns in the UK property market does not automatically lead to a strong negative (positive) gap. Nonetheless, the more time the segment out performs its peers the better the performance investors achieve and visa versa.

16. Conclusions: This paper also has an important implication for UK property investors since the two measures of past performance show a number of differences because of the timing of capital flows, UK direct property market investors should also consider dollar-weighted returns in addition to time-weighted returns when assessing the historical performance of property, a practice that is already available in the US Mutual fund industry.

17. The Performance Gap in UK Property Returns Any Questions?