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alex.moss@consiliacapital malcolm.frodsham@realestatestrategies.co.uk

alex.moss@consiliacapital.com malcolm.frodsham@realestatestrategies.co.uk. MEASURING RETURNS ACROSS THE FOUR QUADRANTS OF rEAL eSTATE : A UK CASE sTUDY. ERES Presentation 6 th July 2013. Alex Moss, Consilia Capital Malcolm Frodsham , Real Estate Strategies. CONTENTS.

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alex.moss@consiliacapital malcolm.frodsham@realestatestrategies.co.uk

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  1. alex.moss@consiliacapital.commalcolm.frodsham@realestatestrategies.co.ukalex.moss@consiliacapital.commalcolm.frodsham@realestatestrategies.co.uk MEASURING RETURNS ACROSS THE FOUR QUADRANTS OF rEALeSTATE : A UK CASE sTUDY ERES Presentation 6th July 2013 Alex Moss, Consilia Capital Malcolm Frodsham, Real Estate Strategies

  2. CONTENTS • Purpose of the Study • Background • Methodology • Results • Summary and Conclusions Consilia Capital 2013 www.consiliacapital.com

  3. PURPOSE OF THE STUDY The last three years has seen an increase in both investor interest in real estate, and new vehicles created for investment across all four quadrants (Public/Private, Debt/Equity) However, we do not believe that there has been a commensurate level of research identifying the expected level of risk and returns from vehicles in each of the four quadrants, both on a comparative basis and specifically relative to an underlying real estate benchmark The purpose of this study, which is the first in a series on this topic, is to generate a series of returns for each quadrant with the returns in the direct market as a common factor This study will present the methodology employed and quantify the returns in each quadrant over identifiable stages of the cycle Consilia Capital 2013 www.consiliacapital.com

  4. BACKGROUND CONSTRUCTING INDICES FOR THE FOUR QUADRANTS • This study generates comparable return series for each of the four quadrants from a single common factor to returns: the ungeared market return • The ungeared market return represents the underlying real estate market return before the influence on vehicle returns of: • Leverage / LTV / Seniority • The activities associated with the operation of real estate investment vehicles • Asset allocation / stock selection (alpha) / style • Liquidity mechanism (closed / open ended, bid-offer spread, equity raising) • Costs • Cash • We have not de-smoothed the market return Consilia Capital 2013 www.consiliacapital.com

  5. METHODOLOGY • This study focusses purely on the UK market, over the period 1992-2012 • For consistency, we have taken the IPD All Property Index as a proxy for the returns available for the direct market • In order to decompose returns and provide a framework for understanding the relationship between them we have then created synthetic across each of the four quadrants as follows: • Private Equity – applying a LTV proxy to the IPD ungeared returns, deduct costs and cash drag • Public Equity – applying the prevailing sector NAV discount / premium and a sector LTV proxy to the IPD ungeared returns • Private Debt - we have modelled the delinquencies using assumptions regarding movements in direct asset capital values and the interest received from estimates of fees and margins over swap rates. Marked-to-market the nominal debt using current lending costs. • Listed debt – As for private debt but marked-to-market the nominal debt using corporate bond yields • For the actual returns we have taken the EPRA UK Total Return Index for listed real estate and the IPD AREF Pooled Funds Index for unlisted real estate. Consilia Capital 2013 www.consiliacapital.com

  6. METHODOLOGY • In order to better understand the performance of each of the quadrants at different stages of the cycle we have broken the twenty year period 1992-2012 into the following five style periods: • End Sep 1992 – End Mar 1998 Interest led recovery • End Mar 1998 - End Mar 2002 TMT Boom • End Mar 2002 - End Dec 2006 The Bull Market • End Dec 2006 - End Mar 2009 The Bear Market • End Mar 2009 - End March 2012 QE Driven Rebound Consilia Capital 2013 www.consiliacapital.com

  7. RESULTSTHE UNDERLYING REAL ESTATE MARKET RETURNS Source: IPD Monthly Index Consilia Capital 2013 www.consiliacapital.com

  8. RESULTSQUADRANT ONE: PRIVATE EQUITY • Underlying IPD Monthly Index • The average leverageof the IPD/AREF Pooled Funds Index • To adjust for costs & fees we reduce the income return by 66bps* • Assume the average cash holdings of Balanced Funds in the IPD/AREF Pooled Funds Index and a monthly LIBOR cash return *IPF A Decade of Fund Returns 2012 Consilia Capital 2013 www.consiliacapital.com

  9. THE DATAQUADRANT TWO: PUBLIC EQUITY • Underlying IPD Monthly Index • LTV ratios of a leading UK company to replicate gearing • The average discount to LTV is extracted from the equity market. To adjust for costs we reduce the income return by 100bps Consilia Capital 2013 www.consiliacapital.com

  10. THE DATAQUADRANT THREE: PRIVATE DEBT • Loans are assumed to be 5-year bullet loans, 60% LTV (no ICR restriction) • Interest = 5-year swap rate plus margin* • Fees are assumed at beginning of term* • The probability of default is defined as the probability that the collateral value falls by an amount such that the equity is wiped out (no interest default) • Defaults are estimated at the end of the 5-year period • A 10% impairment charge is imposed if the loan defaults • Example: • Loan made in January 1990 • Subsequent 5-year capital growth = -15.6% (source: IPD Monthly Index) • Standard deviation of 5-year asset capital values = 6.3% pa (Source: bespoke research using IPD Annual Index) • Probability of Default = 34.9% (probability that 5-year capital growth < -40%) • Expected Loss = -10.8% (including 10% impairment charge) *De Montfort University Consilia Capital 2013 www.consiliacapital.com

  11. THE DATAQUADRANT THREE: PRIVATE DEBT Consilia Capital 2013 www.consiliacapital.com

  12. THE DATAQUADRANT THREE: PRIVATE DEBT ? Consilia Capital 2013 www.consiliacapital.com

  13. MARKING-TO-MARKETQUADRANT THREE: PRIVATE DEBT • Q: How can / should the debt be marked-to-market each period? • Adjust loan value for changes in interest rates • Adjust loan value for changes in risk of the loan / Expected Loss • No real data on margin versus LTV over time • Approach taken: As LTV changes through time the appropriate margin is increased by 1bp per 1% of extra LTV. For example • A 60% LTV = 1.0% margin • A 70% LTV = 2.0% margin • Example: Loan made in January 1990, Swap rate = 12.4% Consilia Capital 2013 www.consiliacapital.com

  14. RETURNSQUADRANT THREE: PRIVATE DEBT • We have assumed an equal value loan is made every month • Return in any single month depends on the: • Current swap rates and margins • Average interest rate of made in previous 60 months • Losses on loan made 60 months previously • Change in mark-to-market value of loan principal Consilia Capital 2013 www.consiliacapital.com

  15. THE DATAQUADRANT THREE: PRIVATE DEBT Assumptions: 5-year bullet loans, 5-year swap rates + margin + fees, debt marked to market at prevailing costs adjusted for average current LTV Consilia Capital 2013 www.consiliacapital.com

  16. THE DATAQUADRANT FOUR: PUBLIC DEBT • We have marked to market using the yield to maturity on corporate bonds Assumptions: 5-year bullet loans, 5-year swap rates + margin + fees, debt marked to market at prevailing costs adjusted for average current LTV Consilia Capital 2013 www.consiliacapital.com

  17. RESULTSFOURQUADRANT Consilia Capital 2013 www.consiliacapital.com

  18. RESULTSFOURQUADRANT Consilia Capital 2013 www.consiliacapital.com

  19. SUMMARY AND CONCLUSIONS • The four quadrants are bound together by their common exposure to the underlying commercial real estate market • Investors must make careful and continuous assessment of the prospects in the direct market when assessing the prospects for any individual quadrant • When assessed independently, from two different perspectives, credit and equity analysts can reach different valuation judgements • Investors that monitor all four quadrants are more likely to identify the investment opportunities that most closely match their investment requirements • Once a quadrant is selected investors must then choose from a wide array of individual investment vehicles comprising the investible universe Consilia Capital 2013 www.consiliacapital.com

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