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Global Real Estate Markets Cycles and Fundamentals

Global Real Estate Markets Cycles and Fundamentals. Bradford Case William Goetzmann K. Geert Rouwenhorst. Pension Plans and Real Estate.

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Global Real Estate Markets Cycles and Fundamentals

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  1. Global Real Estate Markets Cycles and Fundamentals Bradford Case William Goetzmann K. Geert Rouwenhorst

  2. Pension Plans and Real Estate • “Pension-plan investment in real estate is extremely limited and much smaller than one would expect based on most mean-variance models” – Ciochetti et al. (1999) • Target based on MV models: 15-20% • Actual allocation: 3-4%

  3. Arguments for Real Estate • Low correlation with other asset classes • Stocks and Bonds (Titman and Quan, 1999) • Regional Diversification (Goetzmann and Ibbotson 1990) • International Diversification (Eichholz 1996, Eichholz and Harzell, 1996), Liu and Mei, 1998, and others) • Relatively high average return • Goetzmann and Ibbotson (1990), • Provides a good hedge against inflation • Goetzmann and Ibbotson (1990), Titman and Quan (1999), Anari and Kolari (2002)

  4. Forms of Real Estate Investment • Direct holdings in properties • Office • Industrial • Residential • Investment though REITS – stock market

  5. Direct Investment versus Property Shares • Returns on direct investment difficult to measure due to: • Appraisals • Taxes • Transactions Costs • By comparison, share price data: • Behavioral biases

  6. Real Estate Market Integration • Real estate is spacially immobile • Expect regional factors to predominate • Evidenced by diversification benefits • 1991-1992: “Global” real estate crash • Important common component to real estate returns

  7. Global versus local factors • Separate global from local factors in real estate returns • Are national real estate markets correlated through a global or local GDP factor? • Role for Shiller’s “macro futures”?

  8. Preview • World real estate markets are correlated through common GDP effects • A global real estate portfolio is a bet on trends in global production • After controlling for global GDP, local effects are generally small.

  9. Data • International Commercial Property Associates • Yields and cap-rates • Approximate effective rents • Prime industrial, office, and retail real estate in 22 cities around the world,1987-1997 • Converted to U.S. real dollars

  10. Total Returns • Y = going in cap rate • R = effective rent • Assumes perpetuity formula holds

  11. A Decent Approximation? • U.S. Industrial property; .84 correlation to NCREIF • U.S. Office .54 correlation to NCREIF • Little correlation to NAREIT • An instrument for appraisal index

  12. CorrelationTest • Test 1: Remove own GDP effect via regression. Examine change in avg. correlation • Test 2: Remove global EW GDP effect via regression. Examine change in average correlation • GDP factor = real $-valued percent change in annual GDP

  13. Removing GDP factors

  14. Global vs. Local Factors • R2 from TS regression on global vs. local & global (Chow test) • Ratio: )R2/global R2 • Measures incremental value of local over global • What countries are driven by local GDP

  15. Local Factor Variance Ratio

  16. Time-Series Regressions • Country-by-country regressions • GDP change, lagged GDP change and lagged return • Contemporaneous GDP factor significant • U.S. regression • three lags of GDP change three lags of returns • Current GDP and lag-2 value significant

  17. Diversification • Average percentage risk reduction by adding countries to portfolio • Benefits to real estate diversification similar to equity markets • Industrial has greatest benefit • Office has least benefit

  18. GDP-Hedged Diversification • How well does international diversification work if you could hedge GDP risk? • Diversification limits: • Unhedged: 29.8%. (70.2% reduction) • Hedged against GDP risk: 8.6%. (>90% reduction) • Robert Shiller: “Macro Markets”

  19. Conclusions • Cross-border correlations of real estate captured by common exposure to world GDP • Real estate is fundamentally local, but its covariance is global

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