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

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Real Estate Investment: Education & Practice:

Do the Theories fit the Applications?

Keith Lown & Michael White

Nottingham Trent University


Investment Theory & Practice

  • 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?


Modern portfolio theory
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.1927

- University of Chicago

- Modern Portfolio Theory (1952)

John Lintner b.1916, d.1983

- Harvard Business School

- Capital Asset Pricing Model

William F Sharpe b.1934

- UCLA

- A Simplified Model for Portfolio Analysis


The Capital Asset Pricing Model

  • 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

Expected rate of return on market

β Beta value

  • 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 = 1 asset/share rises and falls in line with the market

β = >1 asset/share rises and falls are more volatile than the market – Aggressive Asset

β = <1 asset/share rises and falls fluctuate less than market - Defensive Asset

β = 0 asset/share has no risk

Used Extensively in Analysis of Equities Markets



Capm vocabulary has crept into r eal estate
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

Equities

Bonds

Real Estate

Indirect

Direct


Asset allocation

Funds

Equities

Bonds

Real Estate

Direct

Indirect

Offices

Retail

Industrial

Other

Indirect


Asset allocation

Direct

Retail

Industrial

Offices

Other

City Centre

Business

Parks

High Street

Out of Town

Shopping Centres

Retail Parks

Logistics

Estates

Student Resi.

Hotels

Leisure

Shopping Centres

Regional Dominant

Town Centre

Suburban

Town Centre

Prime

Secondary

Tertiary


Where can MPT/CAPM be employed?

MPT/CAPM?

MPT/CAPM?

MPT/CAPM?

MPT/CAPM?

MPT/CAPM?

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…

There just isn’t the data to use CAPM properly

CAPM can be another way of analysing real estate assets

We have to speak the right language

We are more interested in risk management

Property does not lend itself to such analysis

Property is small beer compared to Equities

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?


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