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Florian Heydenreich, Daniel Kohlert and Andreas Oehler Bamberg University, Germany

Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?. Florian Heydenreich, Daniel Kohlert and Andreas Oehler Bamberg University, Germany Chair of Finance. ERES conference 2009 24th – 27th of July

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Florian Heydenreich, Daniel Kohlert and Andreas Oehler Bamberg University, Germany

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  1. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? Florian Heydenreich, Daniel Kohlert and Andreas OehlerBamberg University, Germany Chair of Finance ERES conference 2009 24th – 27th of July Stockholm

  2. Heydenreich, Kohlert, Oehler (1) Introduction Successful real estate investment depends on an understanding of the determinants of real estate returns (Fraser 1986). Various studies have shown that economic factors are important determinants of real estate returns (e.g., Chin 2003, Jackson / White 2005, Ziering / Hess 1995). Most studies, however, are based on national economic data (e.g., Hendershott et al. 1999 and 2002, Wheaton et al. 1997). Potential conflict between national economic data and regional, local or object-specific return data and investment strategies. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

  3. Heydenreich, Kohlert, Oehler (2) Data and Methodology • Level: NUTS 2 (27 of 37 UK regions) • Time horizon: 1981 – 2004 (yearly) Return data: IPD Investment Property Databank Annual total return (TRt), income return (IRt) and capital growth (CAt) data for office buildings • Economic data: Cambridge Econometrics • Annual GDP (GDPt), unemployment (UEPt), and total investment (INVt) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 3

  4. Heydenreich, Kohlert, Oehler (2) Data and Methodology • Panel Analysis • Static random-effects model (GLS): • Rit = β1x1it+…+ βKxKit + μi +νit • Dynamic random-effects model (GMM): • Rit = β0Ri, t-1+ β0Ri, t-2+ βKxKit +…+ βKxKit + μi +νit • Rit: return variable (CA, IR, TR) of region i in period t • xKit: macroeconomic demand variable (GDP, UEP, INV) of region i in period t • βK: parameter, μi: region specific intercept, νit: overall remainder Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 4

  5. Heydenreich, Kohlert, Oehler (3) Results • Descriptives • Capital Growth R = Region Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 5

  6. Heydenreich, Kohlert, Oehler (3) Results • Descriptives • Investment Return R = Region Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 6

  7. Heydenreich, Kohlert, Oehler (3) Results • Descriptives • Total Return R = Region Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 7

  8. Heydenreich, Kohlert, Oehler (3) Results • Descriptives (Panel) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 8

  9. Heydenreich, Kohlert, Oehler Panel Analysis: Capital Growth Panel Analysis: Capital Growth 9 Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

  10. Heydenreich, Kohlert, Oehler Panel Analysis: Investment Return Panel Analysis: Investment Return 10 Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

  11. Heydenreich, Kohlert, Oehler (3) Results Panel Analysis: Total Return Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 11

  12. Heydenreich, Kohlert, Oehler (3) Results The estimated regression coefficients reveal autoregression for each of the dependent variables Economic factors influence real estate performance criteria However: UEP not important, GDP not the expected sign Data (sample) error? Methodological errors? Does the identical slope assumption make sense? Extra tests (ADR) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 12

  13. Heydenreich, Kohlert, Oehler (4) Extra Tests Autoregressive Distributed Lag Model (n=2, p=1; regional) Number of significant regional results per criterion (univariate) (multivariate, step-ls!) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 13

  14. Heydenreich, Kohlert, Oehler (5) Conclusion The available time series are still to short to offer safe statements about the influence of the regional economic factors GDP, INV and UEP on regional real estate performance. At this point, however, it cannot be recommended to ignore the peculiarities of single regions and to rely solely on national data. The lags of the dependent variables often seem to explain regional real estate performance better than demand-side variables. There might also be a strong influence of non-macro-economic factors, particularly supply-side factors, that have greater explanatory power. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 14

  15. Heydenreich, Kohlert, Oehler Thank you for your comments! Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 15

  16. Heydenreich, Kohlert, Oehler References Ball, M., C. Lizieri and B. MacGregor, B., The Economics of Com­mercial Property Markets, 2001, 2nd edition, London. Brooks, C. and S. Tsolacos, The impact of economic and financial factors on UK property performance, Journal of Property Research, 1999, 15, 327-328. Brooks, C. and S. Tsolacos, Linkages between property asset returns and interest rates: Evidence for the UK, Applied Economics, 2001, 33:6, 711-719. Brounen, D. and P. Eichholtz, Demographics and the Global Office Market – Consequences for Property Portfolios, Journal of Real Estate Portfolio Management, 2004, 10:3, 231-242. Chin, W., Factors for Determining the Office Markets in Southeast Asian Cities with reference to Hong Kong, Singapore, Taipei, Bangkok and Kuala Lumpur, Paper presented at the RICS Cutting Edge Conference 2001. Chin, W., Economic Factors Affecting Office Rental Values in Southeast Asian Cities: The case of Singapore, Hong Kong, Taipei, Kuala Lumpur and Bangkok, Paper presented at the PRES Conference 2003. D'Arcy E., T. McGough and S. Tsolocos, Modelling the Determinants of Office Rental Values in Major European Cities , Discussion papers in Urban and Regional Economics, 1994, Series C, VII: 99, Department of Economics, The University of Reading, Reading. D'Arcy E., T. McGough and S. Tsolocos, National Economic Trends, Market Size and City Growth Effects on European Office Rents, Journal of Property Research, 1997, 13:4, 297-308. D'Arcy E., T. McGough and S. Tsolocos, An Econometric Analysis and Forecast of the Office Rental Cycle in the Dublin Area, Discussion papers in Urban and Regional Economics, 1998, Series C, XI:33, Department of Economics, The University of Reading, Reading. De Wit, I. and R. van Dijk, The Global Determinants of Direct Office Real Estate Returns, Journal of Real Estate Finance and Economics, 2003, 26:1, 27-45. Eichholtz, P., M. Hoesli, B. MacGregor and N. Nanthakumaran, Real Estate Portfolio diversification by property type and region, Journal of Property Finance, 1995, 6:3, 39-59. Fraser, W., Property Yield Trends in a Fluctuating Economy, Journal of Property Valuation and Investment, 1986, 4:3, 239-260. Goetzmann, W. and S. Wachter, Clustering Methods for Real Estate Portfolios, Real Estate Economics, 1995, 23:3, 271-310. Gordon, J., P. Mosbaugh and T. Canter, Integration Regional Economic Indicators with the Real Estate Cycle, Journal of Real Estate Research, 1996, 12:3, 469-501. Giussani B., M. Hsia and S. Tsolocas (1993a), A Comparative Analysis of the Major Determinants of Office Rental values in Europe, Journal of Property Valuation and Investment, 1993, 11, 157-173. Hartzell, D., D. Shulman and C. Wurtzebach, Refining the Analysis of Regional Diversification for Income-Producing Real Estate, Journal of Real Estate Research, 1987, 2:2, 85-95. Hendershott, P., C. Lizieri and G. Matysiak, The Workings of the London Office Market, Real Estate Economics, 1999, 27:3, 365-387. Hendershott, P., B. MacGregor and M. White, Explaining Real Commercial Rents Using an Error Correction Model with Panel Data, Journal of Real Estate Finance and Economics, 2002, 24:1/2, 59-87. IPD Index Guide 2008, 3rd edition. Jackson, C. and M. White, Challenging Traditional Real Estate Market Classifications for Investment Diversification, Journal of Real Estate Portfolio Management, 2005, 11:3, 307-321. Jäger, M. and M. Voigtländer, Determinanten der Renditen von Büroimmobilien, Research Paper of the Institute of the German Economy (Institut der Deutschen Wirtschaft, Köln), 2007. Kling, J.L. and T.E. McCue, Office building investment and the macroeconomy: Empirical evidence, Real Estate Economics, 1987, 15:3, 234-255. Kurzrock, B.-M., B. Rottke and D. Schiereck, Influence Factors on the Performance of Direct Property Investments, Paper presented at the ERES Conference 2007. Ling, D.C. and Naranjo, A., Economic risk factors and commercial real estate returns, Journal of Real Estate Finance and Economics, 1997, 14:3, 283-307. Ling, D.C. and Naranjo, A., The fundamental determinants of commercial real estate returns, Real Estate Finance, 1998, 14:4, 13-24. Malizia, E. and R. Simons, Comparing Regional Classifications for Real Estate Portfolio Diversification, Journal of Real Estate Research, 1991, 6:1, 53-77. McCue, T.E. and Kling, J.L., Real estate returns and the macroeconomy: Some empirical evidence from real estate investment trust data 1972-1991, Journal of Real Estate Research, 1994, 9:2, 277-287. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 16

  17. Heydenreich, Kohlert, Oehler References McGough T. and S. Tsolocas, Forecasting Commercial Rental Values Using ARIMA Models, Journal of Property Valuation and Investment, 1994, 13:5, 6-22. McGough T. and S. Tsolocas, Property Cycles in the UK: an Empirical Investigation of the Stylised Facts, Journal of Property Finance, 1995, 6:4, 45-62. McGough T., O. Olkkonen and S. Tsolocas (1998), The Cyclical Behaviour of Office Rents in Helsinki, European Real Estate Society’s Annual Conference 1998, Maastricht, The Netherlands. Mueller, G. and B. Ziering, Real Estate Portfolio Diversification Using Economic Diversification, Journal of Real Estate Research, 1992, 7:4, 375-386. Mueller, G., Refining Economic Diversification Strategies for Real Estate Portfolios, Journal of Real Estate Research, 1993, 8:1, 55-68. Nelson, T. and S. Nelson, Regional Models for Portfolio Diversification,Journal of Real Estate Portfolio Management, 2003, 9:1, 71-88. Nitsch, H., Die Bedeutung lokaler Marktlagen für die Immobilieninvestition, Zeitschrift für Immobilienökonomie, 2004, 2, 66-82. Quigley, J., Real Estate Prices and Economic Cycles, International Real Estate Review, 1999, 2:1, 1-20. Shilton, L., The changing demand for office space, Real Estate Review, 1995, 25:2, 89-94. Tsolacos, S., G. Keogh and T. McGough, Modelling use, investment and development in the British office market, Environment and Planning A,1998, 30, 1409-1427. Tsolacos, S. and T. McGough, Rational Expectations, Uncertainty and Cyclical Activity in the British Office Market, Urban Studies, 1999, 36:7, 1137-1149. Viezer, T., Evaluating Within Real Estate Diversification Strategies, Journal of Real Estate Portfolio Management, 2000, 6:1, 75-95. West, T. and A.C. Worthington, Macroeconomic risk factors in Australian commercial real estate, listed property trusts and property sector stock returns: A comparative analysis using GARCH-M, Journal of Financial Management of Property and Construction, 2006, 11:2, 21-31. Wheaton, W., The Cyclic Behavior of The National Office Market, AMERICAN REAL ESTATE AND URBAN ECNOMOMICS ASSOCIATION Journal, 1987, 5:4, 281-299. Wheaton, W.C., R.G. Torto and P. Evans, The cyclic behaviour of the Greater London office market, Journal of Real Estate Finance and Economics, 1997, 15:1, 77-92. Wurtzebach, C., The Portfolio Construction Process, Prudential Real Estate Investors, 1998. Ziering, B. and R. Hess, A Further Note on Economic Versus Geographic Diversification, Real Estate Finance, 1995, 12:3, 53-60. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 17

  18. Heydenreich, Kohlert, Oehler Return Formula CV = capital value, CE = capital expenditures, NR = net rent 18 Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

  19. CA, GDP

  20. CA, INV

  21. CA, UEP

  22. IR, GDP

  23. IR, INV

  24. IR, UEP

  25. TR, GDP

  26. TR, INV

  27. TR, UEP

  28. CA, ALL

  29. IR, ALL

  30. TR, ALL

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