Real Estate Investment and Risk Management Survey 2007 Preliminary Results

Transcription

1 EDHEC Asset Management Days 2007 Geneva, March 13 th 16:00-18:00 Real Estate Investment and Risk Management Survey 2007 Preliminary Results Frédéric Ducoulombier, CAIA SM Associate Professor of Finance, EDHEC Business School Director, EDHEC Asset Management Education

2 Real Estate Investment and Risk Management 1. Revisiting real estate as an asset allocation class 1.1 The case for real estate: a brief review of academic results 1.2 Real estate as an asset class: investors perceptions 2. Real estate risks and risk management 2.1 Investors risk perceptions and risk management practices 2.2 The benefits and challenges of real estate diversification 3. New investment vehicles: unlisted funds, REITs, and indices 3.1 Investors perceptions and practices 3.2 Benefits and limits of unlisted funds and REITs 3.3 The potential of indices as investment vehicles 4. The emergence of property derivatives 4.1 Benefits, limits and challenges of property derivatives 4.2 Investors perceptions and expectations 2

3 1.1 The case for real estate: review of academic results The state and limits of knowledge 30 years of academic research have confirmed the excellence of real estate as a diversifier. However, data availability and quality limits make it difficult to define an optimal allocation. The emergence of information providers compiling indices is a recent phenomenon in all but a few countries. Reference commercial property indices are based on surveyors intermittent and subjective valuations which results in late availability, smoothing, lagging and seasonality in data. 3

4 1.1 The case for real estate: review of academic results Real estate in an asset management perspective The early applications of modern finance tools to multi asset class portfolios typically suggested unreasonably high allocations to real estate. Recent studies addressing the biases of indices recommend allocating between 15% and 30% to real estate based on a risk budget comparable to a 60%-40% equities-bonds allocation. 4

5 1.1 The case for real estate: review of academic results Real estate in an asset management perspective Using an unsmoothed constant-liquidity index, Feldman (2003) suggests an optimal allocation to domestic real estate of up to 21% in the U.S. over Direct real estate and REITs typically appear as complements rather than substitutes: the more risk averse investors favour direct real estate for its low risk and diversification benefits, the allocation to REITs rises when investors are ready to take on more risk as they offer more attractive risk adjusted returns. When international investment is allowed for, the overall allocation to real estate is generally found to increase e.g. Hoesli, Lekander, and Witkiewicz (2003;2004) 5

6 1.1 The case for real estate: review of academic results Real estate in an AM perspective: Feldman (2003) 100% Optimal Portfolio Weights - United States % 80% 70% 60% 17,0% 18,4% 50% 14,5% 40% 30% 10,7% 27,5% 35,2% 37,1% 20% 10% 0% 6,5% 4,9% 3,6% 3,8% 16,6% 5,0% 7,5% 6,5% 7,8% 7,0% 10,8% 13,2% 13,7% 12,8% vol:2% - avg:7% vol:4% - avg:8,8% vol:6% - avg:10,6% vol:7,7% - avg:11,9% vol:8% - avg:12,1% vol:10% - avg:13,5% vol:12% - avg:14,3% E-REITs NCREIF CL S&P500 Small Caps MSCI EAFE LT Bonds Cash Feldman (2003) 6

7 1.1 The case for real estate: review of academic results Real estate in an ALM perspective Craft (2001;2005) found a maximum allocation to domestic US REITs and direct real estate of 21% over and documented negative relationships between: (i) risk tolerance and overall allocation to the class as well as share of direct investments in the real estate portfolio, (ii) underfunding and allocation to real estate due to negative/low correlations between real estate and liabilities. Booth (2002) looked at the impact of liabilities on the allocation to domestic real estate. Over , he found allocations in the 5%-10% range in a domestic setting after excluding inflation linked bonds. Low correlations with liabilities were observed. 7

8 1.1 The case for real estate: review of academic results Real estate in an ALM perspective Good correlation to inflation and demographic factors would support the use of real estate for liability-hedging. There is no longer a consensus on whether real estate is a good hedge against inflation; however the question is not yet settled. Studies looking at housing and residential real estate or the longterm confirm inflation protection benefits e.g. Bond & Seiler (1998), Quan & Titman (1999), Goetzmann & Valaitis (2006). Further research is warranted to establish the relevance of real estate within a multi class hedging portfolio. 8

9 1.2 Real estate as an asset class: investors perceptions Geographic and institutional coverage of survey Survey conducted between November 2006 and March 2007 Preliminary results based on 126 completed questionnaires Geographic break-up Europe: 91.3%, USA: 6.4%, Asia: 2.4% In Europe: EU15: 83.5%; EU25-EU15: 2.6%, Switzerland: 12.2% Institutional break-up Insurance companies, pension funds, foundations: 36.5% Diversified asset managers: 32.5%, Real estate investment managers/funds and REITs: 20.6% Private Bankers, Family Offices, Consultants, Others: 10.4% 9

10 1.2 Real estate as an asset class: investors perceptions High level functional coverage of survey Functions 24% President, MD, Deputy MD, Pension fund manager 23% CFO/CIO/CIS, Head of Research 5.6% CIO Alternative Investments, CIO Real Estate 14.3% Fund/portfolio manager 5.6% Investment officers, assistant fund/portfolio managers 4.8% Analysts 2.4% Risk managers. 10

11 1.2 Real estate as an asset class: investors perceptions Experienced survey respondents Experience of real estate 82.5% standing real estate investments 4.8% investments in progress 6.3% reviewing the appropriateness of the class 4.8% no investment project Invested institutions have an average experience of 24 years (median of 15 years). Average real estate holdings: 2bn 11

12 1.2 Real estate as an asset class: investors perceptions Diversification and high returns key reasons for investing Alpha Capture High risk adjusted return Benefits of direct control over assets Capital preservation 0% 5% 10% 15% 20% 25% 30% 35% Exposure to alternative beta(s) Inflation protection High and stable income return Top1 Top1-3 High total return (unadjusted) Low risk Portfolio diversification Potential for capital gains REIRM Survey, EDHEC, All results are preliminary 12

13 1.2 Real estate as an asset class: investors perceptions Investment approach and target allocation Real estate investment specialists excluded 76.6% consider real estate as a strategic asset allocation class Average allocation: 10.6%, Range: 6.2%-14.3%, No significant differences between types of investors 21.5% invest opportunistically 13

14 Real Estate Investment and Risk Management 1. Revisiting real estate as an asset allocation class 1.1 The case for real estate: a brief review of academic results 1.2 Real estate as an asset class: investors perceptions 2. Real estate risks and risk management 2.1 Investors risk perceptions and risk management practices 2.2 The benefits and challenges of real estate diversification 3. New investment vehicles: unlisted funds, REITs, and indices 3.1 Investors perceptions and practices 3.2 Benefits and limits of unlisted funds and REITs 3.3 The potential of indices as investment vehicles 4. The emergence of property derivatives 4.1 Benefits, limits and challenges of property derivatives 4.2 Investors perceptions and expectations 14

15 2.1 Investors risk perceptions and management practices Idiosyncratic, property type, geographic risks drive returns 0% 5% 10% 15% 20% 25% 30% 35% 40% Continental risk Asset specific characteristics Lease terms, quality of tenants Property manager (operational) top1 top1-3 Property type Country risk REIRM Survey, EDHEC, All results are preliminary 15

16 2.1 Investors risk perceptions and management practices Relevance of various risk management approaches Very useful Rather useful Not so useful Useless Average score Allocation ceiling 49.5% 29.7% 9.9% 10.8% 1 Diversification 69.6% 25.9% 3.6% 0.9% 1.6 Capital protected products 2.8% 18.5% 35.2% 43.5% -1 Property derivatives 5.7% 28.6% 34.3% 31.4% -0.6 REIRM Survey, EDHEC, All results are preliminary 16

17 2.1 Investors risk perceptions and management practices Relevance of various diversification approaches 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Property type Geography Asset size Core vs. non core distinction Public vs. private distinction "Growth" vs. "value" distinction Vehicle/manager Financial analysis Physical analysis Other dimensions top1 top REIRM Survey, EDHEC, All results are preliminary

18 2.2 Benefits and challenges of real estate diversification The specific characteristics of direct real estate Indivisibility and large lot size Heterogeneity of property types Heterogeneity of assets Heterogeneity of contracts Importance of local factors Costly and lengthy investment implementation Need for burdensome operational management 18

19 2.2 Benefits and challenges of real estate diversification Diversification is a daunting task Idiosyncratic risk is much more important in real estate than in other asset classes. On average, assets are needed to establish a diversified portfolio this translates into several billion euros on some markets. To do away with the wide variation around this average, Byrne and Lee (2001) and others suggest that several hundreds of individual properties are needed. 19

20 2.2 Benefits and challenges of real estate diversification Benefits of international diversification The bulk of academic studies concludes that international diversification is highly relevant in real estate However, real estate markets are more integrated than many think as they are jointly dependent on economic conditions at the continental and world levels. The existence of a continental factor in Europe and North America has been documented for direct and indirect real estate suggesting additional gains from international diversification beyond the home continent. 20

21 2.2 Benefits and challenges of real estate diversification Benefits of international diversification International Diversification by property type ( ) Case, Goetzmann, Rouwenhorst (1999) Volatility reduction (per cent) Number of countries 21

22 2.2 Benefits and challenges of real estate diversification Property type diversification At the country level, property type diversification is found to be superior to geographic distribution. The use of economic rather than administrative regions confirms this superiority. For international investment, country factors far outweigh property type influences in the characterisation of risk and there is little added benefit for diversifying across property type once an international portfolio has been established. 22

23 2.2 Benefits and challenges of real estate diversification Intermediated investment as a must for diversification Realising the benefits of real estate as an asset class requires a diversified portfolio be set-up. According to practitioners and academics, the two main dimensions for diversification are geography and property type. The specific characteristics of real estate make diversification through direct investments a daunting challenge. Costs and difficulties further increase when an investor leaves its home country or field of expertise. 23

24 Real Estate Investment and Risk Management 1. Revisiting real estate as an asset allocation class 1.1 The case for real estate: a brief review of academic results 1.2 Real estate as an asset class: investors perceptions 2. Real estate risks and risk management 2.1 Investors risk perceptions and risk management practices 2.2 The benefits and challenges of real estate diversification 3. New investment vehicles: unlisted funds, REITs, and indices 3.1 Investors perceptions and practices 3.2 Benefits and limits of unlisted funds and REITs 3.3 The potential of indices as investment vehicles 4. The emergence of property derivatives 4.1 Benefits, limits and challenges of property derivatives 4.2 Investors perceptions and expectations 24

25 3.1 Investors perceptions and practices Investors are open to intermediated investment Which of the following do you consider part of the real estate asset class? 100% 90% 80% 70% 60% 90,5% 91,3% 82,5% 68,3% 50% 40% 37,3% 30% 20% Direct investments Unlisted funds Listed real estate Real estate debt Structured products, indices, derivatives REIRM Survey, EDHEC, All results are preliminary 25

26 3.1 Investors perception and practices Allocations: tie between direct and indirect investments Structured Products 3% Debt 2% Indices 3% Derivatives 1% Listed real estate 18% Unlisted funds 23% Direct real estate 50% REIRM Survey, EDHEC, All results are preliminary 26

27 3.2 Benefits and limits of unlisted funds and REITs Benefits of unlisted funds INREV Survey (2007) Unlisted funds have boomed in recent years, particularly thanks to instititutional investment. The top reasons for investing in these vehicles are: 1. Access to professional management (style, local presence), 2. International diversification of the real estate portfolio, 3. Diversification of the overall portfolio, 4. Access to new markets (new locations, new sectors), 5. Ease of implementation (vs. direct investments), 6. Enhanced returns, 7. Access to specific sectors. 27

28 3.2 Benefits and limits of unlisted funds and REITs Limits of unlisted funds INREV Survey (2007) The top reasons for NOT investing in these vehicles are: 1. Lack of transparency, 2. Limited liquidity (closed funds may be less liquid than direct investments), 3. Lack of suitable products, 4. High costs (fees higher than costs of direct investments), 5. Lack of investor resources to analyse these vehicles, 6. Misalignment of interests, 7. Regulatory limits on private investments. 28

29 3.2 Benefits and limits of unlisted funds and REITs Other benefits and limits of unlisted funds NAVs linked to the long-term value of the underlying investments mean low volatility, high correlation with direct investments and low correlation with listed securities. Large investors may have a say in shaping orientations at set-up and over the life of these funds. While diversification is a key driver of demand for these vehicles, the investor is primarily exposed to the risks of a fund rather than to those of a property type or region: insufficient diversification, alpha hard to estimate and may not be persistent, possible drifts in management style or risk exposure (e.g. core fund investing in non-core assets) leverage, operational risk. 29

30 3.2 Benefits and limits of unlisted funds and REITs Benefits and limits of listed securities Benefits Transparency Ease and speed of implementation Low transaction costs Liquidity of small/mid caps Larger average portfolio (vs. unlisted funds) Limits Portfolio concentration, elusive alpha, style drift, leverage, operational risk. Determining influence of stock market sentiment Narrow market, unequally developed, few sector specialists Taxation of dividend issues (REIT status will help) Initial and ongoing costs of public listing Divergence between NAVs and stock prices 30

31 3.3 The potential of indices as investment vehicles Indices as killer aps? As investment vehicles, real estate indices can: Provide exposure to a diversified portfolio at the property type, country, region, world level, Give investors access to new sectors and regions. Investors can gain exposure to two types of indices: Real estate listed securities / REITs indices Direct real estate indices 31

32 3.3 The potential of indices as investment vehicles Indices as killer aps? Reason for investing in RE Diversification High risk-adjusted return Inflation protection Need for Beta Alpha + Beta Beta Index Relevance Total High Total Key risks perceived Specific Risk Asset characteristics Lease terms and quality of tenants Operational management Geographic Risk At the country or sub-country regional level At the continental level Sector Risk (Property Type) Need for Diversification Diversification Diversification Index Relevance Total Total Total 32

33 3.3 The potential of indices as investment vehicles Only 4%-7% of real estate investments are index-related Structured Products 3% Debt 2% Indices 3% Derivatives 1% Listed real estate 18% Unlisted funds 23% Direct real estate 50% REIRM Survey, EDHEC, All results are preliminary 33

34 3.3 The potential of indices as investment vehicles But 36% of investors have a relative return orientation Main benchmark used for RE performance measurement Index of Peer Other None Performance 2% 2% Composite 3% 2% Indirect Index 12% Absolute return (nominal) 36% Direct index 19% Absolute return (real) 24% REIRM Survey, EDHEC, All results are preliminary 34

35 3.3 The potential of indices as investment vehicles The best vehicle for international diversification? Would a European investable index be appropriate to diversify the direct real estate portfolio of an investor? Direct investments more appropriate 7% Listed securities better 13% Unlisted funds preferable 12% Yes 68% REIRM Survey, EDHEC, All results are preliminary 35

36 3.3 The potential of indices as investment vehicles Benefits and limits of public real estate indices Investable through index funds, ETFs and derivatives, they are relatively low-cost and liquid and more or less transparent. Outside of key countries, listed real estate remains a narrow and incomplete market. Public real estate indices: are primarily influenced by wider stock market movements are poorly diversified outside of key countries/regions, are market-weighted indices that do not try to be representative. Investing in public real estate does not produce an exposure representative of direct real estate risks and returns. Using listed securities to diversify or rebalance a direct portfolio is less than straightforward e.g. Seiler, Webb, and Myer (2001) 36

37 3.3 The potential of indices as investment vehicles Gaining access to direct real estate indices Reference commercial real estate indices are appraisal-based; new transaction-based indices have been are being launched in the US. property derivatives are required to establish a synthetic exposure to these non-investable indices In June 2006, FTSE & MSS launched the first investable indices of commercial real estate. exposure can be established directly by investing in the funds that underlie the indices or synthetically through derivatives. 37

38 3.3 The potential of indices as investment vehicles Direct real estate indices as diversified portfolios Guarantee maximum diversification: Diversification of specific risk, Low correlation to public securities markets, Grant access to and deliver the return of the type/country/region selected which may not be otherwise accessible due to lack of expertise, legal constraints, high entry costs, lack of supply, etc. Protect against selection risk (stable zero alpha from selection), Composites limit - and property type indices guarantee against - style drift, Reduce operational risk (or its impact). 38

39 3.3 The potential of indices as investment vehicles Other benefits of direct real estate indices Faster and easier implementation of decisions: exposure can be modified in days (at worst) vs. months, Reduced information costs due to lower information asymmetry, Reduced direct costs (relative to direct investments): lower transaction costs, lower taxes, attractive management costs for small/medium investors, Better liquidity: transactions take place on a few OTC markets / on centralised markets rather than on multiple localised markets, products are (more) standardised tactical asset allocation becomes possible. 39

40 3.3 The potential of indices as investment vehicles Limits of direct real estate indices Transparency is as good as that of the index. Representativity is as good as that of the index. Fund of fund structure / investment bank adds a layer of fees. Established reference indices cannot be invested directly; synthetic investment through derivatives or structured products may not be suitable for all investors. Investable indices face challenges of representativity and liquidity provision. 40

41 Real Estate Investment and Risk Management 1. Revisiting real estate as an asset allocation class 1.1 The case for real estate: a brief review of academic results 1.2 Real estate as an asset class: investors perceptions 2. Real estate risks and risk management 2.1 Investors risk perceptions and risk management practices 2.2 The benefits and challenges of real estate diversification 3. New investment vehicles: unlisted funds, REITs, and indices 3.1 Investors perceptions and practices 3.2 Benefits and limits of unlisted funds and REITs 3.3 The potential of indices as investment vehicles 4. The emergence of property derivatives 4.1 Benefits, limits and challenges of property derivatives 4.2 Investors perceptions and expectations 41

42 4.1 Benefits, limits and challenges of property derivatives Property derivatives as a hedging tool In a hedging perspective, property derivatives can: protect the financial conditions of real estate investments, divestments and arbitrages to come, immunise a real estate portfolio against market-wide movements to extract its alpha over a given period. Without property derivatives, it is difficult to hedge the risks of direct or unlisted real estate investments and few arbitrage opportunities can be implemented. The limit to hedging with property derivatives is the tracking error of the portfolio vis-à-vis the index. this basis risk can be very important, If the portfolio is the index, hedging effectiveness is optimal. 42

43 4.1 Benefits, limits and challenges of property derivatives Other uses of property derivatives Besides hedging, property derivatives products allow one to: gain exposure to non-investable indices, rebalance portfolios synthetically, implement a wider range of arbitrage strategies, «sell the market» i.e. establish a negative net exposure to a type/zone to benefit from subsequent falls, reduce transaction costs, increase liquidity, take advantage of (potentially very high) leverage, get access to cheaper financing (swaps). 43

44 4.1 Benefits, limits and challenges of property derivatives Challenges of non-investable indices for derivatives issuers Derivatives on non-investable indices are hard to hedge since cash hedging is not possible as the underlying cannot be invested. Two (non exclusive) possibilities exist for hedging such derivatives: A cash based approach through direct and indirect real estate investments one runs into the challenge of setting up and then dynamically managing a diversified real estate portfolio, A synthetic approach relying on risk factor analysis that would create portfolios of liquid assets showing high correlations to the direct index. 44

45 4.1 Benefits, limits and challenges of property derivatives The catch 22 of non-investable indices Difficulty and high cost of hedging derivatives on non-investable indices Lower liquidity Larger bid-ask spreads Lower appeal of market Lower liquidity 45

46 4.1 Benefits, limits and challenges of property derivatives Benefits and limits of investable indices for issuers Investable indices allow for partial cash hedging of derivatives. However, unless short-selling of the index is allowed, synthetic hedging approaches will still be called for. A thriving market in investable indices would be a healthy prerequisite to the offering of derivatives. 46

47 4.2 Investors perceptions and expectations Investors understand the possible uses of derivatives Which of the following are possible uses? 70% 60% 50% 40% 30% 20% 10% 0% Sample Diversified Asset Managers Real Estate Specialists Pension Funds Leverage Design of structured products Hedging Shorting the market Synthetic investment Portolio rebalancing REIRM Survey, EDHEC, All results are preliminary 47

48 4.2 Investors perceptions and expectations Investors reject derivatives as risk management tools Very useful Rather useful Not so useful Useless Average score Allocation ceiling 49.5% 29.7% 9.9% 10.8% 1 Diversification 69.6% 25.9% 3.6% 0.9% 1.6 Capital protected products 2.8% 18.5% 35.2% 43.5% -1 Property derivatives 5.7% 28.6% 34.3% 31.4% -0.6 REIRM Survey, EDHEC, All results are preliminary 48

49 4.2 Investors perceptions and expectations 81% of investors have no intention to use derivatives Do you use property derivatives? Yes 3% No, but we plan to do it before the end of % No, and we have no plans to do so in the foreseeable future 81% REIRM Survey, EDHEC, All results are preliminary 49

50 4.2 Investors perceptions and expectations Investors lack familiarity with or find derivatives unattractive Reasons for rejecting derivatives 60% 50% 40% 30% 20% 10% 0% Sample Diversified Asset Managers Real Estate Specialists Pension Funds Regulatory constraints Investment policy Lack of familiarity Ill-adapted products Other REIRM Survey, EDHEC, All results are preliminary 50

51 Real Estate Investment and Risk Management Conclusion Institutional investors show strong interest in real estate as an asset class owing to its diversification qualities and good performance. Indirect investments are accepted as part of the class and a strong case exists for indices as investment vehicles and portfolio diversifiers. Access to indices through derivatives does not appear to be an appealing proposal and investors express only modest interest in property derivatives overall. 51