The document discusses how portfolio management concepts can be applied to improve business performance consistency for real estate companies. It outlines how defining goals, opportunities, and constraints can help optimize a portfolio of projects to maximize value and minimize risk. A case study application is presented where portfolio modeling and optimization was used for a mid-sized apartment REIT to evaluate if growth targets could be achieved within debt constraints. The analysis found dispositions were needed to reduce risk, and optimizing the portfolio with dispositions improved the net present value and reduced downside volatility.

1. Improving the Consistency of Business
Performance through Portfolio Management
Paul D. Allan
PORTFOLIO DECISIONS, INC.
Nineteenth Annual Meeting of the American Real Estate Society
Monterey, California, April 2 – 5, 2003.
Copyright 2003, Portfolio Decisions,Inc.

2. Agenda
•
•
•
•
Portfolio Management (as applied)
Overview of Methodology
Case Study: Application of Process
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

3. Portfolio Management
Application to tangible (relatively illiquid) assets
–
–
–
–
Oil & Gas Asset management
Pharmaceutical R&D
Chemical production
Real Estate property management
Ø Provides insights into specific decisions
Copyright 2003, Portfolio Decisions,Inc.

4. Portfolio Management
Application of portfolio management concepts…
•
•
•
•
Clearly describes the Goals of the company
Defines the Constraints
Describes the portfolio of Opportunities
Optimizes project selection - Max value, Min risk
Copyright 2003, Portfolio Decisions,Inc.

5. Portfolio Management
Application of portfolio management concepts…
•
•
•
•
Clearly describes the Goals of the company
Defines the Constraints
Describes the portfolio of Opportunities
Optimizes project selection - Max value, Min risk
…from a decision making perspective
• Focus on strategic goals
• Provides insight into specific strategic decisions
Copyright 2003, Portfolio Decisions,Inc.

6. Portfolio Management
Can growth targets be achieved given debt constraints?
What is the probability that earnings targets will be met?
Are property dispositions required? Which ones?
If the economy slows – how bad could it get? What can
be done to mitigate this risk?
Copyright 2003, Portfolio Decisions,Inc.

7. Portfolio Management
Primary Objective: Increase shareholder value
Maximize returns, Minimize risk
Improve Market Perception of the Company
Maintain
Dividend Yield
Lower Asset
Age
Strengthen
Balance Sheet
Maintain Debt
Ratios
Improve Operating
Efficiencies
Copyright 2003, Portfolio Decisions,Inc.
Consistent
Earnings
Rationalize
Assets
Grow Funds from
Operations
OBJECTIVE
FOCUS

8. Portfolio Management
Primary Objective: Increase shareholder value
Maximize returns, Minimize risk
Improve Market Perception of the Company
Maintain
Dividend Yield
Lower Asset
Age
Strengthen
Balance Sheet
Maintain Debt
Ratios
Improve Operating
Efficiencies
Copyright 2003, Portfolio Decisions,Inc.
Consistent
Earnings
Rationalize
Assets
Grow Funds from
Operations
STRATEGIC
FOCUS
Performance
Drivers

9. Portfolio Management
STRATEGIC
DIRECTION
Linear Optimization
Decision Analysis
DECISION MAKERS
Monte Carlo Simulation
Not a ‘Black-Box’ approach…
Real Options analysis
Copyright 2003, Portfolio Decisions,Inc.

10. Portfolio Management
Not a ‘Black-Box’ approach…
‘THE ANSWER’
Linear Optimization
Decision Analysis
DECISION MAKERS
Copyright 2003, Portfolio Decisions,Inc.

11. Portfolio Management
…but a ‘Glass-Box’ process
• Interactions between goals and opportunities
• Impacts of constraints
• Impacts of decisions
INSIGHTS
DECISION MAKERS
Opportunities Goals
STRATEGIC
DIRECTION
Copyright 2003, Portfolio Decisions,Inc.

12. Agenda
•
•
•
•
Portfolio Management (as applied)
Overview of Methodology
Case Study: Application of Process
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

13. Overview of Methodology
Model Description
Opportunities – Goals - Constraints
Type I
Type II
EXPLORATION
Vision
Type III
Goals
Opportunities
Constraints
Copyright 2003, Portfolio Decisions,Inc.
Strategy

14. Overview of Methodology
Model Description:
Describe Strategic Goals:
Describe Opportunities
Specific, well defined metrics
Model existing (known) & potential (surrogates)
Simple stochastic descriptions (Optimistic, neutral, pessimistic)
Define Constraints:
rigid, flexible, self imposed
Ø Evaluate options in terms of the goals:
Linear optimization / Monte Carlo simulation of portfolio results
Copyright 2003, Portfolio Decisions,Inc.

15. Case Study: Application
•
•
•
•
Portfolio Management (as applied)
Overview of Methodology
Case Study: Application of process
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

16. Case Study: Application
Case Study Overview
• Portfolio model of mid-sized apartment REIT
• Models distilled from public data (SEC 10-K data)
• Company issues, opportunity descriptions,
and risks anchored in company data
Ø Intended as example of process – not
analysis of specific company
Copyright 2003, Portfolio Decisions,Inc.

17. Case Study: Application
Key Issues
•
•
•
•
•
•
Dividend Yield consistency
Net Operating Income growth, consistency
Debt/Market capitalization maintenance
Operating expense management
Interest coverage
Asset age reduction
Copyright 2003, Portfolio Decisions,Inc.

18. Case Study: Application
Can growth targets be achieved given debt constraints?
What is the probability that earnings targets will be met?
Are property dispositions required? Which ones?
If the economy slows – how bad could it get? What can
be done to mitigate this risk?
Copyright 2003, Portfolio Decisions,Inc.

19. Case Study: Application
Goals
Reference Goals
Expected Value
Enforced Goals
Total Revenue ($MM)
800
Oper Expenses ($MM)
NOI ($MM)
350
500
300
450
650
250
400
600
200
350
750
Avg. Age (yrs)
FFO ($ per share)
18
16
14
3.00
12
2.00
10
20
08
20
07
20
06
20
05
20
04
Debt/Market Cap (%)
3.50
1.50
55%
50%
Copyright 2003, Portfolio Decisions,Inc.
45%
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
40%
20
04
20
03
20
08
20
07
20
06
20
05
2.50
20
04
20
03
20
03
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
20
04
20
03
700

20. Case Study: Application
Opportunities
Aggregated by:
•Region (NE, SE, SW)
•Market size (Small, Medium, Large)
•Population growth projections
Northeast
Southwest
Copyright 2003, Portfolio Decisions,Inc.
Southeast

21. Case Study: Application
Opportunities
Aggregated by:
•Region (NE, SE, SW)
•Market size (Small, Medium, Large)
•Population growth projections
130 properties aggregated into
•18 unique ‘type’ properties
•18 ‘surrogate’ properties
ØIncludes both existing and new
grass roots development
Aligned with decision structure
Northeast
Southwest
Copyright 2003, Portfolio Decisions,Inc.
Southeast

22. Case Study: Application
Opportunities
Models derived from public data (for the neutral case)
Net operating income forecasts, Net asset values, carrying values, Capitalization
rates, Occupancy rates, Operating costs
Uncertainties captured (for the optimistic, pessimistic scenarios)
•Rental rate growth
•Operating expense levels
•Occupancy rate growth
ØFull range of potential outcomes described
Copyright 2003, Portfolio Decisions,Inc.

23. Case Study: Application
Initial Feasibility testing
Total Revenue ($MM)
800
Original growth target of 6% not feasible
4% growth feasible
Oper Expenses ($MM)
NOI ($MM)
350
500
300
450
650
250
400
600
200
350
750
Avg. Age (yrs)
FFO ($ per share)
18
16
14
3.00
12
2.00
10
20
08
20
07
20
06
20
05
20
04
Debt/Market Cap (%)
3.50
1.50
55%
50%
Copyright 2003, Portfolio Decisions,Inc.
45%
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
40%
20
04
20
03
20
08
20
07
20
06
20
05
2.50
20
04
20
03
20
03
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
20
04
20
03
700

24. Case Study: Application
Initial Feasibility testing
Probability of staying under Debt ceiling
Less than 50%
Oper Expenses ($MM)
700
650
20
03
20
04
20
05
20
06
20
07
20
08
600
300
250
200
Avg. Age (yrs)
16
14
12
20
03
20
04
20
05
20
06
20
07
20
08
10
Copyright 2003, Portfolio Decisions,Inc.
500
1.00
0.80
0.60
0.40
0.20
0.00
3.50
1.00
0.80
0.60
0.40
0.20
0.00
3.00
2.50
2.00
1.50
1.00
0.80
0.60
0.40
0.20
0.00
55%
450
400
350
FFO ($ per share)
20
03
20
04
20
05
20
06
20
07
20
08
18
1.00
0.80
0.60
0.40
0.20
0.00
350
Debt / Market Cap (%)
50%
45%
40%
20
03
20
04
20
05
20
06
20
07
20
08
750
NOI ($MM)
20
03
20
04
20
05
20
06
20
07
20
08
1.00
0.80
0.60
0.40
0.20
0.00
20
03
20
04
20
05
20
06
20
07
20
08
Total Revenue ($MM)
800
1.00
0.80
0.60
0.40
0.20
0.00

25. Case Study: Application
Portfolio Optimization
Evaluated all of the
portfolios that satisfied
the goals / constraints
Efficient Frontier
Reference Strategy
1.30
Risk (Downside Volatility)
1.25
1.20
1.15
1.10
1.05
1.00
0.95
4,800
5,300
5,800
6,300
Portfolio Value ($MM)
Copyright 2003, Portfolio Decisions,Inc.
6,800

26. Case Study: Application
Portfolio Optimization
Evaluated all of the
portfolios that satisfied
the goals / constraints
Risk
NPV
Portfolio Composition
Copyright 2003, Portfolio Decisions,Inc.

27. Case Study: Application
Portfolio Optimization
Noted trends at various
levels of risks
Southwest
Southeast
Northeast
Portfolio Composition
Copyright 2003, Portfolio Decisions,Inc.

28. Case Study: Application
Portfolio Optimization
Compared specific
portfolios in terms of
composition and ability
to deliver goals
Portfolio ‘A’
Portfolio ‘B’
Portfolio Composition
Copyright 2003, Portfolio Decisions,Inc.

29. Case Study: Application
Portfolio Optimization
Compared portfolios: Probability of delivering goals
Even the ‘Best’ portfolio has an unacceptable level of risk
Oper Expenses ($MM)
700
650
20
03
20
04
20
05
20
06
20
07
20
08
600
300
250
200
Avg. Age (yrs)
16
14
12
20
03
20
04
20
05
20
06
20
07
20
08
10
Copyright 2003, Portfolio Decisions,Inc.
450
400
350
FFO ($ per share)
1.00
0.80
0.60
0.40
0.20
0.00
3.5
3
2.5
2
1.5
20
03
20
04
20
05
20
06
20
07
20
08
18
1.00
0.80
0.60
0.40
0.20
0.00
500
Debt / Market Cap (%)
1.00
0.80
0.60
0.40
0.20
0.00
0.55
0.5
0.45
0.4
20
03
20
04
20
05
20
06
20
07
20
08
750
1.00
0.80
0.60
0.40
0.20
0.00
350
20
03
20
04
20
05
20
06
20
07
20
08
1.00
0.80
0.60
0.40
0.20
0.00
800
NOI ($MM)
20
03
20
04
20
05
20
06
20
07
20
08
Total Revenue ($MM)
1.00
0.80
0.60
0.40
0.20
0.00

30. Case Study: Application
Portfolio Optimization
Even the ‘Best’ portfolio has an unacceptable level of risk
Total Revenue ($MM)
FFO ($ per share)
20
08
20
07
20
06
20
05
55.0%
50.0%
45.0%
20
03
20
04
20
05
20
06
20
07
20
08
20
08
20
07
20
06
20
05
40.0%
20
04
20
03
20
08
20
07
20
06
20
05
20
04
Debt / Market Cap (%)
3.50
3.00
2.50
2.00
1.50
20
04
18
16
14
12
10
Copyright 2003, Portfolio Decisions,Inc.
20
03
20
08
20
07
20
06
20
05
20
04
350
20
03
20
08
400
200
20
07
450
250
20
06
300
20
05
500
Avg. Age (yrs)
20
03
NOI ($MM)
350
20
04
20
03
800
750
700
650
600
Oper Expenses ($MM)

31. Case Study: Application
Portfolio Alternatives
Modify Goals and/or constraints
Not an option in this case – market expectations already set
Add opportunities
All existing (known) opportunities currently applied
Revise existing opportunities
ØRe-structure existing deals
ØProperty dispositions made available
Copyright 2003, Portfolio Decisions,Inc.

32. Case Study: Application
Portfolio Alternatives
With Dispositions:
Efficient Frontier
Comparison
1.30
Higher NPV
Risk (Downside Volatility)
Reduced Risk
Original
Includes Dispositions
1.25
1.20
1.15
1.10
1.05
1.00
0.95
4,800
5,300
5,800
6,300
Portfolio Value ($MM)
Copyright 2003, Portfolio Decisions,Inc.
6,800

33. Case Study: Application
Portfolio Alternatives
With Dispositions:
Oper Expenses ($MM)
700
650
20
03
20
04
20
05
20
06
20
07
20
08
600
300
250
200
Avg. Age (yrs)
16
14
12
20
03
20
04
20
05
20
06
20
07
20
08
10
Copyright 2003, Portfolio Decisions,Inc.
500
1.00
0.80
0.60
0.40
0.20
0.00
3.50
1.00
0.80
0.60
0.40
0.20
0.00
3.00
2.50
2.00
1.50
1.00
0.80
0.60
0.40
0.20
0.00
55%
450
400
350
FFO ($ per share)
20
03
20
04
20
05
20
06
20
07
20
08
18
1.00
0.80
0.60
0.40
0.20
0.00
350
Debt / Market Cap (%)
50%
45%
40%
20
03
20
04
20
05
20
06
20
07
20
08
750
NOI ($MM)
20
03
20
04
20
05
20
06
20
07
20
08
1.00
0.80
0.60
0.40
0.20
0.00
20
03
20
04
20
05
20
06
20
07
20
08
Total Revenue ($MM)
800
1.00
0.80
0.60
0.40
0.20
0.00

34. Case Study: Application
Portfolio Alternatives
Without Dispositions:
Oper Expenses ($MM)
700
650
20
03
20
04
20
05
20
06
20
07
20
08
600
300
250
200
Avg. Age (yrs)
16
14
12
20
03
20
04
20
05
20
06
20
07
20
08
10
Copyright 2003, Portfolio Decisions,Inc.
500
1.00
0.80
0.60
0.40
0.20
0.00
3.50
1.00
0.80
0.60
0.40
0.20
0.00
3.00
2.50
2.00
1.50
1.00
0.80
0.60
0.40
0.20
0.00
55%
450
400
350
FFO ($ per share)
20
03
20
04
20
05
20
06
20
07
20
08
18
1.00
0.80
0.60
0.40
0.20
0.00
350
Debt / Market Cap (%)
50%
45%
40%
20
03
20
04
20
05
20
06
20
07
20
08
750
NOI ($MM)
20
03
20
04
20
05
20
06
20
07
20
08
1.00
0.80
0.60
0.40
0.20
0.00
20
03
20
04
20
05
20
06
20
07
20
08
Total Revenue ($MM)
800
1.00
0.80
0.60
0.40
0.20
0.00

35. Case Study: Application
Portfolio Alternatives
Dashed: No Dispositions
Solid: Includes Dispositions
Comparison: Probability of meeting goals
Oper Expenses ($MM)
700
650
20
03
20
04
20
05
20
06
20
07
20
08
600
300
250
200
Avg. Age (yrs)
16
14
12
20
03
20
04
20
05
20
06
20
07
20
08
10
Copyright 2003, Portfolio Decisions,Inc.
450
400
350
FFO ($ per share)
1.00
0.80
0.60
0.40
0.20
0.00
3.5
3
2.5
2
1.5
20
03
20
04
20
05
20
06
20
07
20
08
18
1.00
0.80
0.60
0.40
0.20
0.00
500
Debt / Market Cap (%)
1.00
0.80
0.60
0.40
0.20
0.00
0.55
0.5
0.45
0.4
20
03
20
04
20
05
20
06
20
07
20
08
750
1.00
0.80
0.60
0.40
0.20
0.00
350
20
03
20
04
20
05
20
06
20
07
20
08
1.00
0.80
0.60
0.40
0.20
0.00
800
NOI ($MM)
20
03
20
04
20
05
20
06
20
07
20
08
Total Revenue ($MM)
1.00
0.80
0.60
0.40
0.20
0.00

36. Case Study: Application
Portfolio Alternatives
Range of outcomes: Includes dispositions
Total Revenue ($MM)
FFO ($ per share)
20
08
20
07
20
06
20
05
55.0%
50.0%
45.0%
20
03
20
04
20
05
20
06
20
07
20
08
20
08
20
07
20
06
20
05
40.0%
20
04
20
03
20
08
20
07
20
06
20
05
20
04
Debt / Market Cap (%)
3.50
3.00
2.50
2.00
1.50
20
04
18
16
14
12
10
Copyright 2003, Portfolio Decisions,Inc.
20
03
20
08
20
07
20
06
20
05
20
04
350
20
03
20
08
400
200
20
07
450
250
20
06
300
20
05
500
Avg. Age (yrs)
20
03
NOI ($MM)
350
20
04
20
03
800
750
700
650
600
Oper Expenses ($MM)

37. Case Study: Application
Portfolio Alternatives
Range of outcomes: Without dispositions
Total Revenue ($MM)
FFO ($ per share)
20
08
20
07
20
06
20
05
55.0%
50.0%
45.0%
20
03
20
04
20
05
20
06
20
07
20
08
20
08
20
07
20
06
20
05
40.0%
20
04
20
03
20
08
20
07
20
06
20
05
20
04
Debt / Market Cap (%)
3.50
3.00
2.50
2.00
1.50
20
04
18
16
14
12
10
Copyright 2003, Portfolio Decisions,Inc.
20
03
20
08
20
07
20
06
20
05
20
04
350
20
03
20
08
400
200
20
07
450
250
20
06
300
20
05
500
Avg. Age (yrs)
20
03
NOI ($MM)
350
20
04
20
03
800
750
700
650
600
Oper Expenses ($MM)

38. Case Study: Application
Portfolio Alternatives
Impact of slowing Economy – How bad can it get?
Total Revenue ($MM)
Oper Expenses ($MM)
NOI ($MM)
350
500
300
450
650
250
400
600
200
350
800
750
Avg. Age (yrs)
FFO ($ per share)
18
16
14
3.00
12
2.00
10
20
08
20
07
20
06
20
05
20
04
Debt/Market Cap (%)
3.50
1.50
55%
50%
Copyright 2003, Portfolio Decisions,Inc.
45%
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
40%
20
04
20
03
20
08
20
07
20
06
20
05
2.50
20
04
20
03
20
03
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
20
04
20
03
700

39. Case Study: Application
Portfolio Alternatives
Impact of reducing Debt Ceiling (from 50% to 45%)
Total Revenue ($MM)
800
Max NOI growth < 2%
Oper Expenses ($MM)
NOI ($MM)
350
500
300
450
650
250
400
600
200
350
750
Avg. Age (yrs)
FFO ($ per share)
18
16
14
3.00
12
2.00
10
20
08
20
07
20
06
20
05
20
04
Debt/Market Cap (%)
3.50
1.50
55%
50%
Copyright 2003, Portfolio Decisions,Inc.
45%
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
40%
20
04
20
03
20
08
20
07
20
06
20
05
2.50
20
04
20
03
20
03
20
08
20
07
20
06
20
05
20
04
20
03
20
08
20
07
20
06
20
05
20
04
20
03
700

40. Case Study: Application
Case Study Insights
• Maximum NOI growth of 4% possible
• The Debt ceiling is at risk in 2004 and 2007.
Dispositions in 2004 would improve this situation.
• Lowering the debt ceiling from 50% to 45% reduced
the NOI growth to less than 2%
Copyright 2003, Portfolio Decisions,Inc.

41. Case Study: Application
Case Study Insights, continued
• The existing portfolio of opportunities has sufficient
depth to utilize the proceeds from dispositions
• Three specific markets recommended for divestiture
• Acceleration of dispositions adds significant value to
the portfolio
Copyright 2003, Portfolio Decisions,Inc.

42. Agenda
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•
•
•
Portfolio Management (as applied)
Overview of Methodology
Case Study: Application of Process
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

43. Conclusions
Application of Portfolio Management
• Practical application of MPT
• Helps decision makers weigh the trade-offs
associated with specific decisions
• Stochastic information helps decision makers assess
the range of potential outcomes
• Focusing on the probability of achieving goals helps
to align the organization while setting clear
performance expectations
Copyright 2003, Portfolio Decisions,Inc.