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Risk_Return lecture discussing real esate.pptx
- 1. COMMERCIAL REAL ESTATEFINANCE & INVESTMENTS 1 Vivek Sah, PhD
- 2. CONCEPT MAP Commercial RealEstate Finance and Investment Core Concepts RE industry RE Finance Investment Analysis Asset and Space Markets, Risk, Return and Diversifications RE Leases Commercial Underwriting Leverage in RE Cash Flow Analysis Risk Analysis RE in a Portfolio RE Derivatives RE Market Analysis
- 3. RISK, RETURN ANDDIVERSIFICATION 3
- 4. 4 COMPARING INVESTMENT RETURNS • DOESTHE INCOME PRODUCING PROPERTY PROVIDE A COMPETITIVE RETURN? • KEY CONSIDERATIONS 1. NATURE OF ALTERNATIVE REAL ESTATE INVESTMENTS 2. ALTERNATIVE INVESTMENTS OTHER THAN REAL ESTATE 3. RETURNS ON ALTERNATIVES 4. RISK ASSOCIATED (INCLUDING LIQUIDITY)
- 5. A LOOK ATINVESTMENT OPTIONS 5 What does this tell us about risk-return?
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- 13. RISKS WITH RE •BUSINESS RISK • ECONOMIC CONDITIONS • REAL ESTATE RELATED • TENANT MIX (EXAMPLES ??) • LEASE PROVISIONS (INDEXED TO INFLATION OR NOT??) • FINANCIAL RISK • INCREASES WITH THE AMOUNT OF DEBT • COST OF DEBT • AND STRUCTURE OF DEBT
- 14. CONTD… •LIQUIDITY RISK • CHALLENGESIN SELLING PROPERTY •INFLATION RISK • UNEXPECTED INFLATION • DOES INCOME INCREASE ENOUGH TO OFFSET INFLATION? • TIED TO LEASES AND TYPE OF PROPERTY AS WELL •PROPERTY MANAGEMENT RISK • COMPETENCY OF MANAGEMENT’S ABILITY TO RESPOND TO MARKET CONDITIONS
- 15. CONTD… • INTEREST RATERISK • THE IMPACT ON VARIABLE RATE DEBT • THE IMPACT OF HIGHER RATES ON RESIDUAL PROPERTY VALUE • LEGISLATIVE RISK • REGULATORY CHANGES • ENVIRONMENTAL RISK (SUSTAINABLE MEASURES)
- 16. 16 RISK VS UNCERTAINTY •WHAT’STHE DIFFERENCE? •MEASURES OF RISK • HOW VOLATILE AN INVESTMENT IS? • VARIABILITY IN ASSET RETURNS & RISK PREMIUMS • STANDARD DEVIATION OF RETURNS • IN EXCEL: STDEV(A1:A35)
- 17. 17 17 RISK • RISK ANDRETURN ARE NOT INDEPENDENT OF EACH OTHER • HAVE TO BE ANALYZED IN TANDEM • SHARPE RATIO IS AN APPROPRIATE MEASURE • COMPOSITE MEASURE • RISK ADJUSTED RETURN MEASURE
- 18. 18 18 SHARPE RATIO • CALCULATERETURN FOR A TIME PERIOD • CALCULATE RISK • DIVIDE THE TWO AFTER ADJUSTING FOR RISK-FREE RATE • S.R = RM - RF σ
- 19. 19 THE RE ADVANTAGE *Usingone year T-bill yield and annual returns from 1978 to 2012
- 20. 20 HOWEVER THINGS TOCONSIDER • THE NCREIF PROPERTY INDEX (NPI) AND SOME OTHERS ARE BASED ON APPRAISED VALUES, WHICH TYPICALLY LAG AND ARE SMOOTHER THAN MARKET BASED PRICES • USING ANNUAL DATA MITIGATES THE APPRAISAL SMOOTHING ISSUE, BUT DOES NOT NECESSARILY ENTIRELY SOLVE IT • INDICES MAY NOT REFLECT THE RISK OF THE ACTUAL REAL ESTATE STRATEGY • INDICES DO NOT INCLUDE HIGHER RISK TYPES OF REAL ESTATE INVESTMENTS, AND THE NPI IS UNLEVERED • REAL ESTATE REACTS MORE GRADUALLY TO CHANGING CONDITIONS THAN PUBLIC MARKET SECURITIES
- 21. 21 STEP 1 STEP2 STEP 3 • Get Risk free rate (10 year Treasury-bill rate) • The calculate the ratio by using formula
- 22. 22 ANOTHER MEASURE POST GREATFINANCIAL CRISIS (GFC) • MAXIMUM DRAWDOWN • THE GREATEST PEAK-TO-TROUGH LOSS OVER A TIME PERIOD Source: PREA report, Maximum drawdown over Q1 1978 to Q2 2013
- 23. 23 23 DIVERSIFICATION • LOOK FORASSETS THAT HAVE LOW CORRELATION • RISK MITIGATION TOOL AS WELL • IN REAL ESTATE, TWO POSSIBILITIES • ACROSS PROPERTY TYPES • ACROSS ECONOMIC BASES • GEOGRAPHIC DIVERSIFICATION IS REDUNDANT
- 24. 24 A LOOK ATCORRELATIONS* Sources: NCREIF, Thomson Reuters Datastream (PREA report) *Based on annual returns to : NCREIF Property Index, Russell Top 200 Index, Russell Midcap Index, Russell 2000, Barclays US Treasury Index, Barclays US Corp. Investment Grade Index, Barclays US Corp. High Yield Index, Dow Jones-Credit Suisse Hedge Fund Index.Correlations based on data to 2012, beginning in 1979 (equity indices), 1978 (Treasury and investment grade), 1984 (high yield), and 1994 (hedge funds).
- 25. 25 STEP 1 CORRELATION INEXCEL STEP 2
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- 27. 27 OUTPUT – CORRELATIONMATRIX
- 28. 28 28 ASSIGNMENT 1 –DUE on Bb WEDNESDAY, FEB 24 1. CALCULATE MEDIAN RETURNS, RISK, AND SHARPE RATIO FOR: a) S&P 500 INDEX b) NAREIT EQUITY INDEX c) DOW/NASDAQ d) NCREIF INDICES OFFICE, RETAIL, INDUSTRIAL, APARTMENTS AND HOSPITALITY (5 PROPERTY TYPES) a) NCREIF DATA IS UPLOADED ON BB 2. CALCULATE CORRELATION MATRIX FOR THE 8 INDEX RETURN SERIES 3. GRAPH RISK AND RETURN FOR ALL THE ASSET CLASSES
- 29. 29 GUIDE • DATA SOURCES •REIT.COM • YAHOO FINANCE/GOOGLE FINANCE/BLOOMBERG • NCREIF.COM • USE QUARTERLY DATA FOR ALL INDICES • CONVERT INDEX INTO RETURN SERIES • (P2 – P1)/P1*100 WHERE P2 IS INDEX VALUE AT END OF QUARTER (1,2,3 OR 4) AND P1 IS THE INDEX VALUE AT BEGINNING OF QUARTER • FOR RISK FREE RATE USE 10-YEAR T-BILL RATE
- 30. 30 • EXCEL SPREADSHEETTO BE UPLOADED ON BLACKBOARD BY 12 MIDNIGHT ON MONDAY, FEB 24 WITH: • MEASURES MENTIONED ON SLIDE 13 • CORRELATION MATRIX (7 BY 7) • GRAPH AS SHOWN IN SLIDE 10 • MAKE SURE TO MENTION THE SOURCES OF DATA IN THE SHEET • POINTS WILL BE DEDUCTED IF NOT SOURCES NOT MENTIONED DELIVERABLES