The Restructuring of the Institutional Real Estate Portfolio in the UK

Neil Dunse, Colin Jones and Nicola Livingstone

Introduction

Focus = 30 years of change in real estate portfolios of UK financial institutions

Research based on IPD data Examine temporal patterns of transactions Assess to what these changes reflect

adaptations to risk and return OR changes to urban fabric

Constructing a Real Estate Portfolio

Heart of investment portfolio building is the balance between risk and return

Fundamental question is how to optimally diversify portfolio to reduce non systematic risk

Much research has been applied to achieve optimum portfolio of shares/gilts/property

Real estate allocation in a mixed-asset portfolio 15-20%

A Diversified Real Estate Portfolio

Great interest in diversification by dichotomous choice of real estate sector versus spatial location/region

Studies use different basic areal units and techniques but all divide the real estate into three sectors – industrial, offices and retail

General conclusion is that the principal route to diversification is based on sectors

Problems with Markowitz Mean Variance Concept

Approaches examine returns while risk is calculated by examining standard deviations and covariance of the assets

Approach is not necessarily relevant to many institutional investors that are increasingly viewing risk as a downside phenomenon or within a liability-driven investment

Ignores role of investment horizons, predictability of returns, and can misleading

Investment Horizons

Precise horizon is open to debate Rehring (2010) argues property returns, risk

and return are best measured over longer time horizons

He notes a rolling five year horizon is shortest time period for risk and return measurement

Expected future returns based on uncertain forecasts/sentiment partly based on (recent) economic and real estate trends and cycles

Active Property Investment

Active portfolio management involves the selection of individual properties with specific risk

Add value by controlling the asset and working to improve its cash flow for example through refurbishment or re- development

Urban Change

Stock of real estate investments is dynamic and nature of opportunities change over time

But not simply consequence of investors trying to improve cash flow

Wider investment = context of occupation demand set within urban economies but also information and transport technologies

Fundamental changes in urban real estate markets/decentralisation/new property forms such as office parks and retail warehouses

Institutional Portfolio ChangesProperty Segment 1981 1985 1990 1995 2000 2005 2010

Std Shop 15.2 18.7 16.8 16.8 13.8 10.9 10.3

Shopping Centre 9.4 12.1 12.7 17.3 18.4 19.6 17.9

Retail Warehouse 0.6 0.9 2.9 7.8 12.4 18.1 19.4

Dept / Variety Store 1.9 1.8 1.9 2.2 1.8 1.5 1.3

Supermarket 0.7 0.9 0.5 2.1 1.5 1.4 3.8

Other Retail 0.3 0.4 0.5 0.7 0.7 0.6 0.8

Std Office 56.2 52.2 50.5 36.8 33.6 28.5 27.8

Office Park 0.0 0.5 2.2 2.9 4.6 4.1 3.4

Std Industrial 15.0 11.9 11.1 11.1 10.4 12.3 11.9

Distribution Warehouse 0.5 0.5 1.0 2.4 2.8 3.0 3.3

Institutional Portfolio Returns and Risks 1985-2010 (5 year horizon)

Portfolio Returns Portfolio Standard Deviation

81-85 3.90% 0.019

86-90 9.04% 0.169

91-95 3.82% 0.107

96-00 10.24% 0.029

01-05 10.42% 0.047

06-10 -0.9% 0.165

Empirical Analysis of Restructuring

Isolate trends in transactions activity Hodrick Prescott (HP) filter is applied HP Fiiter is an established statistical

procedure used to separate the cyclical component from the long term trend in a time series of raw data

Trends in Net Transactions for Offices

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

-800.0

-600.0

-400.0

-200.0

0.0

200.0

400.0

600.0

800.0

Std Office Trend

Office Park Trend

Trends in Net Transactions for Retail

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

-400.0

-200.0

0.0

200.0

400.0

600.0

800.0

Std Shop Trend

Shoping Centre Trend

Retail Warehouse Trend

Trends in Net Transactions for Retail

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

-100.0

0.0

100.0

200.0

300.0

400.0

500.0

600.0

Shoping Centre Trend

Retail Warehouse Trend

Supermarket Trend

Trends in Net Transactions in Industrial Property

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

-100.0

-50.0

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

Std Industrial Trend

Distribution Warehouse Trend

Office Transactions: Deviations from Trend

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

-1,500.0

-1,000.0

-500.0

0.0

500.0

1,000.0

1,500.0

2,000.0

Std Office Cycle

Office Park Cycle

Conclusions

Substantial changes to institutional portfolio over 30 years

Limitations of optimal portfolio theory is exposed

Risk and return figures dominated by macroeconomy (five year horizon)

Active institutional portfolio restructuring Driven by urban change