Commercial Real Estate Portfolios Research Articles

Tenant Business Characteristics and Commercial Real Estate Portfolio Fundamental Performance

This paper extends the literature on tenant characteristics and concentration on REIT performance. It fills in the knowledge gap of understanding how tenant business characteristics influence risk-return performance of directly held commercial real estate portfolios. Unlike the literature, it avoids compounding the peripheral information of financial leverage and capital market volatility into analyses for publicly traded real estate portfolios. We build a unique database of direct real estate by manually collecting fair value and rental value of investment real estate from annual reports of publicly traded real estate companies or trusts in New Zealand. Sharpe ratio and its significance on Z-statistic are analyzed and compared across twenty-four hypothetical portfolios sorted by geographic region, real estate sector and tenant business characteristic, respectively. It is found that certain tenant business industry can provide significantly superior performance during the entire sample period over other hypothetical portfolios. Specific tenant business industry and real estate sector show strong resilience to the 2007 global financial crisis. Tenant headquarter location signals commercial real estate risk-adjusted return performance. Our findings can facilitate researchers to extend their exploration of publicly traded real estate portfolios and help the understanding of market efficiency for commercial real estate and its related markets.

Daily appraisal of commercial real estate a new mixed frequency approach

AbstractWe present a mixed frequency repeat sales model for commercial real estate, taking into account changes in net operating income between the date of buying and selling the property. Moreover, we relate monthly private market index asset returns to lags, up to 1 year, of daily (REIT) index returns. The underlying daily model enables us to interpolate the monthly private market index returns on a daily basis, and to predict the private market index asset returns going forward. The mixed frequency repeat sales model facilitates daily appraisal of commercial real estate portfolios. We apply the model on sale prices (all property types, and apartments only) in the period January 2006–July 2020. We find that the mixed frequency repeat sales model reduces 1‐month‐ahead forecasts errors and index revisions, compared to a benchmark model without daily returns.

Intermediary Segmentation in the Commercial Real Estate Market*

AbstractBanks, life insurers, and commercial mortgage‐backed security (CMBS) lenders originate the vast majority of U.S. commercial real estate (CRE) loans. While these lenders compete in the same market, they differ in how they are funded and regulated, and therefore, specialize in loans with different characteristics. We harmonize loan‐level data across the lenders and review how their CRE portfolios differ. We then exploit cross‐sectional differences in loan portfolios to estimate a simple model of frictional substitution across lender types. The substitution patterns in the model match well the observed shift away from CMBS when spreads rose in late 2015 and early 2016. Counterfactuals suggest that the ability to substitute to other lenders offsets about 20% of the effect of a 25 basis point CMBS supply shock.

Daily Appraisal of Commercial Real Estate A New Mixed Frequency Approach

We present a mixed frequency repeat sales model for commercial real estate, taking into account changes in net operating income between the date of buying and selling the property. Moreover, we relate monthly private market index asset returns to lags, up to one year, of daily REIT returns. The underlying REIT model enables us to interpolate the monthly private market index returns on a daily basis, and to predict the private market index asset returns going forward. The mixed frequency repeat sales model facilitates daily appraisal of commercial real estate portfolios. We apply the model on sale prices (all property types, and apartments only) in the period January 2006 up to July 2020, provided to us by Real Capital Analytics. We find that the mixed frequency repeat sales model reduces one-month-ahead forecasts errors and index revisions, compared to a benchmark model without daily REIT returns.

A First Look at the Impact of COVID-19 on Commercial Real Estate Prices: Asset-Level Evidence

This is the first paper to examine how the COVID-19 shock transmitted from the asset markets to capital markets. Using a novel measure of the exposure of commercial real estate (CRE) portfolios to the increase in the number of COVID-19 cases (GeoCOVID), we find a one-standard-deviation increase in GeoCOVID on day t-1 is associated with a 0.24 to 0.93 percentage points decrease in abnormal returns over 1- to 3-day windows. There is substantial variation across property types. Local and state policy interventions helped to moderate the negative return impact of GeoCOVID. However, there is little evidence that reopenings affected the performance of CRE markets.

A First Look at the Impact of COVID19 on Commercial Real Estate Prices: Asset Level Evidence

This is the first paper to examine the transmission of an asset market shock to the capital markets during the COVID-19 pandemic. Using a novel measure of the exposure of commercial real estate portfolios (CRE) to the growth in COVID-19 (GeoCOVID), we find a one-standard-deviation increase in GeoCOVID on day t-1 is associated with a 0.24 to 0.93 percentage points decrease in abnormal returns over one-to-three-day windows. There is substantial variation across property types. Local and state policy interventions helped to moderate the negative return impact of GeoCOVID. However, there is little evidence that reopenings affected the performance of CRE markets.

Practical Applications of Be Prepared: Exploring Future Climate-Related Risk for Residential and Commercial Real Estate Portfolios

<h3>Practical Applications</h3> In <b>Be Prepared: <i>Exploring Future Climate-Related Risk for Residential and Commercial Real Estate Portfolios</i></b>, from the Summer 2020 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Mark Westcott</b> of Vivid Economics, <b>John Ward</b> of Pengwern Associates, <b>Swenja Surminsky</b> of Vivid Economics, <b>Paul Sayers</b> of Sayers and Partners, <b>David Bresch</b> of ETH Zurich, and <b>Bronwyn Claire</b> of the Cambridge Institute for Sustainability Leadership demonstrate the beneficial uses of two climate change models. A primary benefit of using these models is to effect a social change whereby builders and property owners adopt climate adaptation measures at a faster pace. The models expose the physical risks of real estate properties and estimate the risk reduction due to climate adaptation measures. The authors discuss several adaptation methods to mitigate the exposed risks, and their results illustrate the importance of doing so. The results provide a stark comparison between the estimated costs of mitigated and unmitigated damage occurring across a wide range of future temperature scenarios. <b>TOPICS:</b>Real estate, ESG investing, tail risks

The Rank-Size Rule and Challenges in Diversifying Commercial Real Estate Portfolios

The strategy of geographically diversifying a portfolio of commercial real estate assets is an intuitive approach for risk management. However, due to high concentrations of these assets in major metropolitan areas, investors may face additional constraints in the portfolio optimization process. The rank-size rule, a log-linear relationship between city rank and size, provides one of the greatest empirical regularities in regional science. As such, it serves as a possible theoretical guide to the weights given to properties by location in a commercial real estate portfolio. This paper sets forth some ideas relating to the concentration side of portfolio variance and the limiting effect that large concentrations may have on the ability to diversify risk. Two variants of the rank-size relationship – the Zipf distribution and the parabolic fractal distribution – are fitted to a variety of datasets to provide a sense of the degree of concentration in the commercial real estate industry. These empirical findings suggest the presence of limitations to geographical diversification that have varying degrees of severity across different property types or sectors of the commercial real estate market.

Intermediary Segmentation in the Commercial Real Estate Market

Banks, life insurers, and commercial mortgage-backed securities (CMBS) lenders originate the vast majority of U.S. commercial real estate (CRE) loans. While these lenders compete in the same market, they differ in how they are funded and regulated, and therefore specialize in loans with different characteristics. We harmonize loan-level data across the lenders and review how their CRE portfolios differ. We then exploit cross-sectional differences in loan portfolios to estimate a simple model of frictional substitution across lender types. The substitution patterns in the model match well the observed shift of borrowers away from CMBS when CMBS spreads rose in 2016.

Risk Reduction and Tracking Error in Small Commercial Real Estate Portfolios

Because of the extreme heterogeneity and lumpiness of commercial real estate, the topic of diversification and risk management has always attracted substantial interest, and a large body of work has been written on the subject. However, most of the analysis has focused on just a few markets, most notably the United Kingdom, or has been based on limited samples. This article uses asset-level data from over 9,000 office assets in the MSCI Global Annual Property Index to explore the performance of small portfolios (1 to 30 assets) over two separate five-year periods (2007–2011 and 2013–2017) in 16 national markets. The analysis focuses on small portfolios of fewer than 30 assets because many investors (even institutional investors and funds) have portfolios that are relatively small in terms of number of assets. The results provide a globally consistent overview of how asset correlations and market risk affected small commercial real estate portfolios and may have implications for the way investors and managers think about diversification in their exposures. TOPICS:Real estate, risk management Key Findings • Simulating the performance of commercial real estate portfolios with up to 30 assets suggests that even small portfolios can substantially reduce the amount of expected tracking error and volatility. • However, asset correlations vary considerably across markets and over time, meaning that estimates of risk reduction and diversification potential for one market during a specific period may be of limited use when applied to another market or a different period. • Investors may also wish to consider the fact that while the average portfolio can be expected to achieve a reasonable amount of diversification, individual portfolios cannot always be expected to behave like the average portfolio due to the heterogeneity of the asset class.

Value-Drivers and Some Principal-Agent Conflicts in Commercial Real Estate Portfolios: A Company-Level and Market-Level Analysis

This article: i) explains some drivers of both business value and real estate value of commercial retail real estate portfolios; ii) illustrates some principal-agent problems that arise from investment and control of operating companies by hedge funds and private equity funds.

Credit Risk in Commercial Real Estate Bank Loans: The Role of Idiosyncratic Versus Macro-Economic Factors

The commercial real estate market is pro-cyclical. This feature, together with the relative size of the industry and the large capital inflows, has made this sector relevant for financial stability. Using a novel loan level data set covering the commercial real estate portfolios of Dutch banks we aim to uncover potential drivers of distress in commercial real estate loans. Furthermore, we estimate the relative importance of idiosyncratic and systematic factors and emphasize the importance of bank behavior for distinguishing between good and bad credit growth. We find that loans originated near the peak of the cycle are riskier, confirming the pro-cyclical nature of the market. As opposed to loans originated during busts, the risk of boom loans does not decrease when economic conditions improve. Idiosyncratic factors correlated with higher credit risk are loan-to-value ratios and interest rates, especially when coupled with variable rate contracts. Moreover, we find that collateral type plays a role, as loans for non-residential (office, retail, industrial) real estate with higher vacancy rates are riskier. These results have implications for both macroprudential and microprudential supervision, as they demonstrate the pro-cyclicality of the market and show that indicators like loan-to-value, interest rate structure and vacancy rates must be monitored more carefully in boom times.

Frontiers of commercial real estate portfolio performance: Are sector-region-efficient diversification strategies a myth or reality?

This paper departs from the traditional optimisation methods used to evaluate portfolio performance. Rather, the Stochastic Frontier Analysis approach is used to econometrically determine the benchmark real estate portfolio frontier and subsequently assess the gains from diversifying real estate portfolios along regional and sectoral dimensions in the UK. Portfolio specific inefficiency measures are obtained which indicate whether a portfolio is efficiently diversified and therefore places on the benchmark frontier and if not, the degree to which performance can be improved is quantified. Portfolio-specific efficiencies average at 85–91%, indicating scope to further improve performance. Further, diversification be it on a sectoral or regional dimension, contributes to significantly lower variability in portfolio efficiencies.

Limits to Diversification:Tail Risks in Real Estate Portfolios

This study addresses real estate’s riskiness from a distributional standpoint. Several studies have found that real estate returns are best modeled with stable Paretian distributions. This is confirmed using National Council of Real Estate Investment Fiduciaries individual property returns, but the first application of stable distributions to commercial real estate portfolio returns provides evidence that diversification effects ultimately reduce tailedness and, surprisingly, drive the tail parameter toward normality. Further insight is provided by highlighting the importance of a complete view, beyond pure tail parameter considerations. Even when tail parameters reflect normality, the return risk may still be tremendous, and it can only be reduced by diversification effects in property portfolios (and only to a certain, time-dependent extent).

Assessing Targeted Macroprudential Financial Regulation: The Case of the 2006 Commercial Real Estate Guidance for Banks

Abstract In January 2006, federal regulators issued guidance requiring banks with specific high concentrations of commercial real estate (CRE) loans to tighten managerial controls. This paper shows that banks with concentrations in excess of the thresholds set in the guidance subsequently experienced slower growth in their CRE portfolios than can be explained by changes in bank or economic conditions. Moreover, banks above the CRE thresholds tended to have slower commercial and industrial loan growth but faster household loan growth following issuance of the guidance. The results highlight the potentially broad influence that portfolio-based macroprudential regulation might have on bank behavior.

Assessing targeted macroprudential financial regulation: The case of the 2006 commercial real estate guidance for banks

In January 2006, federal regulators issued guidance requiring banks with specific high concentrations of commercial real estate (CRE) loans to tighten managerial controls. This paper shows that banks with concentrations in excess of the thresholds set in the guidance subsequently experienced slower growth in their CRE portfolios than can be explained by changes in bank or economic conditions. Moreover, banks above the CRE thresholds tended to have slower commercial and industrial loan growth but faster household loan growth following issuance of the guidance. The results highlight the potentially broad influence that portfolio-based macroprudential regulation might have on bank behavior.

Assessing Targeted Macroprudential Financial Regulation: The Case of the 2006 Commercial Real Estate Guidance for Banks

In January 2006, federal regulators issued guidance requiring banks with specific high concentrations of commercial real estate (CRE) loans to tighten managerial controls. This paper shows that banks with concentrations in excess of the thresholds set in the guidance subsequently experienced slower growth in their CRE portfolios than can be explained by changes in bank or economic conditions. Moreover, banks above the CRE thresholds tended to have slower commercial and industrial loan growth but faster household loan growth following issuance of the guidance. The results highlight the potentially broad influence that portfolio-based macroprudential regulation might have on bank behavior.

How Active Is Your Real Estate Fund Manager?

Using a holdings-based measure of active management termed the Segment Active Share, this article demonstrates the outperformance of more active commercial real estate portfolios; i.e., those with segment weights least like the index. Employing proprietary IPD data for 256 U.K. real estate funds over the period 2002–2011, we find that funds with high Segment Active Share on average outperformed the real estate market by 1.9% per year. These funds do not seem to take increased risk, and their outperformance cannot be explained by fund size alone, though on average they are smaller funds.

Tales of Tails and Their Removal in Real Estate Portfolios: Does Normality Prevent from Risk?

This study addresses real estate's riskiness from a distributional viewpoint. Several studies have found real estate returns to be best modeled with stable paretian distributions. Using NCREIF individual property returns this is confirmed, but the first application of stable distributions to real estate portfolio returns provides evidence that diversification effects ultimately reduce the tailedness and surprisingly drive the tail parameter towards normality. The study further contributes to the literature by showing the importance of a complete view, beyond pure tail parameter considerations. Even in the presence of tail parameters being close to normal, the return risk may still be tremendous, and can only be reduced by diversification effects in property portfolios, and only to a certain time-dependent extent. The results have strong implications for risk managers, fund managers and holders of large commercial real estate portfolios alike.

Modern Real Estate Portfolio Management (MREPM): Applications in Modern and Post-Modern Real Estate Portfolio Theory (MREPT/PMREPT)

Modern Real Estate Portfolio Management (MREPM): Applications in Modern and Post-Modern Real Estate Portfolio Theory (MREPT/PMREPT)