Realized vs. Required Rates of Return & What It Means to the Real Estate Industry
Riggs, Jr., Kenneth P., Harms, Ryan W., Real Estate Issues
Today's institutional real estate environment is dynamic. One only has to take a brief look at its storied past to see the roller coaster ride it has taken over the past 20 years. Fortunately, institutional real estate has begun the maturation process, or so it seems. Today's investors are exerting more control and are paying closer attention to the tell-tale signs of an impending market slowdown, with most of this control generated from an increase of information available in the commercial real estate market and the influence of the public market real estate vehicles. The importance of technology and "real-time" information has turned the archaic real estate ways of old, obsolete.
The profile of today's successful investor is one that includes descriptives such as informed, tenacious, technologically affluent, and well-read. As summed up by Andrew Carnegie, the steel magnate and multi-millionaire, "There is scarcely a man who has made a fortune by speculation and kept it." In today's instant access environment, the informed investor, more times than not, gets the cash cow.
With this in mind, the authors take you through a historical return analysis of institutional real estate investment and show how information can enable investors to predict future trends in commercial real estate.
The history of the commercial real estate as an institutional investment can be traced by examining pension fund investment as an asset class.
As reported in "Risks and Rewards in Real Estate: A Historical Perspective," prepared by Real Estate Research Corporation (RERC) in April 1983, unlike their European counterparts, U.S. pension funds had just begun in the late 1970s and earlier 1980s to exhibit a true commitment toward commercial real estate investment.  This is contrasted to the large Dutch and German pension funds that began investing in real property in their own countries in the 1950s. First Chicago's Real Estate Fund F, established in 1973, was one of the first real estate funds for pension investors; and as of 1983 had approximately 100 participants with a core investment portfolio of 77 properties. The age of the industry is also documented by the industry's first standardized real estate performance report being published in the first quarter of 1978. In this context, even a casual observer would recognize that the institutional real estate industry is young--20 years or so--compared to the stock and bond markets. In retrospect, is it shocking that the young industry hit the wall in the late 1980s and experienced the most significant depression ever witnessed for any commercial real estate market--the proverbial 100-year flood? The infancy of the real estate market and lack of consistent and readily available information were some of the main drivers in the late 1980's real estate fallout.
The need for concise real estate information on required and realized returns spawned the inception of the National Council of Real Estate Investment Fiduciaries' (NCREIF) Index in 1978, and the introduction of surveyed investment criteria like the Real Estate Research Corporation's (RERC) Real Estate Investment Criteria in 1979. Investors have long demanded bellwether indicators of changes in the U.S. private equity commercial real estate market. This has led us, as analysts in investment activity, to combine sources and reliable data to provide a barometer for investment activity and to predict future trends in commercial real estate.
In a perfect world, investors would favor actual property transaction data that involves similar types of property that are used to develop the indexes. However, the problem is that real estate, by its nature, does not lend itself to continuous, efficient trading mechanisms like the stock and bond markets, although more recently the public markets provide more real-time investment information. Real estate trades are infrequent, their terms are highly property-specific, and the number of trades germane to a particular analysis is limited. …