Style Analysis in Real Estate Markets and the Construction of Value and Growth Indexes

By Marcato, Gianluca | Journal of Real Estate Portfolio Management, September-December 2004 | Go to article overview

Style Analysis in Real Estate Markets and the Construction of Value and Growth Indexes


Marcato, Gianluca, Journal of Real Estate Portfolio Management


Executive Summary. Style analysis in equity markets is becoming more appealing to real estate investors. However, the literature in this sector generally uses either equity indexes (United States), or regional and sector ones (United Kingdom) to explain performances of real estate vehicles. This is a problem, mostly due to the lack of "proper" real estate style indexes. This paper suggests a quantitative model to decide the best criterion to breakdown a sample in order to create style indexes in real estate markets. The empirical analysis uses the Jones Lang LaSalle valuation database (4,004 properties) and ranks properties by their own equivalent yield. The findings indicate "median" as the most appropriate method to split the sample.

During the last decade, portions of equity and bond portfolios have been allocated to different market segments via multi-style management. The market in the United States has been experiencing a specialization of funds and managers not only for equities, but also for real estate assets, where several real estate investment trusts (REITs) focus in specific areas (e.g., residential, commercial, offices, regions, healthcare, etc.). On the other hand, the way funds in the United Kingdom operate does not fully reflect the existing segmentation of available investments. This situation is leading the U.K. property market to face an important issue: Does style management add value to the investment process?

This study begins with a brief discussion of previous works on style analysis carried out in both equity and real estate markets. Next, the theoretical grounds for choosing yields (and in particular equivalent yields) as plausible criteria to distinguish between growth and value properties are presented. However, the way in which the yield measure is to be used to split the sample into two separate sub-samples needs to be assessed. This paper proposes a model of statistical tests to decide the best method. Several growth and value indexes are created by using the Jones Lang LaSalle valuation database (4,004 properties) and three main splitting criteria. Finally, the model is empirically applied to identify the most appropriate method to split the sample.

Literature Review

Style analysis does not aim either to show the existing asset class holdings of a fund, or to compare existing and effective asset mixes, but to construct a generic style benchmark that is useful in the process of portfolio performance measurement. Sharpe (1992) analyzes management styles, via a multi-factor regression model to explain portfolio return series. He defines style analysis as "the use of quadratic programming for the purpose of determining a fund's exposures to changes in the returns of major asset classes." Other authors (e.g., Kemp, Richardson and Wilson, 2000) use a similar, but wider definition. However, this type of analysis is primarily used for equity asset and portfolio management, where the majority of papers identify the "mimicking" portfolio of mutual funds under two main assumptions: positive portfolio weights and total sum of weights equal to one (i.e., you cannot lend or borrow money). DeRoon, Nijman and TerHorst (2004) eliminate these two constraints and review several possible uses of style analysis (see also Lucas and Riepe, 1996); to evaluate mutual fund performances as a term of comparison (benchmark); to determine whether the mimicking portfolio is obtainable at a lower cost than the observed one (see also Keim and Madhavan, 1997); to identify and construct efficient portfolios of mutual funds and/or to estimate portfolio holdings (see also Brown and Goetzmann, 1997).

On the other hand, only a few real estate papers have been already published on this topic: general studies on portfolio diversification (by sector, region, function, etc.) and its explanatory power in describing the variability of returns (Lee, 1998; and Lee and Byrne, 1998); clusters analysis associated with bootstrapping techniques to test for clusters stability (Myer, Young and Webb, 1999); works on style attributes and their linkages with real estate performances, i. …

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