Commercial Real Estate Investment

Prelims:Prelims 6/4/09 11:42 Page i Commercial Real Estate Investment A Strategic Approach Second edition Andrew Baum 2009 A division of Reed Business Information Estates Gazette 1 Procter Street, London WC1V 6EU Prelims:Prelims 6/4/09 11:42 Page ii © Andrew Baum, 2009 ISBN 978 0 7282 0567 3 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the UK Copyright Designs and Patents Act 1988, this publication may not be reproduced, stored, or transmitted, in any form or by any means, without the prior written permission of the Publishers, or in the case of reprographic reproduction, only in accordance with the terms of the licences issued by the Copyright LicensingAgency in the UK, or in accordance with the terms of licences issued by the appropriate Reproduction Rights Organisation outside the UK. Enquiries concerning reproduction outside the terms stated here should be sent to the Publishers. 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Typeset in Palatino 10/12 by Amy Boyle, Rochester Cover design by Rebecca Caro Printed by Short Run Press, Exeter Prelims:Prelims 6/4/09 11:42 Page iii Contents Foreword to the first edition Preface to the first edition Preface to the second edition Part 1 Introduction to the market 1 Commercial real estate — the asset class . . . . . . . . . . . . . . . . . . . . 3 1.1 Property — a global asset class? . . . . . . . . . . . . . . . . . . . . . . . . 3 1.2 What makes property different? . . . . . . . . . . . . . . . . . . . . . . . . 5 1.3 Property depreciates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Box 1: Depreciation and its impact . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.4 Lease contracts control cash flows . . . . . . . . . . . . . . . . . . . . . 10 1.5 The supply side is inelastic . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 1.6 Valuations influence performance . . . . . . . . . . . . . . . . . . . . . 12 1.6.1 Valuation accuracy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1.6.2 Client influence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 1.7 Property is not liquid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 1.8 Large lot sizes produce specific risk. . . . . . . . . . . . . . . . . . . . 18 1.9 Leverage is commonly used in real estate investment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 1.10 Is property an inflation hedge? . . . . . . . . . . . . . . . . . . . . . . . . 26 1.11 Volatility and risk appear to be low . . . . . . . . . . . . . . . . . . . . 28 1.12 Real estate cycles control returns . . . . . . . . . . . . . . . . . . . . . . 30 1.12.1 Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 1.12.2 Rents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 1.12.3 Yields and capital values. . . . . . . . . . . . . . . . . . . . . . . . 33 1.12.4 Returns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 1.12.5 Cycles: the result of market inefficiency? . . . . . . . . . 34 1.13 Diversification — the evidence . . . . . . . . . . . . . . . . . . . . . . . . 36 iii Prelims:Prelims 6/4/09 11:42 Page iv Commercial Real Estate Investment 1.14 Challenges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 1.14.1 The limitations of direct real estate investment. . . . . 42 1.14.2 Securitisation and globalisation. . . . . . . . . . . . . . . . . . 43 2 The market — and who makes it . . . . . . . . . . . . . . . . . . . . . . . . . . 45 2.1 The global property investment universe . . . . . . . . . . . . . . . 45 2.2 The value of the UK real estate market . . . . . . . . . . . . . . . . . 46 Box 2: The UK property market sectors . . . . . . . . . . . . . . . . . . . . . 47 2.3 Market players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 2.3.1 Investors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 2.3.2 Fund managers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 2.3.3 Advisors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 2.3.4 Funds and vehicles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 2.4 A property performance history — the UK. . . . . . . . . . . . . . 64 2.4.1 1950–73: from low inflation to a boom . . . . . . . . . . . 65 2.4.2 1974–81: a small cycle, high inflation . . . . . . . . . . . . . 67 2.4.3 1981–89: high inflation, another boom . . . . . . . . . . . . 68 2.4.4 1990–99: deep recession, low inflation and globalisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 2.4.5 2000–06: boom. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Box 3: A bubble in UK property prices? . . . . . . . . . . . . . . . . . . . . . 76 2.4.6 2007–09: bust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 2.5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Part 2 The investment process 3 Building the portfolio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 3.1 Introduction to portfolio management. . . . . . . . . . . . . . . . . . 95 3.2 Absolute and relative return objectives . . . . . . . . . . . . . . . . . 98 3.3 The top-down portfolio construction process. . . . . . . . . . . 100 3.3.1 The relative return target . . . . . . . . . . . . . . . . . . . . . . 100 3.3.2 The absolute return target. . . . . . . . . . . . . . . . . . . . . . 101 3.4 Setting investment objectives. . . . . . . . . . . . . . . . . . . . . . . . . 102 3.4.1 Criteria for investment objectives . . . . . . . . . . . . . . . 102 3.4.2 Return and risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 3.4.3 Benchmarks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 3.4.4 Time horizons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 3.5 Strengths, weaknesses, constraints: portfolio analysis . . . 105 3.5.1 Recent performance . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 iv Prelims:Prelims 6/4/09 11:42 Page v Contents 3.5.2 Current portfolio structure . . . . . . . . . . . . . . . . . . . . . 106 3.5.3 Strengths, weaknesses, constraints . . . . . . . . . . . . . . 106 3.6 Structure and stock selection. . . . . . . . . . . . . . . . . . . . . . . . . 107 3.6.1 Structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 3.6.2 Stock selection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 3.6.3 Passive and active strategies . . . . . . . . . . . . . . . . . . . 109 3.7 Using forecasts and valuation models . . . . . . . . . . . . . . . . . 110 3.7.1 Forecasts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 3.7.2 Valuation models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 Box 4: Portfolio construction — a case study . . . . . . . . . . . . . . . 113 4 Pricing real estate: the purchase and sale process . . . . . . . . . . 121 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 4.2 Sourcing stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122 4.3 Due diligence: the building purchase process . . . . . . . . . . 124 4.4 A property appraisal model. . . . . . . . . . . . . . . . . . . . . . . . . . 124 4.4.1 Introduction: the excess return. . . . . . . . . . . . . . . . . . 124 4.4.2 The initial yield — a simple price indicator. . . . . . . 126 4.4.3 The Fisher equation . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 4.4.4 A simple cash flow model. . . . . . . . . . . . . . . . . . . . . . 129 4.4.5 Gordon’s growth model (constant income growth). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 4.4.6 A property valuation model including depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 4.5 The model components . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 4.5.1 The risk-free rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132 4.5.2 The risk premium. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132 4.5.3 Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 4.5.4 Real rental growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 4.5.5 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 4.5.6 ‘Correct’ yields . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 4.6 A real analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136 Box 5: ‘Correct’ asset class yields. . . . . . . . . . . . . . . . . . . . . . . . . . 137 4.7 The required return: additional analysis . . . . . . . . . . . . . . . 139 4.7.1 The risk-free rate and the yield curve. . . . . . . . . . . . 139 4.7.2 The risk-free rate: bond and equity components. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 4.7.3 The subsector and property risk premium . . . . . . . 140 4.7.4 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142 4.8 Forecasting rents and yields . . . . . . . . . . . . . . . . . . . . . . . . . 143 v ... - tailieumienphi.vn