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Diversified Investment in Listed Real Estate

Doctoral Session ERES Conference 2009, Stockholm. Diversified Investment in Listed Real Estate – A Competitive Analysis of REIT-Funds, Index-Certificates and Exchange-Traded Funds based on Transaction Cost Theory. Patrick Schlump Stockholm, June 24, 2009

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Diversified Investment in Listed Real Estate

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  1. Doctoral Session ERES Conference 2009, Stockholm Diversified Investment in Listed Real Estate – A Competitive Analysis of REIT-Funds, Index-Certificates and Exchange-Traded Funds based on Transaction Cost Theory Patrick Schlump Stockholm, June 24, 2009 Advisors: Prof. Dr. Karl-Werner Schulte, Prof. Dr. Klaus Röder

  2. Structure of the Presentation 1 Introduction 2 Theoretical Foundation and Fundamentals 3 Analysis and Study Setup 4 Summary 5 Discussion Doctoral Session

  3. Introduction Problem Description 1 Listed real estate as part of a mixed-asset portfolio Stocks Bonds Real Estate Cash Other non-Listed Listed REITs Real Estate Companies Collective Investment Schemes • Listed real estateconstitutes a separate assetclassthan non-listed real estate • Varietyofproductsavailabletoimplementstrategy • Active vs. passive problemarisesfordiversifiedproducts Active Passive • REIT-Funds • Exchange-traded Funds • Index-Certificates • (Index Funds) Dilemma of product choice Doctoral Session

  4. Introduction Problem Description 1 Investment objectives for direct real estate are assumed to apply for listed real estate as well Real Estate Investment Objectives Primary Objectives Safety Rate of Return Maintananceof Capital Diversification Manageabilityof Investment SecondaryObjectives Liquidity Accumulate UndisclosedReserves Exploitationof Tax Advantages Owner-Occupation Prestige Enhancement Common WelfareEnhancement • Hierarchy of objects may vary across investors • Increased cost awareness among (private) investors • More transparency requirements because of Mifid Doctoral Session

  5. Introduction Purposeofthe Study 1 Risk-adjusted Performance The aim of the analysis is to explore which diversified product in listed real estate provides the best outcome from a private investor‘s view in terms of transaction costs Overview of the selected product types History Legal Structure Trading Risks/ Chances Listed real estate products act in “parallel” worlds: Transaction Cost Theory Established stock market products Life Cycle Cost Model + Diversified products for listed real estate Product Type Efficiency Real estate market Identification of most efficient vehicle Doctoral Session

  6. Theoretical Foundation Efficient Market Hypothesis 2 No outperformance for actively managed products in efficient markets in the long run Passive strategies are “cheaper” to implement Passive products such as ETFs and Index-Certificates are superior to mutual funds Within real estate stock markets less information efficiency than within general stock markets is assumed General stock market Listed real estate market • Findings on market efficiency of listed real estate are ambiguous • REIT markets are becoming more efficient • Differences among countries evident • Active management might generate excess returns in listed real estate markets Doctoral Session

  7. Theoretical Foundation Transaction Cost Theory 2 Transaction cost theory traditionally analyses make-vs.-buy decisions, i.e. vertical integration Theory can be applied to various other scenarios Disclosure of TER (Total Expense Ratio) as an indicator of charges Initial charges and implicit costs are not covered by TER Applied measures of costs neglect significant factors “The shortest route to the top quartile in performance is to be in the bottom quartile of expenses.” (Bogle 2000) TER components: Management fees, Custodian bank fees, Audit fees, Disclosure costs Explicit Implicit Brokerage Commissions Market Fees Clearing and Settlement Costs Taxes/Stamp Duties Bid-Ask Spread Market Impact Operational Opportunity Costs Market Timing Opportunity Costs Missed Trade Opportunity Costs Doctoral Session

  8. Analysis and Study Setup Lifecycle Transaction Costs 3 Most transaction costs within an investment lifecycle are implicit and not visible to an investor Ex-ante Ex-post Explicit/Implicit Source: Own illustration following Picot (1982). Doctoral Session

  9. Product Type Efficiency 3 Analysis and Study Setup A generic comparison shows the differences of the product types Doctoral Session

  10. Analysis and Study Setup Product Type Efficiency 3 General diversification benefits of listed real estate Diversification as a criterion for market efficiency Asset Class Level Product Type Level Regulatory provisions, affecting diversification Product Level SectoralDiversification Residential Special Use Commercial Regional/Local Property-Trader National Operational Diversification Property-Developer International Geograph. Diversification Property-Investor Source: Own illustration following Nowak (2005). Doctoral Session

  11. Product Type Efficiency 3 Analysis and Study Setup Further Efficiency Criterions need to be analyzed Market Efficiency Diversification: Analysis and comparison of different levels of diversification Transparency: Ability to observe current and recent levels of market activity and price formation Flexibility and Accessibility: Extent to which investors can use the product Pricing Efficiency Liquidity: Comparison of liquidity provisions offered by the respective product types Price finding: Degree of replicating the underlying best Product costs: Comparison of costs associated with the set-up and running of the legal construct Trading Efficiency Round trip costs: Exit costs: Fees and expenses: Analysis of costs Risk Management Efficiency Benchmarking: General ability and process to mirror an underlying Dividend policies: Methods and consequences of dividend handling Tracking error: Analysis of deviation from a defined underlying Doctoral Session

  12. 4 Summary Lifecycle transaction costs and market efficiency are crucial parts of a comprehensive analysis of diversified products for listed real estate • Listed real estate contributes to a mixed-asset portfolio (assumption based on Literature Review) • In efficient markets passive products are generally superior to actively managed products (assumption based on Literature Review) • Listed real estate markets are less efficient than the general stock market (assumption based on Literature Review) • Regulatory provisions and product features result in different lifecycle transaction costs and efficiency levels (qualitative and quantitative analysis/case study analysis) ETFs, Index-Certificates and REIT-Funds are not equally well suited for diversified investment in listed real estate Doctoral Session

  13. Discussion

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