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Institutional Perspectives on Real Estate Investing: the Role of Risk and Uncertainty

Institutional Perspectives on Real Estate Investing: the Role of Risk and Uncertainty. Ravi Dhar William N. Goetzmann Yale School of Management. Problem. Why is the allocation to Real Estate so low? (1) It’s the right number (2) costs and trouble (3) conceptual issues. Approach.

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Institutional Perspectives on Real Estate Investing: the Role of Risk and Uncertainty

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  1. Institutional Perspectives on Real Estate Investing: the Role of Risk and Uncertainty Ravi Dhar William N. Goetzmann Yale School of Management

  2. Problem • Why is the allocation to Real Estate so low? • (1) It’s the right number • (2) costs and trouble • (3) conceptual issues

  3. Approach • Collect current institutional investor views about real estate as an asset class. • Goal: to understand determinant factors of institutional allocation to real estate. • We survey a large sample of major institutional investors via a web questionnaire.

  4. Findings • Long-term estimates of risk and return are the driving factors • A strong trend towards increasing their real estate allocation. • Trend more pronounced for managers who felt relatively comfortable in relying on historical statistics about real estate returns. • Conjectures about the role of uncertainty.

  5. Data Collection • Focus groups and interviews • Greenwich Associates questionnaire • E-mail administered. • 202 responses, 173completed/1,500 mailed • Focus on CIOs

  6. Sample Size, Composition and Assets Under Management

  7. Cross-Tabulation: Years Invested

  8. Table 3: Cross-Tabulation of Plans to Increase Allocation vs. Type of InstitutionNote: rows sum to 100%

  9. Views on Real Estate Expected Return

  10. Relative Risk

  11. Relative Cost

  12. Uncertainty and Decision-Making • Frank Knight’s 1921 study Risk, Uncertainty and Profit • Uncertainty: you don’t know the distribution • Risk: you don’t know the Std. • Bewley (1986) • investors were prone to inertia • the tendency to remain with the status quo choice. • might even explain the gross under—diversification observed among individual investors.

  13. Institution vs. Individual • Hirshleifer and Welch (2002) model the organization as distinct from the manager. • As the institutional memory for why a decision was originally made fades • Remaining managers have a bias towards the status quo in a steady economic environment. • In a volatile environment they might exhibit impulsiveness.

  14. Does Uncertainty Affect Choice? • Factors to look for: • Extrapolation Comfort • Efficiency of Market Price

  15. Extrapolation Comfort

  16. A strong relationship between confidence of extrapolation and target allocation!

  17. A strong relationship between length of time invested in RE, however it is non-linear.

  18. Crash Probability in next 10 years

  19. Relative Efficiency

  20. Conclusions • MPT statistical model as base of decision. • Other costs, issues and risks pertinent. • Uncertainty (as opposed to risk) plays a role in allocation. • Strong recent “herding” into real estate. • Is this herding irrational? Is it informational?

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