Florian Heydenreich, Daniel Kohlert and Andreas Oehler Bamberg University, Germany

1. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? Florian Heydenreich, Daniel Kohlert and Andreas OehlerBamberg University, Germany Chair of Finance ERES conference 2009 24th – 27th of July Stockholm

2. Heydenreich, Kohlert, Oehler (1) Introduction Successful real estate investment depends on an understanding of the determinants of real estate returns (Fraser 1986). Various studies have shown that economic factors are important determinants of real estate returns (e.g., Chin 2003, Jackson / White 2005, Ziering / Hess 1995). Most studies, however, are based on national economic data (e.g., Hendershott et al. 1999 and 2002, Wheaton et al. 1997). Potential conflict between national economic data and regional, local or object-specific return data and investment strategies. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

3. Heydenreich, Kohlert, Oehler (2) Data and Methodology • Level: NUTS 2 (27 of 37 UK regions) • Time horizon: 1981 – 2004 (yearly) Return data: IPD Investment Property Databank Annual total return (TRt), income return (IRt) and capital growth (CAt) data for office buildings • Economic data: Cambridge Econometrics • Annual GDP (GDPt), unemployment (UEPt), and total investment (INVt) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 3

4. Heydenreich, Kohlert, Oehler (2) Data and Methodology • Panel Analysis • Static random-effects model (GLS): • Rit = β1x1it+…+ βKxKit + μi +νit • Dynamic random-effects model (GMM): • Rit = β0Ri, t-1+ β0Ri, t-2+ βKxKit +…+ βKxKit + μi +νit • Rit: return variable (CA, IR, TR) of region i in period t • xKit: macroeconomic demand variable (GDP, UEP, INV) of region i in period t • βK: parameter, μi: region specific intercept, νit: overall remainder Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 4

5. Heydenreich, Kohlert, Oehler (3) Results • Descriptives • Capital Growth R = Region Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 5

6. Heydenreich, Kohlert, Oehler (3) Results • Descriptives • Investment Return R = Region Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 6

7. Heydenreich, Kohlert, Oehler (3) Results • Descriptives • Total Return R = Region Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 7

8. Heydenreich, Kohlert, Oehler (3) Results • Descriptives (Panel) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 8

9. Heydenreich, Kohlert, Oehler Panel Analysis: Capital Growth Panel Analysis: Capital Growth 9 Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

10. Heydenreich, Kohlert, Oehler Panel Analysis: Investment Return Panel Analysis: Investment Return 10 Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

11. Heydenreich, Kohlert, Oehler (3) Results Panel Analysis: Total Return Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 11

12. Heydenreich, Kohlert, Oehler (3) Results The estimated regression coefficients reveal autoregression for each of the dependent variables Economic factors influence real estate performance criteria However: UEP not important, GDP not the expected sign Data (sample) error? Methodological errors? Does the identical slope assumption make sense? Extra tests (ADR) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 12

13. Heydenreich, Kohlert, Oehler (4) Extra Tests Autoregressive Distributed Lag Model (n=2, p=1; regional) Number of significant regional results per criterion (univariate) (multivariate, step-ls!) Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 13

14. Heydenreich, Kohlert, Oehler (5) Conclusion The available time series are still to short to offer safe statements about the influence of the regional economic factors GDP, INV and UEP on regional real estate performance. At this point, however, it cannot be recommended to ignore the peculiarities of single regions and to rely solely on national data. The lags of the dependent variables often seem to explain regional real estate performance better than demand-side variables. There might also be a strong influence of non-macro-economic factors, particularly supply-side factors, that have greater explanatory power. Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 14

15. Heydenreich, Kohlert, Oehler Thank you for your comments! Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns? 15

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18. Heydenreich, Kohlert, Oehler Return Formula CV = capital value, CE = capital expenditures, NR = net rent 18 Sense and Nonsense of Diversification Based on Economic Factors: Do Regional Economic Factors Influence Regional Real Estate Investment Returns?

20. CA, GDP

21. CA, INV

22. CA, UEP

23. IR, GDP

24. IR, INV

25. IR, UEP

26. TR, GDP

27. TR, INV

28. TR, UEP

29. CA, ALL

30. IR, ALL

31. TR, ALL