Investments in trophy buildings: An analysis of economic and non-economic factors

1. Investments in trophy buildings:An analysis of economic and non-economic factors OUTLINE Introduction Presentation by Fabian Spindler and Carsten Lausberg prepared for the 18th Annual Conference of the European Real Estate Society,June 15-18, 2011 in Eindhoven Characteristics Economic factors Non-economic factors Empirical study Conclusion

2. Introduction Introduction • Definitions: • Landmark building = a buildingwhichsetsitself apart fromother buildings due toitsoutstandingarchitecture, locationorother characteristics • Trophybuilding = a famousbuildingwithwhichtheownercanadornhimself In thispaperusedsynonymously! • Motivation: German open-endedinvestmentfundsarekeeninvestors in landmark buildings althoughtheeconomicsofthisspecialassetclassareratherunclear. Do theyknowwhattheyaredoing? • Objectives: • Identifykey characteristics oflandmark buildings • Investigatewhetherinvestments in trophy buildings pay off Characteristics Economic factors Non-economic factors Empirical study Conclusion

3. Literatureoverview Introduction • Landmark propertiesarethe classic domainofdisciplineslikearchitecture, urban planning, andconstructionengineering; example: Wattset al. (2007) • Still an exotictopic in real estateliterature; landmark buildings aresometimesmentionedindirectly, e.g., whenthe relationship betweenbuildingfeatures (size, height, numberof stories…) andeconomic variables (rent, caprates, value…) isstudied; example: McDonald/Dermisi(2008) • Pioneeringworkswithconnectiontoourresearchobjective: • Hough/Kratz (1983), Vandell/Lane (1989), Gat (1998)  rentalpremiumforhigharchitecturalquality in Chicago, Boston, and Tel Aviv • Shilton/Zaccaria (1994),  price premium for size, height, and other features in Manhattan • Kurzrock et al. (2009)  value/yieldpremiafor large buildings in Germany • Fürst/MacAllister/Murray (2009)  rental premium for office buildings designed by award-winning architects • Dermisi/McDonald (2010)  pricepremiumforfameandfacade in Chicago • Other directions: Real estatemarketing(Temelová 2004) andbehavioraleconomics, e.g., theinfluenceofprestigeandother non-economicfactors on real estateinvestmentdecisions Characteristics Economic factors Non-economic factors Empirical study Conclusion

4. Characteristics oflandmark buildings Introduction • Location Landmark buildings are typically to be found in prime locations, particularly in the central business districts of the largest metropolises • Size • Extraordinaryconstructionheight (meter) orspace (squaremeter) • Point ofreference • Formation ofthe cityscape • Architecture Unique features, so that the individual property will stand out from the surrounding buildings • Image • Positioning of the landmark building as an independent brand • Distinguished from the bulk of other buildings • Value • High construction costs, especially with increasing number of stories and distinctive/unique architecture; as a result: high purchase price • Top rents, especially on the upper stories Characteristics Economic factors Non-economic factors Empirical study Conclusion

5. Key Characteristics Introduction Characteristics Economic factors Non-economic factors Empirical study Conclusion

6. Safety Introduction Figure 1: Preferencesof German institutionalinvestors[Funke/Gebken/Johanning(2010), p. 7] • Assumptions • Specificrisks: High constructioncosts, longduration, highleverage (withhuge potential gains), difficultytodiversify (bulkrisk) • Market risks: Higher volatilityof top rents, lowervacancyrisk • Miller et al. (2003): Rental and value lossesforfamouslandmark buildings after 9-11 terroristattacks Characteristics Economic factors Non-economic factors Empirical study Conclusion

7. Liquidity Introduction • Asset Liquidity Typical characteristics are timing costs, market organization, transaction costs andvaluation diversity. As a result, there is a uncertainty of the futureliquiditation process regarding time and proceeds from the sale • Market Liquidity • Market breadth: Large differences in pricing due tothehighmarket value • Market depth: Market oflandmarkbuildingsaremore illiquid thanother investments (in 2010, for example, only six landmarkbuildings in New York City changed owners) Inability tosellquickly Characteristics Economic factors Non-economic factors Empirical study Conclusion

8. Return Introduction Assumptions about the most important factors: • Acquisition • High purchase price due to the high construction costs • Investors need to be clear that they will pay a premium for extraordinary construction height and prestige • Rental income • Pressure on higher rental income compared with ordinary office buildings because of considerable acquisition and maintanance costs • Top rents are generally achieved only on the upper stories • Sale proceeds Pressure on estimated sale proceeds due to the high acquisition costs Characteristics Economic factors Non-economic factors Empirical study Conclusion

9. Non-economicfactors Introduction • Prestige = respect or esteem from other people (Maslow 1943) • Subjective component (evaluation according to the values of the society) and objective component (importance that a person or a firm derives from this for herself or others) • Not necessarily contrary to economic objectives, e.g., prestige important to canvass new customers • Power = the ability of an actor to realize his or her will in a social action, even against the will of other actors(Weber 1946) • Assumptions: • Investment funds and their managers can increase prestige and power by buying trophy buildings • Decision-makers with strong prestige or power motives tend to prefer trophy buildings due to the possible increase in prestige or power respectively • Non-economic factors occasionally dominate economic factors Characteristics Economic factors Non-economic factors Empirical study Conclusion

10. Empiricialstudy, partone: Survey Introduction • Methodology: Survey amongdecision-makers • Online questionnaire(anonymous) • 14 closedand open-endedquestions • Invitationsweresentto 154 portfoliomanagers; selection criterion: internationally operating real estatecompany • All potential interviewerswerecontactedpersonallyover a businessplatform (www.xing.com) orvia email including online link forthesurvey • Total populationunknown not representative • Response rate 55% (n=84) • July/August 2010 • Description ofthe sample • 80% work in real estateinvestment, 20% in assetmanagement • 55% fundmanagers, 18% assetmanagers, 27% otherfunctions • 91% experiencewithlandmarkproperties, 9% noexperience Characteristics Economic factors Non-economic factors Empirical study Conclusion

11. Empiricialstudy, partone: Survey Introduction • Results • Landmark buildingscomparedtoordinaryoffice buildings: • Nosignificantadvantageswithreferencetosaleopportunities (in periodsofeconomicdifficulty), incomeretunandcapitalgrowthreturn • Advantages with referencetovacancyrisk • Risk factors: small number of potential buyers, highprice, leaseabilityand financing • Investment decision in landmark buildings: • Liquidityas a risk factor plays a medium role • Prestige andmarketingpurposesareimportantfactors • Prestige-orientedtenantsarewillingtopay top rents • Most importantadvantagesanddisadvantagesofinvesting in landmarkbuildings: • Advantages: stable market value, prestige, leaseability • Disadvantages: low return, highoperatingexpenses, high investment volume Characteristics Economic factors Non-economic factors Empirical study Conclusion

12. Empiricialstudy, partone: Survey Introduction • Evaluation ofthepurchasecriteriato an investmentdecision in landmark buildings (Scale: 1 importantto 5 unimportant ): Characteristics Economic factors Non-economic factors Empirical study Conclusion

13. Empiricialstudy, parttwo: Data analysis Introduction • Methodolgy: Data analysis • Identificationoflandmark buildings accordingtoourlistofkey characteristics frominvestorreports, annualstatements, propertyfactsheets, andotherpubliclyavailabledocuments; in addition: informationfrom expert interviews • Collectionofdatafromthe same sources • Mainly simple comparisonsanddescriptivestatistics • Data: • Property dataof 31 landmarkbuildingsfrompubliclyavailableand private sources: Total return, capitalgrowth, rentalincome, vacancy rate, buildingfeatures • IPD real estateindicesforAustria, France, Germany, Holland, Japan, UK, and USA; NCREIF Property Index for USA • 2006-2010, annualdata Characteristics Economic factors Non-economic factors Empirical study Conclusion

14. Empiricialstudy, parttwo: Data analysis Introduction • Average returns of all landmark buildings in the sample: • Other results: • Positive results for 231 out of 291 figures (= 79%), whilst 48 are negative • Strong performance in 2006 and 2007 • Solid performance in periods of economic difficulty • Average total return 7.7% • No negative returns on average • Stable income return Characteristics Economic factors Non-economic factors Empirical study Conclusion

15. Empiricialstudy, parttwo: Data analysis Introduction • Landmark buildingscomparedtoofficebuildingindices • Returns were greater than the respective benchmarks in most years, especially in 2008 and 2009 • In absolute figures: 191 out of 289 positive (= 66%) • Capital growthreturnand total returnshow higherdifferencesthanincomereturn • Link tables • Differencebetween index return and property return • Descriptive statistics for differencebetween index return and property return • Relationship between the returns for landmark buildings and the indices Characteristics Economic factors Non-economic factors Empirical study Conclusion

16. Empiricialstudy, parttwo: Data analysis Introduction • Risks Total return Characteristics Economic factors STD: 8.1% Non-economic factors STD: 1.3% Empirical study Conclusion

17. Empiricialstudy, parttwo: Data analysis Introduction Vacancy rate: Characteristics Economic factors Ø:8.3% Non-economic factors Ø:4.9% Empirical study Conclusion

18. Conclusion Introduction • Stableincomereturn • Stablemarket value especiallyduringdifficulteconomictimes • Total return shows a less volatile progression compared to office buildings • Lower vacancy rate • Prestige plays an outstandingrole Landmark buildingsrepresent a qualitative and alternative real estateinvestment Therearemanybenefitstoinvesting in landmarkbuildingscomparedtoordinarybuildings BUT: More data needed for more reliable and precise conclusions Characteristics Economic factors Non-economic factors Empirical study Conclusion

19. Questionsor Comments? Contact information: Campus of Real Estate Nürtingen-Geislingen University Parkstr. 4 73312 Geislingen, Germany Fabian Spindler Dr. Carsten Lausberg, M.S. Professor of Real Estate Banking privat.spindler@googlemail.comcarsten.lausberg@hfwu.de Phone: +49 17 73 09 14 60Phone: +49 89 41 92 92 14

20. Empiricialstudy, parttwo: Data analysis Introduction • Differencebetween index return and property return (in basis points) Characteristics Economic factors Non-economic factors Empirical study Conclusion back

21. Empiricialstudy, parttwo: Data analysis Introduction • Descriptive statistics for differencebetween index return and property return Characteristics Economic factors Non-economic factors Empirical study Conclusion back

22. Empiricialstudy, parttwo: Data analysis Introduction • Relative relationship between the returns for landmark buildings and the indices Characteristics Economic factors Non-economic factors Empirical study Conclusion back