Tue, 17/11/2009 - 06:00
Simon Coxeter, Director at Swisslake Capital Asia, discusses the importance of a multi-disciplinary approach to real estate investment.
For an investor’s allocation to real estate, what is most important in shaping returns across the market and economic cycle? Is it a thorough understanding of the underlying physical market, or is it the ability to invest shrewdly across asset classes and strategies?
Clearly, both are important, but the latter is still neglected by many investors, a phenomenon which in itself presents sophisticated allocators to real estate with the opportunity for superior returns.
This article examines the importance of a multi-disciplinary approach to real estate investment, and the benefits of complementing direct real estate exposure with more liquid real estate-related assets.
The liquidity crunch playing out over the last eighteen months forced many investors to reconsider their approach to real estate investment. Inherent weaknesses within the risk management and return optimization functions of institutional investment processes were either overlooked or tolerated through the good times, perhaps partly because of the way in which real estate investment departments were integrated (or rather, insufficiently integrated) into wider investment organizations, and partly because the illiquid nature of physical property lends itself to a longer-term strategic mindset (which in some cases could be referred to as the ‘we don’t concern ourselves too much with short-term volatility’ mindset).
This longer-term strategic mindset, however, has on occasion been severely tested by what has been the overwhelming confluence of liquidity-driven and fundamentals-driven shocks to the asset pricing mechanism.
Institutional investors with large exposure to physical real estate assets either directly or through private equity funds, for example, have faced difficulties not only from a liquidity standpoint, but also in maintaining a portfolio position consistent with their investment view – often left with the option to offload the best assets and retain the worst in order to meet liquidity requirements.
A holistic approach to real estate investment, combining a team of professionals from different investment disciplines, impacts positively upon both risk management and return optimisation.
But what does a holistic approach really involve? First, it requires a unified investment philosophy, which allows for a congruent assessment of risk and reward across asset classes and strategies.
Second, it requires the creation and ongoing re-evaluation of a strategic benchmark allocation to the full spectrum of liquid and illiquid real estate assets, around which tactical maneuvering can take place across the market cycle.
This is a simplification, of course, and there are many hurdles in the course of implementing even a simple multi-asset class multi-strategy investment model. For example, comparing valuations across private and public asset classes can be a nebulous process at the best of times, as the risks and value drivers are very different.
Simply comparing current cap rates in the direct market with some form of implied cap rate in the listed market does provide a starting point, but other factors and necessary assumptions cloud transparent comparisons.
Therein lies both the challenge and the opportunity, as value gaps between asset classes emerge across the cycle. Price discovery in private markets can be sluggish, which has resulted in convenient return-smoothing for some, but frustrating uncertainty and disillusion for others. Volatility in public markets can lead to extreme value dislocations. These contrasting value dynamics must be taken into account when identifying pricing anomalies.
Properly integrating public and private market investment functions within an organisation sets the backdrop for a nimble and proactive (rather than reactive) approach to real estate portfolio management. The scope to short specific securities, indices, and physical sub-markets, for example, can significantly reduce downside deviation within a portfolio of real estate assets.
Equally, expertise in the physical real estate market is better leveraged with a wide array of investment tools available to express a particular view.
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