Real Estate Investments: The Case of Italian Market

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1 Financial Management Association European Conference june 2005 Real Estate Investments: The Case of Italian Market Gabriele Sampagnaro Dipartimento di Studi Aziendali, University of Naples arthenope.

2 Real Estate Investments: the case of Italian market Topic: analysis of the role of Italian real estate in a mixed-portfolio with the MVO framework. Some initial questions: Which aspect of the role? Why MVO? Which the limits? Which data use? rivate or public market? private ublic Market, characteristics: Italian closed property funds Officially started in with the institution of specialized closed fund (fondi comuni di investimento immobiliari, Law 86/994) Illiquidity of the market and the limited number of listed funds Lack of a benchmark Real estate companies ABS

3 Global Real Estate Transparency Index 2004 Rank Real Estate Transparency Tier -5 (2004) Real Estate Transparency Tier -5 (2004) Real Estate Transp. (200) Australia.9 Same 2 New Zealand.9 Same 3 US.24 Same 4 UK.24 Same 22 Italy Improved Highly Transparent (Tier ) Transparent (Tier 2) Semi-Transparent (Tier 3) Low Transparent (Tier 4) Opaque (Tier 5)

4 Benefit from inclusion of an asset class not correlated returns C σ Max A σ Max B σ Max Frontier A without RE Frontier B A σ Min B σ Min C σ Min with RE Frontier C σ Min with RE σ Max From A to B : sling effect risk From A to C: raising effect

5 A Measure of Benefit Change in Mean Risk Adjusted erformance of Frontier (MeRAF) MeRAF returns = N N i= * R i σ i C σ Max N =0 decile MeRAF A σ Max B σ Max Frontier A without RE Frontier B A σ Min B σ Min C σ Min Deciles ortfolio (A C) ort. Var. Max. (A C) with RE Frontier C with RE D D2 D3 D4 D5 D6 D7 D8 D9 D0 Deciles ortfolio (A B) risk

6 DATA ortfolio are mixed in 4 domestic asset classes ) Stock COMIT Globale Index 2) Long Term Government Bond Buono Tesoro oliennale,bt 0 Y 3) Risk free rate 6-m; Buono Ordinari del Tesoro, BOT 6-m All Time series are monthly based. Time eriod: Jun 997-Jun ) Real Estate Scenari Immobiliari General Index Not Residential Index sectors Residential Commercial Inustrial Office

7 Real Estate DATA The SI indexes are based on a sample of 2000 properties, under the hypothesis they are representative of domestic market They are domestic indexes: the properties located in 03 town. The General and Not Residential Index consider the weight of each sector in Italian market They started the st of June 997 They are calculated following a mix approach (transaction/appraisal). In details, they re based on three variables: ) change in rental values; 2) Change of returns; 3) Change of volumes.

8 Real Estate DATA 280 Figure Cumulated returns may-96 sept-97 feb-99 jun-00 nov-0 mar-03 aug-04 Monthly Returns Residential Office Commercial Industrial SI General Not Residenial 5,00% 4,00% 3,00% 2,00%,00% 0,00% Figure 2 aug-96 jan-98 may-99 oct-00 feb-02 jun-03 Correlation Resid. Off. Comm Ind. Res. 0,50 0,48 0,52 Off. 0,58 0,42 Comm. 0,24 Ind. -,00% -2,00% -3,00% Residenziale Industriale Uffici ISI Generale Commerciale ISI Gen. non Residenz.

9 0,250 Table Asset Classes: perfomance and risk Stock LT Bond Risk free RE Mean 0,93% -0,47% 0,33%,% Standard Errors 0, , , , Median 0, , , ,08 Mode n.c. n.c. n.c 0,023 Standard Deviation 0,072 0,039 0,003 0,0063 Kurtosis 0, ,7392-0,532-0,936 Skewness 0,4065 0, ,5353-0,556 Min. -0,6875-0, ,000-0,0009 Max. 0,2352 0, , ,023 Figure 3 Data unsmoothed 0,200 0,50 Stock A Bond B Risk Free C RE (SI Gen) D RE Unsm. E 0,00 0,050 0,000 /03/997 24/07/998 06/2/999 9/04/200 0/09/2002 4/0/2004-0,050 A B C 0,090 0,06-0,56-0,00 D -0,002-0,044-0,005-0,50 E -0,29 0,066-0,080 0,767-0,200 Stock LT Gov. Bond Risk Free Real Estate

10 6 Empirical Results: RE General Index Annualized Return (%) unsmoothed 00% Stock 00% RE (SI Gen) 00% Bond 00% Risk Free Risk (%) Frontier withour RE Frontier with RE Frontier with RE (unsmoothed returns) 00% 0% 0% 00% 0% Risk 0% Risk % 0% 0% Risk Risk Free Rate LT Gov. Bond Stock RE Smothed RE Unsmothed

11 Empirical Results: RE not Residential Index 9 8 Annualized Return (%) % Stock 00% ISI non Res. 00% Bond 00% Risk Free Risk (%) Frontier without RE Frontier with RE Frontier with RE (unsm. ret.) 00% 0% 0% Risk % 0% 0% 00% 0% Risk 0% Risk Risk Free Rate LT Gov. Bond Stock RE Smothed RE Unsmothed

12 Returns (%) 7 6 Bayes&Stein rocedure 00% Stock 5 00% Re not Res. 00% Bond 4 00% Risk Free Risk (%) Frontier without RE Frontier with RE (Not Res.) E( ri ) = rg + wi ( ri rg ) w B&S Approach: i 2 ( k 3) σ i = max 0, 2 ( ri rg ) 00% 0% 0% Risk Risk Free Rate LT Gov. Bond Stock RE Smothed

13 0 Efficient Frontier contrained 9 Return (%) % Stock 00% RE not Res. 00% Bond 00% Risk Free Risk (%) CONSTRAINTS 0% Liquidity 5% bond equity 0% Real Estate 00% Risk Free Rate LT Gov. Bond Stock RE Smothed 0% 0% risk

14 Benefit of Diversification: MeRAF Efficient Frontier *Withour Real Estate With Re (SI Gen.) With RE (SI Gen Unsm.) With SI Non Resid. Index With SI Not Resid. Unsm. Index B&S Approach Constrained ortfolios MeRAF,5846 7,9670 3,7523,9076,7858,5577 0,60 Change - 9,0% 49,3% 20,4% 2,7% 4,2%,7%

15 Final remarks Use of more asset classes, (and not only domestic)..but the results do not change roblems with Italian real estate data. ublic markets.. Transaction costs and indivisibility of real estate investment

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