In an insightful end-of-year study, asset manager Real I.S. AG, the real estate subsidiary of Munich-based Landesbank BayernLB, has analysed property investment funds’ key risk indicators and classified real estate classes and market segments according to their risk/return profiles.
Based on Real I.S. AG’s 20-year comparison, hotel and office properties offer investors the lowest levels of risk, while investments in logistics properties have comparatively the highest risk. Based on its pan-European analysis, Real I.S. has also identified significant variations in risk between individual countries and markets.
According to Sven Scherbetitsch, research and investment strategist at Real I.S, “In contrast to stock market investments and bonds, real estate funds are not subject to daily price updates and do not usually have lengthy time series of data. Thus, the established risk assessment tools from the securities sector cannot be easily transferred to real estate funds”.
As to the methodology of the study, Real I.S. analysed real estate data from the property indexes maintained by U.S. financial services provider MSCI, which objectively measure the performance of direct private real estate investments. MSCI collects its real estate data from institutional investors and aggregates the data by country, region and asset class (office, retail, hotel, residential, logistics, other). To determine a specific fund’s risk/return profile, Real I.S. used MSCI’s data to create benchmark time series and calculate a fund’s annual total returns (total investment performance per year) and change in value returns.
Said Scherbetitsch, “This method allows us to create valid, long-term time series over a 20-year period that correspond precisely to each fund’s asset allocation. The model has proven itself in practice and is an appropriate risk assessment tool, particularly as it even includes difficult market phases, such as the global financial crisis, in the data set.”
Lowest risk: hotel and office real estateReal I.S. used the empirical Value at Risk (VaR) indicator to assess market risk. VaR indicates the maximum negative change in yield over a period of one year and with a statistical probability of 99%. The analysis reveals that investments in hotel and office assets offer investors the lowest risk, with VaRs of 5.7 % and 5.8 % respectively. Over a 20-year timeframe (1999 to 2018), hotel properties generated average annual total returns of 5.7 %, thereby offering slightly more attractive returns than office assets (5.0 % p.a.).
While average total returns were higher in the residential (6.7 % p.a.), retail (6.5 % p.a.) and logistics (7.0 % p.a.) segments, investors in these sectors also had to factor in higher levels of risk. Logistics real estate had the highest VaR (10.6 %), some distance ahead of retail real estate (7.7 %) and residential (7.4 %).
Taking the last five years in isolation, the data reveal a significantly stronger performance overall. Over this timeframe, average total returns are higher across all real estate asset classes while risks are consistently lower. Hotels were the best performing assets over this five-year period, generating average total returns of 10.9 % per annum. Retail properties may have been the weakest, offering average total returns of 7.5 % per year, but they were also subject to the lowest risk (1.5 %). The residential sector was subject to the highest risk over the last five years, with a VaR of 3.7 %.
“These performance and risk indicators provide a clear reflection of investment trends over the past few years. In most markets, interest rates and property purchase yields have fallen steadily and rents have risen. Our five-year analysis reveals that risks are significantly lower than in the long-term comparison, largely because the financial crisis and euro crisis are not included in the period under review”, explains Kramer.
Significant variations in European risk levels: A country-by-country analysis of the risk indicators reveals a number of significant variations in risk/return profiles. The variations between European office markets are particularly striking. Value at Risk is lowest in Belgium (3.4 %), Finland (4.1 %) and Germany (5.0 %). In stark contrast, VaR is highest in Great Britain (26.3 %) and Ireland (38.2 %). There are also major variations in the logistics segment. Risk in The Netherlands (8.6 %) and Germany (9.5 %) are definitely manageable, compared with a VaR in Spain that is roughly twice as high (18.3 %). The greatest variations in risk revealed by the analysis of asset classes and countries were identified in the retail sector. The range extends from 2.5 % in Germany to 45.0 % in Ireland.
“We have identified a broad range of risk/return profiles in the markets and market segments we have analysed. As a result, investors would be advised to invest via a real estate fund with a well balanced portfolio that includes properties from different asset classes and in different countries”, recommends Scherbetitsch.
Real I.S. Research News 08/2019 can be accessed free of charge at: https://www.realisag.de/de/immobilien-management/immobilienmarkt-research/risikokennzahlen-fuer-immobilien/index.html
