In a warning to institutional investors who claim they have found steady ground by investing directly in property rather than seeking listed exposure, a paper from global real estate securities manager Cohen & Steers (CNS) argues that the performance of listed property markets can be leading indicators of returns from direct property assets.
Listed property returns generally front-run those from the direct property market by about six months since liquidity in the listed space enables more immediate pricing transparency and information transfer than in the direct markets, where valuation methodologies can be inconsistent, Scott Crowe, portfolio manager and global research strategist with CNS, wrote in a report delivered to a Centre for Investor Education real estate conference last month.
“Since the underlying asset of an LPT is real estate, its performance should track that of the underlying property returns, unless the listed markets are extremely inefficient or the measurement of direct property is wrong,” Crowe wrote. “Direct property market participant should pay attention to listed market moves,” Crowe said.
When CNS imposed a six-month lag on listed property returns across a number of developed markets, the correlations to direct property returns increased. For instance, in the UK, returns from the FTSE Real Estate 350 had a 0.63 correlation with the IPD Capital Return index between 1988 and 2007. In the US, between June 1987 and December 2007, the MIT/NCREIF Capital Return and the FTSE NAREIT Equity REIT Price-Only indices produced a correlation of 0.53 per cent.
Results from similar tests in other markets included: a 0.72 correlation in returns from Hong Kong office assets between September 1991 and December 2007, and a 0.69 correlation in performance among Tokyo office properties in the same timeframe. However, in Australia, only a 0.2 correlation between the direct and listed markets was observed between June 1994 and December 2007.
According to Crowe, the reasons for this low correlation among the Australian markets were the “inferior quality” of the direct market index due to valuers’ “greater inertia to change capitalisation rates”, and that a large proportion of the direct property sample used in the IPD/PCA Capital Return index is only revalued on a three-year rolling basis.
Moreover, there is no standard method of valuing direct property assets, although metrics commonly used include equivalent yield, gross/net income yield, initial yield, reversionary yield and the measure of dollar-per-square-foot. “The ability of direct market participants to determine value in a timely manner is more complicated,” Crowe commented.
Taking cues from the listed market, investors could buy direct property during troughs in the performance of listed property, and sell direct assets during its peaks in an arbitrage strategy, Crowe wrote.