Should All Real Estate Investors Be Value Investors?

CRE Finance World, Winter 2014

Should All Real Estate Investors Be Value Investors? An exploration of momentum investing in real estate markets Akash Shivashankara, CFA A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 87 Last year, the Commercial Real Estate Finance Council invited graduate and under-grad students to participate in its inaugural CRE Finance World® Award competition. Students throughout the United States submitted article entries related to commercial real estate finance to be reviewed by the CRE Finance World Editorial Board. Below is the winning entry authored by Akash Shivashankara, a graduate student at Columbia Business School. Akash has been awarded a $2,000 scholarship, sponsored by Amherst Securities Group LP, and complimentary admission to the CREFC June 2014 Annual Conference in New York City. Second place was awarded to Martín Kielmanowicz, Columbia Business School and third place to Yating Fang, New York University, Schack Institute of Real Estate. Sponsored By: s commercial real estate investors, we are told time and again by investing legends that the key to long-term success is value investing — buy during times of uncertainty and pessimism, and sell during periods of “irrational exuberance.” In the words of Oaktree founder Howard Marks, “The herd applies optimism at the top and pessimism at the bottom. Thus, to benefit we must be sceptical of the optimism that thrives at the top, and sceptical of the pessimism that prevails at the bottom.” We all aspire to invest like Ronald Perelman, snapping up tens of billions of assets during the height of the Savings and Loan Crisis. Or to be Lone Star’s John Grayken, pulling the trigger on Merrill Lynch’s housing-backed CDO portfolio for $0.22 on the dollar in July 2008. In both cases the investors reaped massive payouts for their bets placed during the height of market fear. We all know that value investing works, but is it the only effective strategy for commercial real estate investing? Should all real estate investors be value investors? One strategy known to be effective in other asset classes is momentum investing, or trend following1. Momentum investing can often feel like the opposite of value investing and a seemingly irrational strategy: buy when asset prices have gone up, and sell when prices have gone down. However, it has proved a winning strategy in everything from traditional asset classes such as stocks and bonds to newer asset classes such as commodities. This article sets out to test the idea of employing a momentumbased investing strategy in commercial real estate. Further, the article compares the strategy to value investing, and analyzes possible synergies in combining the two strategies in real estate portfolio construction. Data and Methodology The first question in this analysis was selection of an appropriate real estate index. I surveyed the Datastream US REIT index (monthly), the NCREIF National Property Index (quarterly), and the Green Street Commercial Property Price Index (monthly). While I understand that US REIT prices do not provide a complete representation of private market real estate prices, I have chosen to present analysis based on the US REIT index given the significantly higher data quality and longer period of data availability than the other indices. Furthermore, I found that the effectiveness of momentum not only held for the NCREIF and Green Streets indices but was in fact more pronounced. Please see Appendix 1 for results from these alternative indices. I used extremely basic metrics to define value and momentum as outlined below. Value I used the 10 year inflation-adjusted price-earnings ratio (Shiller PE) as my measure of value. I considered the use of dividend yields as a value signal, but abandoned this measure after considering that dividend yields increased steadily for the 20-year period between the early 1980s and early 2000s, despite multiple valuation cycles occurring during this period. The increase in dividend yields over time was more likely attributable to other factors such as increasing investor preference for yielding properties. I determined mean Shiller PE by looking back over the previous 5 years on a rolling basis. Standard deviation of this mean was also determined on a rolling 5-year basis. When the current Shiller PE ratio was lower than 0.5 annual standard deviations below the mean, a buy signal was given and the strategy invested in the real estate index. This represents the concept of buying when real estate valuation levels are low. The value strategy stayed invested until the index value was 0.5 annual standard deviations above the rolling mean and a sell signal was given. This represented the concept of selling when valuations are high. After divesting, the strategy held cash until the next buying opportunity and valuations were low. A Columbia Business School, MBA Candidate, 2014


CRE Finance World, Winter 2014
To see the actual publication please follow the link above