A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 91 managers6, he would have been left with a mere $300 million by June 2013, or roughly one quarter of the returns. Chart 8 Real Estate Strategy Performance Comparison Conclusion Before adopting any investing strategy, it is important to think about the reasons why such a strategy has provided excess returns, and to consider whether it was a fluke of past market conditions or will continue to prove successful. For financial markets in general, several behavioral explanations have been given, including the herding nature of investors, inability to process data, and tendency of investors to extrapolate into the future based on the recent past. The tendency to extrapolate is particularly true in commercial real estate where cap rates are used as the standard measure of value. As the economy continued to look rosy through the mid-2000s, investors extrapolated on recent rent growth to forecast unreasonably aggressive future NOIs, thereby creating higher and higher real estate valuations. As long as real estate investing decisions continue to be made by human investors, it seems likely that these momentum-producing phenomena will continue. One important factor specific to commercial real estate is the debt financing cycle. Unlike publicly traded securities, the majority of real estate investors rely on debt to finance acquisitions. Throughout several cycles, we have seen financing most active and lending terms most lenient at the height of the market. On the other hand, debt becomes unavailable and expensive at the market trough. The result is a debt market that promotes pro-cyclical real estate investing. As long as this behavior continues, there will be benefits to an investment strategy that exits the market when financing terms are the best and re-invest after lenders begin to trickle back in. It is impossible to replicate the investing genius of real estate legends through a simple set of rules and a short backtest. The inherently idiosyncratic nature of real estate investing will always leave room for outsized returns to those investors who can source off-market transactions and underwrite properties more accurately than other market investors. However, I believe this study provides a starting point for the inclusion of momentum in commercial real estate investing. Appendix 1 – Alternate Index Performance Green Street Real Estate Index NCREIF Index Note 1: High Sharpe Ratios and low drawdown figures for both Green Street and NCREIF are likely the result of the appraisal based nature of these indices. Note 2: No consistent value signal was available for either NCREIF or the Green Street Index. Should All Real Estate Investors Be Value Investors?
CRE Finance World, Winter 2014
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