Segmentation

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Segmentation

ERES / CUREM SEMINAR, ZURICH

Diversification and Real Estate Allocation

How Effective is Sectoral and Regional Diversification?

Professor Colin Lizieri

University of Reading Business School


Real Estate Portfolio Structure

General Issues and Problems

• We Need to Diversify Away Asset Specific Risk:

- Build a Diversified Portfolio Within Each Asset Class

- Real Estate Characteristics Make This Problematic

- Need a Framework for Making Fund Decisions

• We Need an Operational Structure:

- Sector Specialists, Area Specialists

- Management and Investment Teams

• Need criteria for benchmarking performance:

- How Well Has Our Fund Done?

- Is That Because of Fund Structure or Stock Selection?


Sector and Geography:

The Standard Approach

• We Separate Real Estate into Sectors:

- Office, Retail, Industrial, Residential …

• Or Sub-Sectors?

Sectors?

- Shopping Centres, Retail Warehouses, Standard Shops …

• We Separate by Geography:

- Global Regions: Europe, Asia, North America

- Countries: Switzerland, Germany, UK

- Regions: Fribourg, Bernese Oberland, Schweizer Mittelland

- Cities: Zurich, Genève

ve, , Bern

Segmentation

- Sector / Region Splits for Strategy and Management

- Cannot Segment Too Far …


Is Segmentation Useful?

Segmentation is Useful IF AND ONLY IF:

- Properties WITHIN a Segment Behave in a SIMILAR Fashion

- Properties in DIFFERENT Segments Behave DIFFERENTLY

- Segments Behave in DIFFERENT Ways

• IF This Holds Then:

- Segments are Useful in Shaping Strategy

- Segments are Useful in Benchmarking Performance

• But ….

- “All Properties are Unique”

• We need to TEST the validity of Sector-Geography Splits


UK Evidence …


The Value of Segmentation:

UK Evidence

• UK Commercial Real Estate:

- Three Standard Sectors (Office, Industrial, Retail)

- Regions – 10 Government Regions

- “Super Regions” London, Rest of South East, Rest of UK

- IPD Portfolio Analysis System Segments:

o

o

o

o

o

o

o

o

o

o

Standard Retail, SE

Standard Retail Rest UK

Shopping Centres

Retail Warehouses

City Offices

W End Offices

SE Offices

Rest UK Offices

Industrial- SE

Industrial – Rest UK


UK Evidence:

What We Know So Far …

• Byrne & Lee (various)

- Even at town level, sector dominates geography

- Limits to risk reduction due to common structure, size effects

• Cullen (1993)

- Industrial returns homogenous

- Retail property structured by ownership and lease terms

- Offices have geographical sub-structure, structure, City distinctive

• Hamelink et al. (2000), Hoesli et al. (1997)

- Importance of sector clear

- London offices, Scottish retail different

- Economic regions more effective than standard regions

• MacGregor & Schwann (2003)

- Strong common cycle, separate retail cycles, London different


Devaney & Lizieri

UK Segmentation Tests: Research Strategy

• Take Individual Property Returns from IPD

• Collect Characteristics of Those Properties

• Test Whether Return Patterns Fit Sector-Region Groupings

• Cluster Data and Characterise the Groupings

- do they map onto sector-region region groups?

- can we identify other dimensions of structure?

• Do Other Dimensions/Variables Explain Return Patterns?


Data

• Sub-set of IPD databank

• Properties with continuous returns 1995-2004

• Property data covering:

- Sector

- Region, town, micro-location type

- Size (floorspace, value)

- Yields, reversionary potential, cap-ex

- Tenancy information (unexpired term, multi-let)

let)

• Final dataset 1,219 properties

• Commercial constraints limit scope of analysis


Methods … the Technical Bit …

• Discriminant Analysis:

- Properties are assigned to their Segments

- Returns are analysed statistically

- Do returns predict the Segment well?

• Cluster Analysis:

- Create groupings based on patterns of returns

- Are these groupings consistent with Segments?


Three Sectors ... Three Regions

• 3 Sectors: 69% buildings correctly grouped

• 75% of retail buildings correctly grouped

• But high within group heterogeneity

• 3 Regions: just 49% correctly classified

• London 58% correct

• Geography alone insufficient as structure

Predicted

Predicted

Retail

Office

Industrial

London

RoSE

Rest of UK

Actual

Retail

Office

486

36

52

215

111

61

Actual

London

RoSE

198

99

70

138

73

144

Industrial 48

67

143

Rest of UK

81

150

266


Sector-Super Super Region and PAS Segments

• Three by Three Sector Super-Region

- Just 35% of buildings correctly classified

- Highest group 54% - Rest of UK Offices

- Worst group 20% Rest of SE Industrial

- 76% of offices, 70% retail correct into sector

- 61% of London classed as London

‣ Questionable Value for Strategy or Performance Measurement

‣ Sector Splits Still Dominate

‣ London is Different


PAS Segments

• 10 PAS Segments

- < 35% of Buildings Correctly Classified

- Useful Segments:

o Retail Warehouses (64%), RUK Offices (62%), City Offices (62%)

- Almost No Information Content:

o SE Retail (15%), RUK Industrial (18%), SE Industrial (28%)

‣ Sector Still Dominates: Geography Not Helpful

‣ Validity / Usefulness of Sector-Region Classification Cast

into Doubt for Portfolio and Benchmarking?


What’s s Missing Then?


What Else Might Explain Variation?

• Yield (Cap Rate)?

- Assign Properties to High / Medium / Low Yield

- 61% Correct (75% of Low/High)

- 50% Correct from 3x3 Sector-Yield Grouping

- May imply a Growth-Value distinction?

• Tenancy Characteristics

- Single-Let versus Multi-Let?

- Improves Predictive Power of Other Factors

• Size?

- Weak Size Effect Emerges

‣ Some Evidence of Segmentation by Income Characteristics?


Thinking Outside the Nation State …

• The UK is a Small Country …

- Weaker regional effects outside London?

• Cross-National Diversification?

- Nation Specific Factors?

- But Convergence Effects?

- Equity Market Shows Sector Dominates …

- But Real Estate IS More Local in Nature

- We Invest in Cities Not in Countries!

• Are There Global / Regional Sector Effects?

- Business Service Demand?

- Consumer Expenditure?

- Industrial Production?


Some Investment Implications

• Do Standard Segmentations Really Reflect Different

Patterns of Return?

• Attribution-Based Performance Measures Based on Faulty

Segmentation May Mislead

• Results Suggest:

- Sector is More Important than Geography …

- Cashflow Characteristics are Significant …

• Strategic Implications:

- What are the Economic Fundamentals Determining Cashflow

- These Will Determine Diversification

• Fund and Vehicle Structures

- Economic Logic is for Specialist not Diversified Vehicles

- But … Specialist in What??

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