Real Estate’s Investment Personality

By Art McIlwain, President, Gleneden Property Service Corporation

A world leader in real estate performance analysis reports an $8 billion dollar, 8.5% loss in the unleveraged capital value of its now $93 billion dollar 2,500 property Canadian index for the 12 months ended Sept 30 and the negative total return was the lowest in 35 years. Real estate investment managers huddle with auditors about reporting negative portfolio performance – many for the first time in their careers and it is useful to reflect on the low-risk-high-performance financial personality of real estate as an asset class. This issue focuses on the last 25 years.

2009 Lowest in 35 Years

2009 is the fourth year of falling returns since the 19%, 2005 top that marked four successive increases. Commercial Real Estate’s 2009 negative 3.2% Total
Return is a 35-year low, edging out the record set in 1993, and is 1,290 basis points below its 9.7%, 25-year mean, and 640 basis points outside its 6.5% standard deviation. Industrial at minus 11.3% has the largest capital value loss, followed by Retail at 8.8% and Office at 7.7%.

Real Estate Outperformed Stocks

Over that past 25 years, Canadian Commercial Real Estate’s Unleveraged Total Return on market value kept pace with the TSX/S&P Composite Total Return Index providing a cumulative return sometimes behind Stocks and, as in 2009, sometimes ahead.

Stocks and Real Estate both had higher cumulative Total Returns than no-risk long Canada bonds.

Negative Total Returns were both small and rare for commercial real estate, the lowest being 3.2% in 2009, not much different than 1993, and Real Estate’s cumulative returns were higher than stocks and bonds. That context informs the discussions of professional real estate investment managers’ with their auditors and clients.

Stocks, Bonds & Real Estate

Total Returns of Real Estate, Stocks and Bonds have been non-covariant. Each asset class has been suitable for inclusion in portfolios designed to minimize non-systemic risk by diversifying into noncovariant asset classes. Office, Industrial and Retail returns have been covariant so it has not been necessary to invest in each to have real estate help minimize non-systemic portfolio risk.

Risk & Return

Commercial Real Estate provided 25-year mean total returns comparable to Stocks at less than half the risk. Stocks provided a mean total return of 10.2% and a standard deviation of 16.4%. 6.5% was Real Estate’s standard deviation – less than half that of Stocks, but Real Estate’s 9.7% mean return is nearly identical.

Long Canada Bonds provided a 7.2% mean return and a 2.4% standard deviation.

Industrial Real Estate and Stocks

Simply, Industrial Real Estate outperformed stocks with less than half the risk over the past 25 years. 2009 marked eight successive years when Industrial provided higher cumulative Total Returns than the TSX/S&P Composite Total Return Index. Industrial’s 25-year mean return of 10.4% was higher than 10.2% for Stocks whose 16.4% standard deviation was well more than double the risk. 6.3% was Industrial’s.

Toronto House Value Growth

The 2009 increase in the average selling price of a single detached Toronto house was 4.3%. That was 178 basis points below the 6.0% mean growth, well within its 10.6% standard deviation, and was the 13th year of increases following seven years of declines.

By Art McIlwain, President, Gleneden Property Service Corporation
Reprinted with permission
Comments Invited: Email gpsc [at] bellnet[dot]ca for technical notes or to provide comments.