Introduction
While considering the German institutional real estate investors, the authors investigate whether the current decision-making generates efficient data for the real estate in this case. The authors argue that real estate markets are characteristics of imperfections owing to high costs of transactions, difficulty in entry of market, market structures that are decentralized and low level of public information. The determination of the return series in real estate markets cannot be similar to that in stocks or bonds because the earlier involves the need to manage an investment property and has a special form of performance evaluation.
Discussion
The authors hold that portfolio managers apply capital market models based on Modern Portfolio Theory, in an effort to optimize portfolio allocation. Investors will draw simple conclusions based assumptions they make in their individual rationality in investment decisions, information efficiency of the market, the way prices are settled and the resulting return distributions. These restrictions are not suitable for real estate assets. An investor may make biased decision if he/she fails to consider that “prices in heterogeneous asset classes comply with model assumptions with varying extents”. Although investment analysis and capital market theory can be transformed one into another and have similar foundations, the two decision making processes differ considerably in literature and application. The breach in the application of models does manifest in the valuation and the different data sets that are employed, and not in theory. According to the authors, more efficient allocations in real estate can result from comparison of the results of alternative decision-making models under particular decision-making circumstances.
Portfolio managers will be concerned with optimization of future cash flows of the present investment. Return factors which will help to explain the behavior of a variable overtime may help the investors in this case. The authors describe the discount rate as the investor’s attitude “towards the risk he perceives from the future realizations” of the expected return values.
Income generation from real estate depends on the amount of rents and the property sale values while expenditure on the investment relates to the construction and age of the building. The investor will need to analyze the regional economic conditions and factors that influence supply and demand for rental space and thus the resale price of the property at a given time. The evaluation will be based on future estimation, and a discount rate so chosen relates to the risk amount. There are tools for estimating a risk range for the investment, for example safety margins and sensitivity analysis.
Comparing assets is implicated by presence of individual estimations and assumptions in relation to estimation differences for single assets among different investors and optimal capital allocation for two different assets. The authors find historical time series data inefficient in efficient use of capital in Germany. In this investment environment, all the aspects of capital user are not covered in the investment decisions based on asset allocation recommendations. In the Germany case, analysis of microenvironment and object criteria means more to investors as the property categories for which they are experienced in, more than does the economic information that could influence development of supply and demand. The study generates evidence for inappropriateness of risk valuation tools in real estate investment. There is lack of information and ability among fund managers to adjust their portfolio to the perceptions on market risks. It is not possible for investors to completely accurately determine the true opportunity cost for capital in real estate allocation considerations. The study found that German portfolio managers could not estimate historical performance valuations and unable to demonstrate future determinants as important to their current investment decisions. Investors focus on future needs whereas they could calculate the historical risks associated with their property.
Conclusion
Portfolio managers in German’s real estate scenario do not consider historical data as to influence their estimates in current investment decisions. Analysis of microenvironment and object criteria means more to investors in Germany as does the property categories for which they are experienced in, more than does the economic information that could influence development of supply and demand.
References and Bibliography
Armonat Stefan & Pfnuer Andreas. (2004). Asset allocation versus entrepreneurial decisions in real estate investment. Henry Stewart Publications 1473–1894. Briefings in Real Estate Finance. Vol. 4 NO. 2. pp. 131 – 146.