Everything that surrounds us is in fact in a constant state of movement. There is a constant change in the interrelationships and that is why, what was once up, is now down. The largest asset component in all other markers is Real Estate. It is this Real Estate Market which draws a lot of investors. Reason for this huge attraction is key cycle in Real Estate which effects the sustainable length of profound economic depression (Armstrong 2009).
According to Armstrong 2009,"This cycle breaks down as a harmonic or a derivative of the Economic Confidence Model (ECM). It is composed of a broader period of time with duration in total of 78 years (6*13). When this cycle turns down, it is a profound event for it effects the entire population on a wide scale. The decline from the major high consists of a period duration of 26 years. This leaves us with a wave of generally rising prices of roughly 52 years"
There is a popular belief that investors are impatient about choices in the short term but are highly patient when it comes to invest in long-term options. This impact on timing of investment depends on the factor as whether investors are sophisticated or naïve (Grenadier, 2006).
Volatility in Real Estate
Price behavior in real estate has always been an area of keen interest to all the investors because like any other profitable opportunity it also reaps return on investment. Over the years there has been a lot of study by researchers on this pricing behavior and they have developed appropriate models to suit the diverse needs of various stakeholders.
Since investment involves temporal factor that is why various stakeholders, portfolio managers have always wanted to predict the pricing behavior. Experts such as Alan Stockman and Tesar Linda, Lane Philip and Girouard N and Blondal have described the housing price behavior from a dynamic general equilibrium point of view (Stockman and Tesar, 1995, Girouard and Blondal, 2001 and Lane, 2001). Studies undertaken by Driffill John and Sola Martin explored the model in the context of market bubbles (Driffill and Sola 1998). Attempts have also been made by Francois Ortalo-Magne and Rady Sven to incorporate variables like transactions in the real estate sector, changes in the demography of participants, macro factors.
The model developed by R. Engle in 1982 is found to be relevant in the present scenario where he did address housing price prediction by taking care of time-varying volatility and studied through time series analysis. There has to be an appropriate risk/return trade-off in the allocation of the assets (such as equities, bonds and property) by an investor. In order to do this, some estimate has to be made of the fluctuation which comes from this uncertainty in these property assets.
According to Stewart Richie (2008),"Estimation of solvency is not only likely to change but their correlations between assets types are highly sensitive too. In other words, estimation of volatility is determined through a yardstick of uncertainties which can be shown in a matrix of variance-covariance"
Application
Higher return strategies like wealth creation, value added, income enhancement are the key focal areas of styles of investment and objectives of return in real estate portfolio management. Due to the asymmetric nature of real estate, diversification in real estate portfolio and strategies leading to optimization are spread out over multiple periods.
Historically, there exists a negative correlation between real estate and financial asset because of factors like lease, inflation indexation. The ability to add real estate to a stock or bond portfolio, generates the diversification benefits to portfolio managers. According to Bruce (1991), allocations to portfolios of real estate depend on contributing returns and risks which are associated with acquisitions.
There are many reasons why institutional real estate portfolio managers sell of properties. Few such reasons are: poor performance of real estate portfolio, rapidly declining property income and asset values. According to Buckley (1994), disposition strategies include: pooled asset portfolio sales, bulk portfolio sales.
Despite its shortfalls, MPT has stood against the time-tide and everyone recognizes it as a powerful "engine of inquiry" (Viezer, 2010). In last two decades, researchers have debated its use and shortcomings, attempted to better understand and optimize data inputs and test improved estimation tools and optimization models
Modern Portfolio Theory (MPT) has become the backbone of finance because of its ability to understand and create the best possible portfolio for financial asset investment. Diversification has been an immense issue since MPT has been accepted as a tool in managing real estate portfolio. According to Hishamuddin (2003),"The paradigm shift of real estate investment from tactical and operational to strategic and tactical style of management has transformed the perception of real estate from just bricks and cement to more institutional in business environment".
Past researchers through their analysis have concluded the followings:
Risk-averse investors will always invest in portfolios and assets classes that will give them the highest long term risk adjusted rates of returns
Risk-neutral investors will always continue to invest in those portfolios and asset classes that will give them the highest long term expected rate of returns
Speculative or risk-seeking investors will always invest in portfolios and asset classes that give them the chance to get abnormal rates of returns
