Investment Styles and Style Boxes in Equity Real Estate: Can the Emerging Model Succeed in Classifying Real Estate Alternatives?

Journal of Real Estate Portfolio Management, Jan-Apr 2005 by Kaiser, Ronald W

Decision Issue: Current Portfolio or Mandate?

The survey also detected that consultants could reach different style box conclusions depending on whether one considers the "mandate" of possible actions given the advisor, or just looks at the portfolio as it currently exists. There definitely is a question of what to do when the written documents allow for a riskier set of actions than are actually utilized by the advisor (at least to date).

Greater Diversification Can Serve to Mitigate the Definition

Some of the consultants acknowledged that a welldiversified portfolio of properties could approach the "core" definition, while yet containing perhaps 10% to 20% in "value-added" or development (opportunistic) projects. The risk statistics might be indistinguishable from a peer universe of core funds, while the returns might be a bit higher. The NCREIF white paper says that a portfolio should only contain "a preponderance" of core attributes to be core; a "mix of core and others with less reliable income" to be value-added; and contain "preponderantly non-core" assets to be opportunistic. It would be a useful research project to attempt to define the statistics of the boundaries suggested by Exhibit 5.

Style Box Performance Benchmarking: A Peer Group Process Only

In the absence of a fixed universe to benchmark against, as is possible in the world of stocks and bonds where investors can buy shares of the assets in the universe, real estate cannot fulfill the requirements of Bailey (1988?). However, Geltner and Ling (2001) argue that a well-conceived peer universe can reasonably well serve the need for a performance benchmark. The NCREIF property universe is an excellent peer universe for core style box managers, as most of the properties in that database must meet most of the core definitions to be included. As NCREIF adds more data points (occupancy levels, for example) it becomes ever clearer how a portfolio compares to the benchmark.

Beyond that conceptual agreement, actual industry practice is less precise. Advisors find that their various funds can be assigned to different style boxes, depending on the judgment of the consultant involved. NCREIF's initial development of a fund-level style universe asks the advisors to selfassign their funds to a style box. There is no formal referee. Universal agreement will be difficult to achieve in such a process. As in the public securities arena, the consultant or rating service must fill that role.

Possible Implications of the Trend toward Greater Use of Style Boxes

The increasing use of style boxes will impact the behavior of the real estate investment industry. However, there are some concerns that should be considered.

Investors and Consultants Must Be Careful about Moving Beyond Core or Enhanced Core Styles

The core style box usually involves considerable diversification, which by itself offers some protection for the inexperienced investor. In the higher return potential of value-added or opportunistic styles, the more targeted bets taken by advisors require a higher level of investor sophistication in real estate portfolio structuring. Again, the consultant's role may be crucial.