The Endless Search for the Alpha and Beta Investment in Commercial Real Estate

The Endless Search for the Alpha and Beta Investment in Commercial Real Estate

There is a substantial flow of capital coming into commercial real estate from at home and abroad. Performance in this market has consistently outpaced investor expectations. REIT is part of the S&P 500 and can be used by both alpha and beta investors. However, commercial real estate does not share all of the same characteristics of the stock and bond markets. Alpha and beta investors need to be well-informed about the changing opportunities in commercial real estate.

What are the Alpha and Beta?

The Alpha is defined by the amount the active investor exceeds or underperforms when compared to a chosen benchmark index. When the benchmark was chosen is the S&P 500 index for US stocks, the alpha would be your portfolio percentage minus the S&P 500 percentage.

The Beta compares the volatility of an investment or portfolio to its benchmark value. A beta value more than 1 shows more volatility than the benchmark index, a coefficient of 1 is for portfolios or investments that will move with the market, coefficients less than 1 are determined to be less volatile than the selected benchmark index. Beta investors are typically passive investors, not looking to exceed the given market, but accept returns that match the chosen index.

Investors can test out each style for themselves with a hybrid approach. Use what works for as long as it works and incorporate alpha or beta techniques when applicable.

What are the Challenges for Investors?

Commercial real estate investment characteristics are not to be confused with those of the stock and bond market. Opportunities and investment options are not quick to materialize to satisfy alpha or beta investor demand. Projects take time to develop and return on investments. In addition, it is affected by a global market that affects local construction costs, interest rates and materials.

There are a number of factors that can add risk to any property investment. Such factors include political risk, market conditions, tenant risk, property occupancy, and physical condition. These should all be considered during a commercial real estate investment. Lack of transparency, the issue of a centralized location of investment history and even identification of the right investment parties can not only be difficult for investment opportunities abroad, but also for those within the United States.

Commercial real estate is divided into the classifications of opportunistic, value-add, core-plus and core based upon the risk and return spectrum. Core investments are high-quality, stabilized assets that have less risk and lower equity returns than the other categories. Opportunistic investments are at the other end of the spectrum, offering investors the potential for the highest returns but are placed within the highest risk category. Offshore investments are often classified as such and higher leverage is typically required.  An individual investment or a fund of a number of properties may fall into these classifications. Real estate investors compare “expected” returns of the hoped for performance of the investment to the “realized” return or the historical performance of such an investment.

What to Expect

Investors are taking on more alpha characteristics and shifting capital from core to value-add or even opportunistic real estate investments with the continued and expected experience of yields higher than expected. Investors are going past their safe zone in search of opportunity. Real estate opportunities in Japan, Europe and India and in other countries have become increasingly attractive.

In addition, the NCREIF Property Index will be undergoing expansion to include additional properties not found within currently. Healthcare properties, self-storage buildings, medical offices, manufactured housing and more may soon add to the categorized opportunities and pose additional challenges for the alpha and beta investor.