This report reviews whether an investor should consider involving the real estate segment in his investment portfolio to achieve a higher risk adjusted yield. In other words, the possibility of creating a higher yield at a lower risk and thus create a diversification benefit is examined. To create an overall view for the reader this report is organized in three sections. The first one is about pricing and risks regarding the real estate segment. The next is a survey whether real estate adds to a higher Sharpe Ratio, and finally the report is rounded off with a critical view of the problems the survey also provides. As an introduction, the investor will be informed of the characteristics related to real estate investment focused on the risks the investor will be exposed of. The price mechanisms of the real estate market are initially presented by the intuitive models “The Real Estate Economic Basis Model” and “Tobins Q”. Afterwards the importance of certain economical fundamentals for the pricing are reviewed. Finally, the significance of price bubbles is reviewed and the risks directly involved with investments in real estate. The main topic of the report is to examine whether a higher Sharpe Ratio is possible in a diversified investment portfolio of shares and bonds by including three chosen real estate indexes one by one. The real estate indexes used are the REIT-, IPD UK- and STOXX-600 index, which all have different characteristics to offer. Surprisingly, the review shows a great difference in the diversification return – depending on the index included. An including of the two first-mentioned indexes will contribute to a better performance of the investment portfolio, whereas the last index does not seem to be applicable. However, as an investor you shall be aware of the pitfalls involved in such an examination. An analyse of these pitfalls will be made in the last part of the report. In this part of the report, the marketability of real estate compared to the return is reviewed, together with the cash position in real estate versus the anticipated return. Further, a closer review of the statistical challenges in the analysis is made. I go through the importance of the used time period in relation to the Sharpe Ratio achieved, and the problems regarding the use of normal distribution and correlation.
|Educations||Graduate Diploma in Financial Planning, (Diploma Programme) Final Thesis|
|Number of pages||86|