We all know the classic four categories on the risk-return graph, Core, Core+, Value-Add and Opportunistic. These investment strategies are widely used, but are also arbitrary as investors define Core, Core+, Value-Add and Opportunistic strategies differently. So, in this article, we will outline a new factor investing approach and compare this with the conventional private real estate strategies.
WHAT IS FACTOR INVESTING?
Factor investing is an investment approach successfully used in fixed income and equity investment management. The approach identifies multiple factors that explain excess returns compared to the market portfolio. Initially, these factors focused on small caps, value and growth stocks, but then expanded in scope. By identifying the most relevant underlying factors, investors can benefit from market inefficiencies in a rules-based and transparent way. If you consistently select stocks, bonds or sectors whose performance have been driven most by factors delivering excess return, you should beat the market benchmark in the long term.
HOW IT IS APPLIED IN REAL ESTATE?
We introduced a rules-based Factor investing framework with three steps. Firstly, we defined the six most relevant conceptual factors based on our review of academic and industry literature as Yield, Value, Growth, Quality, Liquidity and Volatility. Secondly, we selected the most appropriate available data series to represent each of these six factors, normalise these based on their Z-scores and identify each office market’s exposure to these underlying factors. For example in the case of Growth, we select GDP growth, general and FIRE employment growth and office rental growth as underlying factors. Thirdly, we created the historical total return series for each Factor for each quarter over the last 15 years using the 80th percentile of our market universe.