Real estate, alternative real assets and other diversions

Why property investment is like a game of darts

The Analyst

A player’s three-dart shooting average offers a clear metric that can be analysed to reveal the best strategic options – investment management has parallels

Statistically, if a player’s three-dart shooting average is less than 80, they should aim at treble 19 rather than treble 20. In practice, amateur dart players usually average less than 80, but the vast majority still aim for treble 20. The three-dart shooting average is a simple, transparent, quantitative metric, the analysis of which can reveal strategic options that can lead to better outcomes. Is there an equivalent measure in real estate? If so, how can it be calculated? Can this measure also allow managers to communicate to investors how they intend to either deliver this return or even exceed it?

In darts, the player’s ‘return’ is a score, while in property investment, the investor’s return is from the cash flow. This cash flow is driven by the initial rent, rental growth, leases, costs and vacancies. Market pricing of these cash flows should therefore reflect differentials in expected future growth rates, costs and vacancies between markets and properties within markets. The market pricing of shopping centres, for example, has been marked down as growth expectations have fallen and higher expected future vacancies and costs are factored in. Industrial pricing, by contrast, has risen as a result of higher growth expectations and more optimistic cash flow assumptions for tenant retention and letting periods.

The impact of these changes in expectations can be approximated by the MSCI yield impact measure. Over the last three years this has recorded a yield impact of -16% for UK shopping centres and 19% for UK standard industrials. Coupled with the differential in market rental value changes, this has resulted in a 21% fall in shopping centre capital values compared with a rise of 34% in standard industrial capital values. In other words, the change in pricing (or expectations) had a bigger impact on capital values than the actual change in rental values to date. The change in yields therefore reveals only the impact of changing expectations and we are left to guess what is driving this change. We can make no judgment as to whether the change is justified or overdone.

Drivers of UK capital growth, Q2 2016 to Q2 2019
Source: MSCI

Calculation of the expected return has parallels to throwing darts. Just as a throw point average is the aggregation of multiple scores, every property investment has multiple possible cash flows, depending on whether breaks are exercised, leases are renewed, tenants stay solvent, and the length of any resulting vacancy periods. The calculations are straightforward, although they require a computer model to crunch the numbers. The results are as easy to understand as a dart player’s shooting point average: sectors with longer lease terms, shorter letting periods, stronger covenants and higher expected growth will generate higher cash flows and should be priced accordingly.

Some investors will have the equivalent of a higher shooting point average due to stock selection or active management skills. Such investors are able to pay the market price, as though the properties will achieve the average cash flow for the sector, and then extract a higher return. These skills can be identified and communicated in terms of the cash flow drivers: higher tenant retention, lower letting periods, higher growth or lower irrecoverable costs. The goal of the researcher is also more defined: to identify links between the cash flow drivers and exogenous factors like demand and supply, and to quantify their impact on the cash flow.






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