Regional and Sector Diversification for Real Estate Investment

Abstract

Real estate is characterized as a useful diversification asset in an investment portfolio as it is well structured and balanced. Especially the UK real estate investments have proved that they are capable of ensuring annualized returns at comparable levels to the investments in equities and UK government bonds. (As per the Investment Property Databank to Dec 2005 the real estate has provided annualized returns over a period of 25 years at 10.9 percent while it is 13.9 percent from equities and 10.9 percent from bond with an inflation rate of 4.2 over the period)

The specialty of such returns is that they have been made possible at low levels of volatility. In order to get the required returns from diversified investments in the real estate in the UK, it calls for specialized skills and investment knowledge. In this context this paper presents the various facets of real estate investments in the UK including the type of properties, the opportunities for investment in such properties, expected returns and the associated risks. The paper also presents a detailed review of available literature on the sector and regional diversification to present a critical analysis there of. The tangible benefits of the diversified investments in the real estate has been analysed in the paper with the aid of data derived from the Investment Property Data Bank.

Chapter 1 Introduction

Availability of limited resources in respect of the lands and the stringent planning and construction measures by the national and local authorities have made the intrinsic value of the of all the existing real estate properties in the UK soar. While these constraints pose a limitation on the supply of the real estate properties that are suitable for investments, the demand position remains almost consistent with the pension funds and the institutional investors vying for good properties to invest. “An active commercial real estate market is dependant on a stable and well-managed economy. The UK economy has matured with inflation held in check by the Bank of England controlling interest rates”. (Daniel Freedman et al, 2006)

The retail market in the UK was subjected to a pressure in the year 2005 and later on got stabilized. In August 2006 the retail sector showed an increase of 4.3 percent over the previous year. With the backing of the strong economic outlook the interest rates were raised by the Bank of England in August 2006 and in this context the commercial real estate sector was looked in to as a promising one to ensure competitive returns. Despite the promising outlook and the possibility of getting returns at par with the investments in securities or bond, the investments in real estate are susceptible to fluctuations in terms of returns while there are sector and regional diversification. This is due to the reason that the real estate market performance is influenced greatly by the influence of different markets like commercial and other sectors. According to Hamelink et al (2000) classifying properties in the market is nothing but defining the market risk dimensions, which means that the different markets such as commercial, residential and industrial all influence the market performance of real estate.

It is true that when the investments are distributed over the different types of properties the gains and losses are also getting distributed accordingly resulting in a ‘common or average return’ on the portfolio. It may also be said it will be the same case when the investment is spread over the properties in different regional areas. In this case also there should be a clear definition of the market risk dimensions without which there can not be an optimal diversification. “The most important decision in investment is based on the expected returns and the associated risks to analyse whether there exists any benefits of diversification of the investments.” (MacGregor and Nanthakumaran (1992) and Newell and Webb, 1996) With this background I intend to present in this paper out of the research conducted a detailed analysis of the investments in the UK real estate market.

The research questions have been designed in such a way that the study extends to the analysis of different type of properties available in the UK, the opportunities available for investments in those properties, the likely returns such investments can produce and the risks one has to consider while making such investments. Based on this analysis I intend to derive plausible answers to the research questions which involve an in-depth analysis of various factors affecting the UK real estate market. At the completion of the study the research should be able to examine and arrive at a conclusion as to whether the sector wise and region wise diversification of the investments in the real estate portfolio really has an impact on the overall return from the real estate investment. The study will also find out whether there are any tangible benefits that result to the investor by adopting sector wise and region wise diversification of his investment portfolio. For this purpose I intend to analyse the data which can be derived from the Investment Property Data Bank with respect the returns from the real estate sector in the UK. To authenticate my analysis I propose to add a detailed review of the available literature on the real estate sector in the UK as a part of the thesis.

1.1 Research Objectives:

Among other things this research study has the objectives set below to achieve by undertaking an extensive research in to the investments in the real estate in the UK.

1. To make a detailed study of the investments in the various sector and region of the UK so that the variations if any in the respective diversification can be presented in an analytical way.
2. In the process to make a detailed study of the real estate market in the UK and also the opportunities for investments together with a study of the associated risks.
3. To present a comparative analysis of the tangible benefits from the sector and regional diversification of the investments in the real estate properties in the UK market based on the interpretation of the data collected from the Investment Property Data Bank.

1.2 Research Questions:

This thesis attempts to find a convincing answer to the research questions outlined below:

1. Is there a variation in the returns from the diversified investments in the real estate in different sectors and regions of the UK?
2. Is there any tangible benefits accruing to the investor by adopting such a diversified portfolio of real estate investments in the UK context?
3. Are there any risks associated with such a diversified investments? If so what is the magnitude and effect of such risks on the return from the investments?
4. Is it is really worth taking the efforts to diversify a real estate investment portfolio within a property type across the regions or sector?

1.3 Structure of the Dissertation:

 In order to make a cohesive presentation of this paper I have divided the paper in to different chapters. Chapter 1 makes a brief introduction to the readers of the background of the subject the thesis is going to deal. This chapter also outlines the objectives of the research and sets the questions that the research intends to find answers. Chapter 2 makes a detailed review of the available literature on the real estate sector in the UK economy with a view to familiarize the readers to the discussions on the core subject of the paper namely the diversification of the investments in the real estate in the UK context. In Chapter 3 I present an account of the research methodology that was adopted to gather the information and data needed for the completion of the research along with a justification for the chosen method of research. The findings of the research and an analysis there of constitutes Chapter 4. Some concluding remarks recapitulating the issues discussed forming the content of the text is presented in the final chapter 5. I have also specified the limitations of this study and the scope for further research in that chapter.

Chapter 2 Literature Review

A brief introduction to the real estate as an investment portfolio followed by a discussion on the investments in the UK real estate market including the effect of making the investments in different sectors and regions of the UK on the returns from such investments is dealt with in this chapter. The chapter also deals with the question of whether any tangible benefits accrue to the investor as a result of such sector and regional diversification.

2.1 Investments in Real Estate Properties – An Overview

In generic terms ‘Real Estate’ is regarded as:

• A symbol of financial success and individual independence
• A commitment against the tenants of the property
• A business that expends all types of overheads
• A definite and tangible increase in the net worth of an individual
• A place of occupancy that can be named a ‘home’ and
• An immovable property of some intrinsic value acquired for enjoyment in the future (Rodirques. L)

The benefits of owning a real estate property is well explained by Rodrigues in his article as:

• Cash flow:  A real estate property is bound to provide a definite and positive cash flow to the owner for his benefit in the long run.
• Value Appreciation: There is ample scope for the increase in value of property caused either by making some renovation there of or by the inflationary tendencies. This enhances the value of the property in the hands of the owner.
• Financial Leverage: Of late it has become possible to acquire real estate properties without investing any own capital. It is easy to obtain a mortgage or other property loan to buy any property. This provides a lot of financial leverage for the individual.
• Benefits of Amortization:  The terms of repayment of the loans usually specify a fixed monthly instalment to be paid by the borrower which goes to make good the interest in the outstanding amount and the balance goes to reduce part of the principal amount. This process of making the payment monthly is known as amortization. This works out beneficial to the borrower for a planned repayment of the amounts borrowed over a long period.
•  Tax Advantages: Distinct tax advantages on the interest payments on the monies borrowed for acquiring real estate properties and other expenses relative to the real estate property are allowed as deductions from the tax calculations. (Rodriques .L)

2.1.1 General Comments on Property Investments:

Normally any property investment is made only in the areas which are beneficial to the investor in the long run. Adair et al (1995) outline certain specified characteristics features as to the regions and sectors in which the real estate investments are likely to take place. These factors involve:

• Economic sectors and regions that have returns within acceptable risk parameters
• Areas which are not considered peripheral to the core economy.
• Positive image of the regions and sectors.
• No restructuring economies

Adair et al (1995) further argue that if the above conditions with respect to the investment in any particular property are not satisfied then the investors would feel that investing in such a sector or region would result in a sluggish long-term growth and also the risks involved in suck kinds if investments are more. It can therefore be inferred that there are bound to be greater risks in property investments, when they are made in different sectors or regions of an economy.

However, the fact that investments in real estate property could offer greater returns for the investors, in general there has been an increasing tendency to make more investments in various properties and such investments always remain popular. Pensioners and retired professional who have investible surplus look in to the investments in the properties as an attractive proposition and also they view such investments which can be passed on to the next generation.

For those who look for investments in real estate properties Real Estate Investment Trust (REIT) – a detailed report on REIT is dealt with elsewhere in this paper) offers quite a good help and information on a variety of issues connected with real estate investments.

With the rapid changes in the economic development all over the world the investments in real estate properties have increased manifold. The investment in real estate has been recognised as an important segment of the portfolio along with other investments. “The portfolio investments have increasingly been recognised as a novel method of financial planning. There has been a sharp increase in the property related investments due to the volatility in the interest rates and the lower return from stock market securities and other forms of investments.” (Midas) Investments in properties have increased the confidence level of many of the investors as the safest and a high performing asset class.  Investments in real estate properties are usually made either to derive some expected returns or for acquiring the property for own dwelling or renting it out. A well maintained property enhances the value of the investments and is regarded as a good income generating asset. The primary advantages of property investments are (1) a continued growth in capital and (2) tangible tax advantages (UK Real Estate Fund)

According to a Property Investment Specialist, the growth in the property investments has increased to a level as high as 920 percent during the last two decades. (Midas) This indicates that the probability of the investments in the property to give the investor a higher rate of return at very low risks is very high which ensures the long term capital growth and increase in revenues from the property related investments.

A sound knowledge in the portfolio management techniques is of critical importance while making a decision to investment in real estate to take into account all parameters of such investments including the risk and return involved as the investment is expected to result in future revenues and positive cash flow to the investor. It is important to take into account to consider a number of factors like tracking rents, ground rents, tenancy expirations, miscellaneous charges and mortgage payments at the time a property investment decision is taken. It is also vitally important to monitor all these aspects routinely to ensure that they do not turn in to risk generating ones in the long run instead of remaining as profit generating ones or lowering of the risk elements. Property investment involves a lot of speculation and demands the investor to keep abreast of the consequences of all the associated risks when he or she seriously considers property related investments.

2.1.2 Investments in Properties – Position in the UK:

High rate of migration, increased life expectancy of the people and the increase in the number of single living people looking for individual houses has tremendously increased the demand and pressure for the properties in the UK. The investments in properties in the UK context may be considered in different segments such as vacant land, housing, commercial, retail and industrial sectors. The following figures go to confirm the suitability of the UK real estate market as the best one to consider:

• “250,000 to 3,500,000 new homes are needed over the next 15 years rising to 4,400,000 new homes are needed over the next 20 years.

• The UK is the second most densely populated country in Europe and has a fast rising migrant population

• Over the last 30 years the demand for new homes has increased by 30%.” (Midas)

The availability of land in the UK for investment purposes may be categorised as below:

• “Brownfield land. These areas are found in urban areas which has had an increase in development over the years.

• Greenbelt Land. These areas are found around the urban areas and offer very good opportunity for development and investment.
• Open Countryside. These are areas ready and prepared to offer the best opportunity for development and investment.” (Midas)

2.2 Real Estate Investment Trusts (REIT):

Real Estate Investment Trusts (shortly REIT) function as the widely publicised investment vehicle in the UK property investment segment. “Initially developed for the US market REITs are something of a holy grail for both private and institutional investors as they offer a high-profit, low-tax investment vehicle via a broad property portfolio which is traded on the stock market.” (UK Investment Advice, 2006)The commercial real estate market was regarded as a highly successful one during the recent past. But with the investors feeling the pinch of the devastating effects of the corporate scandals and the consequent share price volatilities were looking for investments which are lower in risk but still can bring home higher returns.

For them there were only two possibilities of entering the property investment market existed; one as a sole investor which demanded a high capital investment and the other way is to enter in to limited partnerships which had the shortcoming of a high taxation rate. These issues had kept the potential investors away from the property market. Only in this context the formation of REITs were seriously considered. “A REIT is basically an organisation with the sole purpose of owning and managing investment properties. REITs provide a string of advantages such as tax breaks, income return and inflationary protection.” (UK Investment Advice, 2006) REIT is a ‘passing-through’ organization in which the most of the income is distributed by way of dividends to the investors free of corporation tax. Usually the income for the trusts is derived by rental revenue from the properties being managed by the trusts. While it is difficult to buy and sell the properties as such, it is much easier to trade in the shares of REITs in the stock market. This unique phenomenon of the flexibility is considered in favour of investments in REITs which represent “affordable, broad and balanced way of investing in property”. (UK Investment Advice) The attraction of REITs lie in the distinct tax advantages resulting from the investments as they are free from the incidence of capital gains tax or corporation tax which come along with the traditional investments in the landed properties.

REIT is aimed at playing a significant role in the UK real estate market. They offer all investors cost savings strategies and advantages over the period of the REIT. Both the investors as well as investment managers are set to gain from this tax saving model.

According to Ray Prince (2006) the REITs are being introduced mainly with a view to take advantage of the tax breaks. He observes “the main reason is that there will be generous tax breaks for the property companies. REITs will not have to pay income or capital gains tax on the returns produced by their property portfolios, so long as they distribute most of their profits to shareholders via dividends” (Ray Prince, 2006)

It is important that investments are divided along with the risk so that the tolerance level is much higher and the potential return as well can be easily achieved. According to Richard (2007) pp.), the salient features requirements of a corporate structure are that a REIT must have the following,

“be a company; be close ended; be exclusively UK tax resident; have only one class of ordinary shares (other than non-voting fixed rate preference shares); be listed on a recognised stock exchange; distribute annually at least 90% of property rental profits by way of dividend, to the extent lawfully possible; and have no shareholder who holds more than 10% of the shares.”

REITs aim to remove all risks that are involved in buying and opening a real estate property, while also allowing the investor to access other near by facilities, such as schools, shopping malls, offices and surgeries.  Markets are expected to expand and grow with the introduction of REITs. Properties are expected to offer a higher level liquidity over the investment rather than the physical property itself.

According to KPMG (2006) one of the big 4 accounting and consultancy firms in the UK, for a company to qualify for a REIT some conditions need to be met. These are listed as follows:

• “UK tax resident (and not dual resident).
• Listed on a recognised stock exchange (i.e. not the Alternative Investment Market).
• Not an open ended investment company
• The only classes of shares allowed are ordinary shares (one class only) and non participating preferences shares.
• Distribute 90 percent of its net taxable rental profits (not capital gains) during the relevant accounting period or within twelve months of its end.
• Derive at least 75 percent of its total profits from its tax exempt property letting business.
• At least 75 percent of the total value of assets held by the REIT must be held for the tax-exempt property letting business.” (KPMG, 2006)

Warriner (2006) says that when a company converts itself in to a REIT, the company stands to gain a lot of advantages otherwise not available to the listed companies. As far as the investor is concerned, REIT is expected to an opportunity for better and safe investment with higher returns.

Despite the much talked about advantages the REITs are also subject to several criticisms. According to Court (2007), REIT has the following disadvantages:

• “There is still doubt whether they will offer more long term gains like “property unit trusts and OIECs”
• REIT will be far more volatile than other investment trusts, as they reflect sentiment of the market more than the actual value of the property itself.
• More awareness is required for any investor considering “a non-correlating asset” in a commercial property.
• Dividend shares of REIT are “taxed at 20pc”, as it is considered as income generation due to letting.
• They also deduct tax from any marginal income profit distributions at the tax rate of 22pc.” (Court, 2007)

Because of the above observations it is understandable that investors as well as companies still are still not confident enough about REITs as a safe mode of investments.  However REITs have been found operating successfully in the US as well as in Australia since a long time. The investors in these countries have found this investment vehicle as a convenient and successful mode. But in the UK context the success or otherwise of REITs can be judged only over a period of time when the investors and the REITs have become used to the operating procedures and the adaptability of REITs as an investment mode by the investors is established.

When the investments are made in different forms of assets like the real estate, securities or bonds, a ‘portfolio’ of investment is said to be created by the investor. Over the period of time several studies have been conducted on the construction of portfolios and the effect of diversification of the portfolios into different forms of investments on the probable return on the investments to the investor. One major milestone in the area of research on the investment portfolios is the ‘Modern Portfolio Theory’ which is being dealt in the following section of the paper.

2.3 Modern Portfolio Theory:

Harry Markowitz (1952) introduced The Modern Portfolio Theory (MPT) in the Journal of Finance in the year 1952. Markowitz’s got the idea from Williams and Burr (1938), who suggest a proposition as below:

The customary way to find the value of a risky security has been to add a “premium for risk” to the pure rate of interest, and then use the sum as the interest rate for discounting future receipts. . . . Strictly speaking, however, there is no risk in buying the bond in question if its price is right. Given adequate diversification, gains on such purchases will offset losses, and a return at the pure interest rate will be obtained. Thus the net risk turns out to be nil. (Williams and Burr 1938: 67–69) 

The Modern Portfolio theory deals with how diversification can be used effectively to optimise the investment portfolios and also the methods by which the pricing of a risky asset can be attempted. The theory centres round the basic concepts like the efficient frontier, capital asset pricing model (CAPM), alpha and beta coefficients and the capital and security market positions.

The model is based on the assumption that any investor is risk averse as far as his investments are concerned. When presented with the investment opportunities in two equally rewarding propositions, the investor would normally prefer the one with the least risk. Therefore it can be inferred that the investor would take more risk on any investment only when there are higher returns expected from the investment. It is also true therefore that any investor who wants to get more returns should be prepared for a higher risk exposure.  The trade-off between the risk and reward will be determined by the risk bearing characteristic of the investor concerned. Therefore the theory implies that any investor who makes rational decision will not make any investment in any class of asset if there exists another alternative portfolio which has a better risk-reward ratio.

Hui (2005) had used the Modern Portfolio Theory to test the benefits of international diversification. It was found that this method allowed individual investors and portfolio managers to reduce a set of national markets under consideration to a manageable subset, thereby saving search time and costs. This allowed the investors and the portfolio managers to select large and significantly developed markets so that the risk involved can be substantially reduced.

McClure.B. (2006) states that in terms of the modern portfolio theory, risk can be divided into two components. They are stated as follows,

• “Systematic Risk – These are market risks that cannot be diversified away. Interest rates, recessions and wars are examples of systematic risks.
• Unsystematic Risk – Also known as “specific risk”, this risk is specific to individual stocks and can be diversified away as you increase the number of stocks in your portfolio. It represents the component of a stock’s return that is not correlated with general market moves.” (McClure.B, 2006)

MPT have made a definite impact on the perceptions of the investors with regard to the returns from the investments and the associated risks. The theory has given rise to an effective portfolio management by the investment managers. In this way the risks involved in the various investments were reduced.

The Modern portfolio theory is not left without shortcomings. Irrespective of the advice on an efficient portfolio diversification, still the risks associated with the different investments are not eliminates which may turn to the detriment of the investor due to unforeseen developments or unexplainable reasons due to the nature of various security markets. Hence the investor still has to consider the investments in the light of associated risks and rewards. It is advisable that the investor takes a small calculated risk before he considers any major investments in any particular class of assets to gain larger profits.

The application of the Modern portfolio theory to the present study can be seen from its assumption that stock selection is possible based on the individual performance of selected stocks independent of other investments in the portfolio. Even though it is the case with the stocks of company shares and bonds that there are no such stocks which act independently without relation to the others stocks especially when the market is under the influence of external factors affecting the stability, in the case of real estate investments it is possible to identify and select the properties based on the regions and sectors that offer more return on the investments.

Similarly over the period the investments on the real estate have been proved that they can provide effective returns and hence the Modern Portfolio theory can be aptly applied to the investments in real estate properties. Hence the study infers that the investments in the real estate properties can also be decided on the basis of the Modern Portfolio theory.

Irrespective of the risk-reward association and the soundness of the individual investors as well as the fund managers, there are several other elements in the investment in the real estate property that influence the returns from the investments and the safety of the same.  They include type of the properties, location of them, and the market forces of demand and supply for that kind of property in a particular location. Depending on these variations the benefits accruing to the investor varies. Such factors are generally known as sector and regional diversification with respect to the investments in the properties.

2.4 Property Investment Diversification in the UK:

Several studies have been conducted on the benefits resulting sector and regional diversification of the property investments. “Using a variety of statistical techniques, the consensus has been that sector (property-type) diversification is preferable to regional (geographical) diversification in terms of risk reduction “(see Viezer, 2000 and Hamelink et al, 2000)

 “The simplest way to examine this issue is to calculate the correlation across sectors and regions and test whether the average sector coefficients are significantly lower than the average regional coefficients, as the lower the average correlation, the greater the diversification benefits.” (Stephen Lee and Steven Devaney 2004)

Andrew et al (2003) have identified a cyclical behaviour in the relative benefits accruing from the sector and region diversification. They found that the periods of high dispersion are followed closely by periods of low dispersion making the benefits out of the investments in the real estate available according to the respective cyclical behaviour.

2.5 Considerations for Sector diversification in the UK:

 The following factors will form the basis for the sector diversification in the UK:

• Region
• Geographic area
• Attractive for institutional investors
• Economy
• Cultural issues
• Availability of regional performance figures from IPD

According to Lee and Byrne (1998) a 1994 a survey has found that London (17 per cent) and the South-East of England (13 per cent) together attract the attention of 30 percent of the investment institutions. The other regions that were being considered for potential investments include Scotland, the West Midlands, the East Midlands and North-West of England.

The main question is if the investor needs to diversify by the sector or by region. According Lee and Byrne (1998) there are two ways in which an investor can decide. They are the analysis of intra- and inter-correlation coefficients and the efficient frontiers. Even research undertaken by Webb (1984) and Louargand (1992) said that the main criteria for investor diversification are real estate type and their regional or geographical variety. Eichholtz et al (1995) had analyzed sector and regional diversification in their paper by using different methods such as mean-variance analysis, principal components and correlation analysis. The results of their study showed that the performance of the retail sector in UK was considerably different from the performance by commercial property which consisted in majority the office and industrial properties. All these studies advocate that the diversification with respect to the property type may be considered advantageous with more scope for reduction in the portfolio risk than diversification by regions. It was also evolved as a result of these studies that the geographic diversification could not be measured precisely in the absence of aggregated data. Moreover the data available were based on administrative divisions rather than economic divisions which may not really suit the purpose for which the data is required.

Byrne and Lee (2000) studied 392 locations all over UK and found that sector diversification offered low risk level than regional diversification risks. Lee and Stevenson (2005) in their paper said that for the development of the real estate market in the UK that investment in only one sector and in one region (London) was unsafe when taking into account of the returns and the risks involved. If there is significant progress in diversification things would be a lot more improved. All these papers justified that diversification meant better and improved performance. In Adiar et al (2006) a more general approach is taken, wherein the most favourable portfolios are taken into consideration using the direct as well as the indirect real estate property return.

Hoesli et al. (2002) suggests that a three sector diversification approach for the three regions needs to be taken. This approach covered three sectors (the office, retail and industrial properties respectively) in three regions (London, rest of South East UK and rest of UK respectively).

Lee and Byrne (1998) used a similar classification that had a “regional code” for the Standard Regions in UK. The paper divided South East into London and Rest of the South East. The data used in their study were from IPD over the period 1981-1995. All this information is summarized and shown in the table below.

Table: 1 Number of Towns in Regions/Sectors

Source: Lee and Byrne, (1998)

From the above table it may be observed that there is an even spread of the different types of properties across the regions. The location of nearly 50 percent of the properties in the two regions, London and the South East, reflect the institutional bias towards the South of England. “In addition, the data reflected an inclination towards service dominated areas and high-tech growth centres, representing over half of the real estate properties in UK, also cantered in the south of England.” (Lee and Byrne, 1998) Therefore it can be inferred that the performance of the real estate investments in the other regions might be considered comparatively lesser in significance than in the areas of London and the South East.

Lee and Byrne (1998) also used the weighted average risks & returns and the MAD (Mean Absolute Deviation) method to measure the performance of real estate investments for Standard Regions, three Super Regions some functional groups and three real estate sectors. The results were shown in Table 2. 

Table: 2. Summary Statistics of Average Return and Risks for Regions,

Functional Groups and Sectors

Source:  Lee and Byrne (1998)

From Table 2, it is seen that for the standard and super regions, the general better returns were outside London and the South East. In addition, it could be found from Table 2 that the further away from the South the lower was the risk. In comparison, the return and risk for the functional groups were much more diverse. Moreover, in terms of sectors, industrials had the higher returns but higher risk, while the retail sector had the lowest risk and a bit higher return than the offices.

Therefore, the conclusion from this paper is that sector diversification needs to be firstly considered for portfolio diversification. The paper also says that when functionally based groupings are compared to Standard Regions, greater risk reduction benefits accrue from the functional groupings (Lee and Byrne 1998). Lee and Byrne (1998) went on to conclude that Diversification across the SuperRest Region would have outperformed almost all other diversification strategies. However, in comparing functional grouping with this Super Regional approach, the economically based classification produced results that were equally good.

It becomes abundantly clear that the principal issue to be resolved is the development of a set of widely acceptable functional groupings, since the evidence now coming forward indicates that such groupings offer generally superior risk/return performance than the static Standard Regional classification widely used in the UK. Furthermore, in the development of a real estate portfolio diversification strategy, portfolio managers might well prefer the richer descriptions that such definitions of functionality allow.”

In the paper from Berry et al (2006), ten cities in Ireland and UK were analysed for their total returns, income returns for the office, retail sectors. The data used was taken from IPD for the period 1984 to 2002. The finding showed that risk were of different levels, in which the income level carried low risk and the capital tended to be far more risky and volatile. This showed that sectors such as office and retail performed well and did not have to depend on it being in London or not. This research also found that the income stream was less volatile and had a lower risk factor whereas the capital growth was far more volatile and had a larger risk factor involved. The other significant finding was that the income, appreciation or the total return was dominated by the property type that is retail and office and not by the region.

The paper explained all the details related to the cities in Ireland and UK, so it was easy to decipher which area was doing well and which had good investment opportunity for the individual investor as well as the company.

Chapter 3 Research Methodology

This chapter presents a detailed explanation of the research methodology which will be used in conducting this research report. The development of this research will depend on both qualitative and quantitative survey method to achieve its objectives.

3.1 Research Philosophy:

The research presented in this paper will be based on a positivist epistemology and an objective ontology. The reason for the above mentioned philosophical stance is that data collected in this research will not contain any of the researcher’s personal perceptions. The required data for the thesis will be obtained from factual information of the sector and region diversification of real estate property investments in the UK obtained during the research period, so an objective ontology is appropriate for this research.

3.1.1 Ontological position: objective

Ontology is actually an orientation or set of assumptions about the nature of reality that has a role in a hypothetical zone. Two competing ontological positions are common. The first of the two approaches is related to the conceiving of problems, phenomena and methods in objective terms i.e., the perspective is being held through an external viewpoint. The second approach depends on subjective terms, while conceiving of the problems, phenomena and methods with an internal perspective (Denzin and Lincoln, 2000).

This research undertakes an objective perspective research. Objective research is based on factual information, not biased by personal beliefs or feelings (Neuman, 2000). An objective ontology is based on the search for the regularities and causal relationships that can be observed and described objectively without interfering with the phenomenon being studied. It is distinguished from other forms of explanation because of its requirement for systematic experimentation (Laresgoti et al.1996).  The main reason for the choice of objective approach presented in this research is that this research is being conducted in a manner where data are collected without bias.

3.1.2 Epistemological Position: Positivist:

The epistemological aspect of the research method is the way of working for getting knowledge for the research inquiry. The basis of the research of this type is the information retrieval being done from the set of data which have been gathered for further analysis and information generation. Epistemological positivist refers to the grounds of knowledge in the research work being done to develop the thesis (Remenyi, Williams, Money, and Swartz, 1998). Furthermore, positivist research uses deductive reasoning to discover existing universal laws that can be used to predict general systems of human activity (Gephart1999, Cavana et al 2001). In American research 97 percent corresponds to a positivist paradigm (Orlikowski and Baroudi, 1991). Ridley and Keen (1998) found that 88% of Australian research also conforms to a positivist epistemology. Therefore, this research approach can be considered as the dominant research approach worldwide. The table 3 shows the main characteristics of a positivist paradigm.

Table: 3 Comparison of the Positivist paradigm underpinning business research

Source: Adapted from Lincoln and Guba (2000),Gephart (1999) cited in Cavana et al. (2001)

Two main benefits are identified for researchers who adopt positivist research methods. One benefit is that positivist research is always easier to carry out and also expends less time. The other benefit is that it is easier for researchers in defending their approaches and methods because positivist research is widely accepted by readers and editors (Deetz, 1996).From the above discussion, we can see that this research is positivist as it will treat reality as independent of the researcher. It will seek to understand causal relationships and it will use precise measures to investigate the phenomenon. Hence I chose the qualitative method based on the positivist approach and on the basis of the qualitative method I constructed the research designs which are explained elsewhere in this paper.

3.2 Research Methods:

I considered several methods of collection of data for this research. I found it necessary to arrive at a specific method that will be appropriate to attain the objectives of the research. For arriving at the appropriate research method I collected the available information about research methods and carefully analysed the differences between the two major data collection approaches (i.e. the qualitative and quantitative research methods). On an analysis of the relative merits and demerits of both the techniques I decided to use qualitative method to collect the required data. A brief description of both the techniques is presented below for the information of the readers.

3.2.1 Qualitative Method:

The qualitative method is ‘one of the two major approaches to research methodology in social science’, which involves ‘investigating participant’s opinions, behaviours and experiences from the informants’ points of view’.

In contrast with the quantitative research method, the qualitative research method ‘does not rely on quantitative measurement and mathematical models, but instead uses logical deductions to decipher gathered data dealing with the human element’. The difficulty in using this research method is ‘that it is more expensive, has smaller sample sizes and is hard to measure’. In qualitative research method non-quantitative’ methods of data collection and analysis are being used (Lofland & Lofland;1984). Qualitative research method has been defined as ‘focuses on “quality” rather than quantity. While some other researchers say Qualitative method involves a subjective methodology and making the researcher as the research instrument (Adler and Adler; 1987)

3.2.2 Quantitative Method:

Quantitative method is a research method which depends less on subjective methods but is more focused on the collection and analysis of numerical data. Quantitative research involves analysis of numerical data. According to Burns and Grove, quantitative research is: “a formal, objective, systematic process in which numerical data is utilized to obtain information about the research question” (Burns and Grove cited in Cormack 1991 p 140). Quantitative research uses methods which are designed to ensure objectivity and reliability. In quantitative research the researcher is considered external to the actual research, and results are expected to be the same, no matter who conducts the research. The strength of the quantitative method is that, it produces quantifiable and reliable data. William Trochim (2001)

3.3 Research Aim:

This study here is to identify whether it is better to diversify a real estate portfolio within a property type across the regions or within a region across the property types. All the research and data collection is within the UK real estate investment sector. Based on the research purpose, a wide range of literature review has been conducted in order to identify all of the possible factors that could influence the performance of real estate investments. From the literature review/background reading in the previous two sections, it is found that a number of factors, such as the REIT, the investors’ risk-averse levels, the performance of the previous sector or regional diversification, etc, could affect the investors to make their investment strategy in the UK real estate sector. In addition, from the literature review, regional or sector diversification of real estate portfolios has become a focus that more and more researches have been done in this area. Therefore, this research will be based on the previous findings to further investigate into the regional and sector diversification of real estate investment portfolios by using the most updated data that are available.

3.4 Research Design

In terms of the limitations of the research study, this research will be conducted based on the following format:

• Property Types

The property types discussed and analysed were according to the data available from the IPD.  The different property types are as follows,

• Retail
• Office

• Regions or the geographical areas

While deciding on the analysis of properties with respect to the investments and returns on the basis of regions, I analysed the source from which the data could be obtained as it is difficult to collect the required data on a personal basis. Hence I considered using the data available with IPD. Since the information recorded in the IPD has been collected only in a particular order I considered extracting the data as available from the IPD.  Hence the research design consisted of different geographical areas as follows as the data is recorded in the IPD,

• South East
• Rest of South East
• Rest of UK
• City
• West End and Mid Town
• South Eastern
• All Property Available

The above mentioned geographical locations are studied with respect to the property types. The results found are discussed in the following section.

3.5 The data

It normally is difficult to gather the kind of information required for completion of the study both in terms of quality and quantity putting personal efforts, as the selection of samples would be difficult as it covers a wide geographical dispersion. Moreover it cannot be expected to get the primary data about the quantum and rate of return that people are getting out of their investments in real estate properties because such information is considered too personal. and may not be divulged. That is the reason why this study chose to use the data from the IPD database is since the IPD covers a wide range of properties with detailed information and data which can perfectly fit into the study. The data used in this study are the IPD annual market standing investment performance total percentage returns over the last two years (2006-2007).

At the end of 2003, the 10811 properties covered by Annual Index in IPD were valued at £ 105 billion – equivalent to 45% of the total property assets of UK institutions and listed property companies (IPD 2007). Therefore, from a vast database IPD is able to breakdown the data into a large number of sectors and regions. Moreover, due to the fact that nearly half of the total property assets are included in the database, the results found based on the data from IPD could to a high degree represent the total market situation in the UK real estate sector. With regard to why the period of 2006-2007 is chosen for this study, there are generally two reasons. The first one is that from the literature review, it is found that most of the researches available are before 2006 and that most of the findings from the previous researches are that sector diversification should be better than regional diversification. The second reason is that the data over the period of 2006-2007 are the most updated data that the researcher can access and that the researcher needs to use the most updated data to test the previous findings which were identified by the previous researchers.

Chapter 4 Findings and Analysis

Under this chapter the findings relating to the subject under study’ the benefits relating to sector and regional diversification of the investments in the real estate properties in the UK are presented followed by a detailed discussion of the findings.

4.1 Findings

The findings on the basis of the data retrieved from IPD with respect to year wise and region wise data are listed in Appendix I

The findings will be categorised as follows for convenient understanding. The provisional results for the year 2007 showed that the retail and the industrial sectors out performed the office sector. The year end December 2006 results showed that the retail sector out performed the office and the industrial sectors. The year end December 2005 results showed that the retail sector out performed the office and the industrial sectors. The year wise performance with respect to the capital value of the region in respect of the different classes of assets is discussed as below:

4.1.1 Performance of the Retail Sector:

The year wise performance of the Retail sector is found to be as follows:

Provisional Results for 2007:

South east performed a lot better than the rest of UK; the shopping centres were very insignificant. The retail warehouses showed the highest value. The number of properties taken into account showed that South east had far more properties when comparing to the rest of UK and retail warehouses were of the highest number. The percentage capital value was zero for the South east region and it was even lower for the rest of UK.

Performance for the Year 2006:

The Rest of UK performed the best with the South East coming close. The rest of UK was close to the South East in performance. The value for the South Eats and Rest of UK was almost the same. The percentage value of South East was not significantly lower than that of the Rest o UK.   The number of properties taken into account showed that Rest of UK and the South East was almost the same.

 Performance for the Year 2005:

The Rest of UK performed the best with the South East a close second… The value for the South East and Rest of UK was almost the same. The percentage value of South East was not significantly lower than that of the Rest of UK.   The number of properties taken into account showed that Rest of UK and the South East was almost the same

4.1.2 Performance of the Office Sector:

The year wise performance of the office sector is as below:

Provisional Results for 2007:

Rest of South East performed the best when compared to the other areas. The second highest performer was the rest of UK, next was West End and Mid Town, with the City coming last. The number of properties taken into account was the highest for Rest of South East and the lowest for the City. The percentage capital value was zero for the City and West End and Mid Town. The rest of South East showed a significant high percentage capital value.

Performance for the Year 2006:

The Rest of South East out performed all the other regions. West End and Mid Town was a close second. The number of properties taken into account was the highest for The Rest of South East and the lowest for the City, whereas the other areas West End and Mid Town, Rest of South East and Rest of UK were close in number. The percentage capital value was the highest for the Rest of South East and the lowest for the Rest of UK. The City and the West End and Mid Town were almost the same.

Performance for the Year 2005:

The Rest of South East out performed all the other regions. West End and Mid Town was a close second. The number of properties taken into account was the highest for The Rest of South East and the lowest for the City, whereas the other areas West End and Mid Town, Rest of South East and Rest of UK were close in number. The percentage capital value was the highest for the Rest of South East and the lowest for the Rest of UK. The City and the West End and Mid Town were almost the same.

4.1.3. Performance of the Industrial Sector:

The year wise performance for the industrial sector is produced below:

Provisional Results for 2007:

In the industrial sector the South Eastern region performed the best. The South Eastern percentage capital value was therefore, not that high very close to the zero value of the rest of UK. The number of properties taken into account was almost equal in number.

Performance for the Year 2006:

In the industrial sector the Rest of UK performed the best. The South Eastern percentage capital value was therefore, not that high very close to the value of the rest of UK. The number of properties taken into account had only a small difference. The percentage value is lowest for the Rest of UK and higher for the South Eastern region.

Performance for the Year 2005:

In the industrial sector the South Eastern performed the best. The Rest of UK percentage capital value was therefore, not that high very close to the value of the rest of UK. The number of properties taken into account had only a small difference. The percentage value is lowest for the Rest of UK and higher for the South Eastern region.

4.1.4 The Annual Index changes for the Year 2007

The provisional results for the year 2007 showed no significant changes in the annual index. It is found to be either the retails sector or the office sector that is doing well when compared to the region.

4.1.5 Annual Index Changes for the Year to December 2006

The changes in the annual index for the year 2006 in respect of the various elements of the property investments are produced below:

Total Return

IPD UK Annual Index Year to Dec 2006 (Total Return)

The office sectors had the highest percentage out of which London Offices were even greater. Although the index at Dec 2005 showed the retail and the industrial sectors greater than the London Offices. The percentage year to December 2006, showed that the office sector was greater than the industrial and the retail.

Capital Growth:

IPD UK Annual Index Year to Dec 2006 (Capital Growth)

The office sectors showed significant growth out of which London Offices were even greater. Although the index at Dec 2005 showed the retail and the industrial sectors greater than the London Offices. The percentage year to December 2006, showed that the office sector was greater than the industrial and the retail.

Income Return:

IPD UK A Index Year to Dec 2006 Income Return 

The industrial sector shows the highest return, closely followed by the offices and then the retail. The index at Dec 2005 showed the industrial sector greater than the retail and the office. Out of which the London Offices were significantly lower. The percentage year to December 2006, showed that the industrial sector was greater than the office and the retail.

4.1.6 Annual Index Year to December 2005:

The following represent the findings for the various elements relating to the real estate investments in the UK for the year 2005.

Total Return:

IPD UK Annual Index Year to Dec 2005 (Total Return)

The office sectors had the highest percentage although the index at Dec 2004 showed the retail and the industrial sectors were greater than the office. The percentage year to December 2006, showed that the office sector was greater than the industrial and the retail.

Capital Growth:

IPD UK Annual Index Year to Dec 2005 (Capital Growth)

The retail sectors showed significant growth. The index at Dec 2004 showed the industrial a close second. The percentage year to December 2005, showed that the office sector was greater than the industrial and the retail, but there was a minimal difference between the retail sector and the office sector.

Income Return:

IPD UK Annual Index Year to Dec 2005 (Income Return)

The industrial sector showed the highest return, closely followed by the offices and then the retail. The index at Dec 2004 showed the industrial sector greater than the retail and the office. The percentage year to December 2005, showed that there was very little difference between the industrial and the office sectors.

4.1.7 The Quarterly Index end March 2007:

The quarterly index result of end March 2007 results showed that the retail sector out performed the office and the industrial sectors. The capital value of the region is discussed as follows,

IPD Index UK Quarterly Index Profile: end March 2007

Retail sector:

The Rest of UK performed the best with the South East a close second. The value for the South East and Rest of UK was almost the same. The percentage value of South East was not significantly lower than that of the Rest of UK.   The number of properties taken into account showed that Rest of UK and the South East was almost the same with only a small difference.

Office Sector:

The Rest of South East out performed all the other regions. West End and Mid Town was a close second. The number of properties taken into account was the highest for The Rest of South East and the lowest for the City, whereas the other areas West End and Mid Town, Rest of South East and Rest of UK were close in number. The percentage capital value was the highest for the City and the lowest for the Rest of UK. The City and the West End and Mid Town were almost the same.

Industrial Sector:

In the industrial sector the South Eastern performed the best. The Rest of UK percentage capital value was therefore, not that high very close to the value of the rest of UK. The number of properties taken into account had only a small difference. The percentage value is lowest for the Rest of UK and higher for the South Eastern region.

4.1.8 Quarterly Index Profile end March 2007

The results of the Quarterly Index Profile for the period up to March 2007 are presented below;

Total Return:

IPD UK Quarterly Index end March 2007 (Total Return)

The office sectors had the highest percentage although the index at Dec 2006 showed the retail sector was greater than the office. The percentage quarter to March 2007, showed that the office sector was greater than the industrial and the retail.

Capital Growth:

IPD UK Quarterly Index end March 2007 (Capital Growth)

The retail sectors showed significant growth. The index at Dec 2006 showed the retail the highest and the industrial a close second. The percentage quarter to March 2007, showed that the office sector was greater than the industrial and the retail, but there was a minimal difference between the retail sector and the industrial sector.

Income Return:

IPD UK Quarterly Index end March 2007 (Income Return)

The industrial sector showed the highest return, closely followed by the offices and then the retail. The index at Dec 2006 showed the industrial sector greater than the retail and the office. The percentage quarter to March 2007, showed that there was very little difference between the industrial and the office sectors, although the office was slightly higher.

4.2 Analysis:

4.2.1. GENERAL OBSERVATIONS

“Traditionally, diversification of real estate investment has been by region (geographic/economic) and/or by type or different permutations of these two diversification strategies”. (Kwame Addae-Dapaah et al,2002) However the public data obtained from IPD does not contain detailed cash flow details that could facilitate the comparison of Internal Rate of Return to assess the particular returns from region wise or sector wise properties.

The data available on the IPD was only limited and did not give more details about many areas. Even the areas available were quite limited and did not give scope to analyse a wider range of regions of the UK. The database used was only IPD as there was no access to many of the database available. Even if the database was available then the criteria used to collect the data was different, so therefore, there would have been a contradiction in the results analysed.

That is one of the main reasons that the thesis has only used the limited data available. Similarly though the data provide the increase in the value of the properties over different regions and sectors the data could not be used for an effective comparison of valuation for the different properties situated in different regions or sectors. Any valuation theory or model for comparison of the growth in the returns as well as increase in the valuation could be possible only when it is possible to collect data relating to specific returns and increase in value of the real estate properties form any pension fund or similar other private agency holding a wide range of properties in different sectors and regions. Since identifying the source of such information is difficult and beyond the time and cost involved in this study specific models as developed by Williams (1995) who based his work on Black and Scholes (1976) could be used.

4.2.2. an Analysis of the Previous Research Works

The subject of diversification of the properties on the basis of sectors and regions have been analysed by many researchers. There has been no consensus on the part of the authors as to which way of diversifying the investments in properties would be advisable; whether sector wise or region wise. But the most important factor to consider is that a majority of the research works have used the data from the IPD for their analysis. Usually the papers have used the time periods ranging to different number of years. Some papers have even used a time span of eleven years as the period for which they presented and analysed the data. But still there were some overlapping of the periods under these papers. But this was not evident in the works. The methodologies that have been used are usually the same among the papers researched.

The papers don’t clearly explain the reason for the usage of the particular method, so it is difficult to come to a decision as to which method is the best for portfolio diversification. One of the other results also found was that many papers overlapped in their ideologies, and didn’t exactly specify as why the same testing tools was not used for analysis.

The area of portfolio diversification is still found to be a very huge area that researchers find intriguing, as there have been many reasons that have been used to justify the use of the particular methodology, although there still has been no paper that has been written to test the same set of data in the different methodologies specified and used over the time.

Even though differences persist it was found that most of the papers believed that the sector (office, retail and industrial) diversification as far more superior and beneficial than the regional diversification.

4.2.3 analysis of IPD Data and the result of this research

One of the main results got from the IPD analysis was that no matter what region was taken the property type fared much better. In some of the data that was available there were offices in London that did well but that was only in London. At the same time the other sectors that were not specifically in London equally did well or did even better. This goes on to explain that the region London could not have been the sole reason for the better sector.

The various types of properties are spread across the UK and all of them were doing well. It was evident from the performance achieved in terms of the income return, capital growth and total return of such properties. This shows that the results depended more on the sector than the region to which it belonged to.

4.3 Analysis of Sector wise Overall Performance

In the matter of sector wise performance for the year 2007 the retail sector had performed well as compared to the other two sectors under consideration. This is shown from the fact that the percentage capital value for the year 2007 based on September 2006 structure for all retail sectors shows a figure of 51.8 percent as compared to 29.3 for the all office and 16.3 for all industrial figures. This clearly shows that the retail sector has outperformed the other two sectors in terms of capital growth.  This trend has been maintained even in the years 2005 and 2006 with the retail sector outperforming the other sectors.

The annual index for the year 2006 indicates that the retail sector has achieved the maximum capital value than the other sectors at 47.2 percent which is slightly less than that for the year 2005. Nevertheless the performance of the sector is quite impressive. Within the sector the warehouses showed an all round better performance. This may be due to the increased economic activity with buoyant markets. There is no marked change in the capital value of shopping complexes during the year 2007. However in the year 2006 both the shopping complexes and the warehouses have increased their capital values almost equally. In the year 2005 the performance of the shopping complexes is marginally higher than the warehouses. Since the collection of data by IPD pertains only in respect of shopping complexes and warehouses individually the analysis is limited to the comparison of these two retail properties in the absence of data about the other types of retail properties.

However the performance of the retail sector in terms of the total return for the year 2006 taking the year 1980 as the base year is not that impressive with a percentage increase of 15.20 against 23.04 percent for all offices and 17.65 percent in respect of all industrial properties. This may be due to the fact that there is a greater demand for the office and industrial properties than the retail properties which has resulted in a higher total return for the office and industrial properties.

As far as the capital growth is concerned the performance for the year to December 2006, the percentage value for all property is at 12.61 signifying that the growth of all property values has increased by 12.61 percent on an average from the year 2005.  In the area of capital growth also the retail sector is found to be sluggish than the other two sectors. The performance of all industrial properties in the area of capital growth is high at 17.23 percent with all industrial following at 11.29 percent.

On the income return aspect all the sectors have done almost equally for the year 2006 with industrial properties topping at 5.7 percent with a figure of all office at 5.01 percent. The retail sector has done poorly at 4.60 percent than the other sectors.

For the year 2005 the all office properties has performed well in the total return area at 20.28 percent with the retail and industrial properties performing equally around 18 percent. The average for all the properties thus is found to be around 19 percent. In terms of capital growth the retail sector has shown a significant development on the basis of the index levels in the year 2004 and 2005. However on the percentage basis the office sector has performed marginally higher than the retail and industrial sector with 13.39 percent as against 13.14 percent and 11.12 percent respectively for the retail and industrial sectors. There has been no great changes in the income return of the different sectors form the year 2004 with the industrial sector showing the highest return at 6.58 percentage while the office and retail performing at 6.13 percent and 5.14 percent respectively. Since the analysis of the quarterly figures may not really represent the trend of the variations in the attributes of the different properties this paper does not venture into analysing the quarterly figures for the first quarter of the year 2007. The data was included just for the information of the readers.

4.4 Analysis of Region wise Overall Performance

As outlined earlier this study has a serious limitation in that there is lack of availability of region wise data except that the sector wise data has been collected in respect of the certain specified regions as below:

Retail Sector: South East and Rest of UK

Office Sector: City, West End and Mid Town, South East and Rest of UK

Industrial Sector: South East and Rest of UK

Hence from the available data retrieved from the IPD on the above regional basis the paper could not make a meaningful analysis of the findings. However despite the limitation an attempt has been made to compare the available data and present an analysis.

The results for the year 2007 signify a better performance of the South Eastern Region than the rest of the UK as far as retail properties are concerned. In the case of office properties also the rest of UK has done well. In the case of industrial properties the South Eastern Region has outperformed the rest of UK.

In the year 2006 the rest of UK region’s performance is better than the South Eastern Region in terms of the number of properties. Taking the same scale even in the case of office properties south eastern region has performed much higher than the rest of the UK. It is not a good comparison to judge the diversification benefits on the basis of the number of properties handled in the City of London with rest of UK and south eastern region. Hence the figure for city is not taken into account for analysis. Rest of UK region is found to be having dealt with more number of industrial properties than south eastern region.

The figures for the year 2005 are not analysed as the trend is more or less the same as that of the year 2006.

From this data analysis it can be clearly seen that the property type diversification benefited the investor more than the region level diversification. One of the main reasons might be that in this day and age in the UK the regions are becoming less significant because the cities are becoming over saturated. These regions area already developed and any investments in these regions involve huge capital outlay making the interest costs unaffordable. Consequently the returns on these properties get reduced. In such a situation the only better option is to do diversification by the property type.

4.5 Answers to Research Questions

The answers to the research questions are as follows:

1. Is there a variation in the returns from the diversified investments in the real estate in different sectors and regions of the UK?

From the analysis it is observed that though there are not significant variations in the returns due to sector or regional diversification, still there exists some variation which justifies the sector wise diversification of the investments.

2. Is there any tangible benefits accruing to the investor by adopting such a diversified portfolio of real estate investments in the UK context?

The findings show that there are some tangible benefits accruing to the investor when investments are diversified into different regions and segments. However there are not enough data to prove this and answer this research question straight. Though the initial capital outlay is high an investment in a property in London city might provide better return and capital growth to the investor. But unfortunately this research is unable to find any source of data which can precisely prove this point.

3. Are there any risks associated with such a diversified investments? If so what is the magnitude and effect of such risks on the return from the investments?

There are no evidences to prove that there are significant risks associated with the diversification of the investments as the total return and capital growth in respect of all types of properties are showing only increasing trends. Again the study is seriously incapacitated in getting the region wise comparable data to decide on the factor of risks associated with the diversification into different regions. On the basis of the findings on a sector base the study can very well confirm that there are no significant risks associated with the diversification.

4. Is it is really worth taking the efforts to diversify a real estate investment portfolio within a property type across the regions or sector?

Yes! It is really worth to make a diversification of the investments in the real estate on the basis of the different sectors as there are significant variations in terms of capital growth and total return in between the different sectors of properties. On the basis of the analysis of the findings this study is able to confirm this with respect to sector diversification. But no comments can be made as to whether it is really worth diversifying in terms of different regions, in the absence of relevant data. Only experience with each region and location can really help the investment decisions in such cases where the regional element is to be taken in to account in deciding the investment.

Chapter 5 Conclusion:

By way of concluding remarks this chapter includes a recapitulation of the issues discussed in the paper and adds the limitations to this study. The chapter also presents a short note on the scope for further studies.

5.1 Conclusion:

The paper presented an overview of the intricacies of the investments in the property market in general and the effect of diversifying within different sector and regions of the UK property market in particular. The potential of the REITs as an investment vehicle was also discussed at length. While the paper presented a detailed discussion on the ‘Modern Portfolio Theory’ it also has discussed the diversification aspects of the property market in the UK. On the basis of the data derived from the IPD the paper presented various findings on the basis of which the income return, capital growth and total return in respect of various periods and for three different years were presented along with an analysis of the trends of these attributes in relation to the investments in the properties.

The income return represents the annualise returns from the investments in the properties and the total return represents the increased value of the property over the period of time. Despite the limitations on the availability of the data to precisely determine the benefits accruing to the investors from the sector and region diversification the paper relied on the data available with IPD and presented the findings to answer the research questions. The analysis of the findings on the basis of the data retrieved from the IPD website was somewhat lopsided due to the data being administrative division oriented rather than economic divisions in respect of the region diversification. On the sector diversification the data were fully usable to arrive at the desired results and analysis. The paper basically considered three different property sectors namely retail, office and industrial as the IPD data were grouped under these categories of properties. Similarly in the case of presentation of regions wise findings the paper followed the administrative divisions adopted by the IPD so that the data could be retrieved for such administrative regions.

The findings of this paper suggest among other things the potential for improvements in the benefits from the diversification of the portfolio among the several alternative sector and region property markets. The existence of long term relationship among different regional markets indicates that the investors cannot expect a large variation in the returns due to regional diversification. However it is also not possible to rule out the possibility of increased returns to some extent because of the geographical diversification in the investment portfolios. In the short run also there may be distinct advantages resulting from the linkage between the regional property markets. But due to high transaction cost it may not really be possible that such benefits are derived by the investors.

Another important factor that needs consideration is the characteristic of certain UK regional property markets in showing the low level of variance in the returns over the period than the other markets. Examples may be found in Outer South-East region where shows very little variance over the period as against the North West and North regions which show 46 and 36 percent respectively. A proper combination of these regional markets with extreme variations with other regional markets may really bring out the benefits of diversification, within a domestic property investment portfolio.

A proper study of the results in terms of capital growth in the different markets and their comparison with other regions may help developing a ‘modeling price discovery’ in the UK market.

5.2 Limitations:

The study suffered from the limitation of non availability of past studies and researches conducted in this field. Though several studies have been conducted in the US with respect to the sector and regional diversification of the real estate investments, the less number of studies in the UK context made the collection of information and data for the completion of the study complex and devoid of exhaustion.

The other limitation was that the data available relating to sector distribution was mainly based on administrative divisions rather than economic divisions which did not really suit the purpose for which the data is required and made the study to depend on the available resources.

The data related to real estate investment performance in IPD are classified by real estate type; IPD does not classify the data into regions clearly. There is no clear classification of regions based on economic activities in IPD. Some of the previous work suggested that using the model of three super regions (namely London, South East, the rest of UK) and three sectors (namely retail, industrial and office) are reasonable to do the comparison between sector and regional diversification. However, due to the changes of format of the IPD database, the researcher cannot access to the data related to the three super regions exactly. All of these presented above result in great limitations when comparing the regional and sector performance of real estate portfolios.

5.3 Scope for Further Studies:

Being a vast area the diversification factor in influencing the return and safety of the investments in the UK properties give rise the scope for many further studies. Some of the areas that can be explored by further research are:

1. The success or otherwise of REITs in offering a vehicle of investment for the prospective investors based on the past performance in the limited period of its existence.
2. The influence of constraints on the property additions in some categories or in some regions on the benefits of diversification. The study may be confined to certain exclusive properties or regions where such constraints are there.
3. Further studies relating to specific geographical locations like a district or a group of towns may be interesting to pursue.
4. A study covering the diversification in other major cities of the world wherever comparative figures are available may be considered.

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