Investing in Irish commercial property is not diversified enough

[Jim2007]

Moderator's note: These posts are moved from this thread: Green REIT plc


The real question is what should the asset allocation to property be in a Euroland portfolio and of that how much should be allocated to Ireland? Only when you reach a decision on that one, should you think about funds.

A couple of months back I had some discussions with asset managers at two Swiss banks on the very subject and some of the figures for the real estate element might be of interest:

|Allocation
Low Risk|2 - 4 %
Medium Risk|4% - 6%
High Risk|6% - 8%

Note that these are Euroland wide figures, so for instance a low risk portfolio of say 250K should have about 10K in total real estate across the Euroland zone and of this 10K very little should be allocated to Ireland!

People need to realise that when they allocate a large portion of their portfolio to Ireland, they seriously skew the risk profile of their portfolio. This may well result in better returns, but it does represent more risk.

 

[Brendan Burgess]

Hi Jim

A fair point, and that seems like a very low proportion to put in property for a low risk fund. What is the overall distribution of assets for , say the medium risk fund?

I think Rory's original point is that Irish commercial property has bottomed out and now is a good time to invest in it. I don't know if Rory is suggesting a particular percentage or not.

Brendan

 

[Gary]

Brendan - to your point "Friends First and New Ireland fund priced on a Bid Basis, giving a potential once-off return of 10%, when they are repriced to offer basis."

I'm not sure that this is the case.

Difference between acquisitions and disposals basis of pricing is much smaller now given the significant reduction to stamp in the 2011 budget. As a reference, the Aviva fund recently changed its basis of pricing and the uplift was in the order of 5%. The change in pricing basis will ultimately be made by the appointed actuary, so you are in there hands really.

Also, I think the New Ireland fund is an Irish and UK fund (it may have an Ireland only fund that I am not aware of), so difficult to make the comparison with Irish only funds.

Jim2007 - your point about skewing the risk in the portfolio by having a large allocation to Ireland is a bit confusing (at least in the context of what risk actually is). If your measure of risk is some sort of tracking error against a benchmark, then maybe (volatility and its associated risk metrics are wholly inappropriate w.r.t. property).

To me, the only appropriate measure of risk in a portfolio is the potential for losing your capital. By that measure (given the strength of the valuation argument), the rationale for a large allocation to Irish commercial property (within your real asset allocation) is warranted.

 

[Jim2007]

Hi Jim

A fair point, and that seems like a very low proportion to put in property for a low risk fund. What is the overall distribution of assets for , say the medium risk fund?

I think Rory's original point is that Irish commercial property has bottomed out and now is a good time to invest in it. I don't know if Rory is suggesting a particular percentage or not.

Brendan

Hi Brendan,

From my notes and what I recall the figures we were kicking around were close to these:

Asset Class|Low Risk|Medium Risk|High Risk
Cash|23%|7%|3%
Bonds|34%|20%|11%
Equities|20%|48%|68%
Commodities|4%|5%|5%
Real Estate|4%|6%|8%
ATS|15%|14%|7%

The Real Estate is allocation is normally low because property is not considered to be the low risk option that most Irish investors seem to assume.

ATS = Alternative Trading Strategies: An attempt to generate risk-adjusted returns with a weak correlation to other assets classes (we did not spend too much time on this one).

 

[Brendan Burgess]

Hi Jim

That is interesting but I don't fully understand it.

It says "cash and bonds are safer than other categories" - fair enough.

But I don't think it's saying that equities are a lot safer than Real Estate?

It seems to be determing the allocation to Real Estate on some basis, other than risk.

 

[Jim2007]

Jim2007 - your point about skewing the risk in the portfolio by having a large allocation to Ireland is a bit confusing (at least in the context of what risk actually is). If your measure of risk is some sort of tracking error against a benchmark, then maybe (volatility and its associated risk metrics are wholly inappropriate w.r.t. property).

No not at all! If you skew your country allocation in favour of Ireland you will place a major portion of you investments in one of the small economies of Euroland and any negative impact on the Irish economy is likely to impact all of your asset classes.

To me, the only appropriate measure of risk in a portfolio is the potential for losing your capital. By that measure (given the strength of the valuation argument), the rationale for a large allocation to Irish commercial property (within your real asset allocation) is warranted.

Where do you get valuation??? Prices are definitely down from the over inflated prices of the past, but that does not mean that they represent good value. There is no active market and given the over exposure of the banks to property financing of new projects is going to be a challenge. I've already said that I see this REIT as an attempt at alternative financing and I've not seen anything to make me change my opinion.

People are going to do what they are going to do, but they need to realise that when we talk about well diversified and balanced portfolios, we do not mean portfolios contain a large portion of property concentrated in a small European economy.

 

[Gary]

Jim2007 - "Where do you get valuation??? Prices are definitely down from the over inflated prices of the past, but that does not mean that they represent good value. There is no active market and given the over exposure of the banks to property financing of new projects is going to be a challenge. I've already said that I see this REIT as an attempt at alternative financing and I've not seen anything to make me change my opinion."

You are correct, just because something has fallen in price doesn't mean it represents good value. But there is a hell of a difference between price and value. My assessment of value is based on objective measures of valuation (not my opinion). These measures have been aired by others in a previous post within this thread. The basis for your conclusion seems to centre more on your own subjective assessment of the situation. Though you make a fair point about financing and banks, I would be more comfortable placing greater emphasis on objective facts and figures.

I think I know what I don't know - and that includes where Irish commercial property values are going in the next 12 months. But what I do know is that price at which you buy something is the ultimate determinant of the return you get from an asset. The price at which I am buying Irish commercial property at today, would suggest the odds are strongly in my favour over a long time horizon. That's the best I can hope for.

There is crazy situation going on at the moment, whereby buyers of government debt are quite happy to lend money to the Germans at less than 2% p.a. for ten years, who then in turn buy prime real estate in Dublin city centre (one office on Baggot street yielding c. 14% for example). My money is on the Germans to be the ultimate winners of this trade!

On a separate but related (risk) note, your low/medium/high risk portfolios above, you have 34% in bonds in one that is labelled 'low' risk. Again this goes back to what your measure of risk is, but yours seems to be based on historic volatility. Volatility is next to useless as a measure of risk for investors allocating money to prospective investments. How can the risk of an asset be assessed without reference to the value of that asset? It can't. And volatility takes no account of this. To rely on it as your compass is forcing investors to be completely valuation indifferent. Bonds are high risk in the context of the their valuation, but low risk according to the flawed measure of risk the finance industry uses.

 

[Rory Gillen]

Warren Buffett once asked whether a parcel of land that had just declined in value by 50% - which meant volatility had risen - was more or less risky? He went on to say that common sense tells you that it is less risky, and that volatility has nothing to do with risk.

No one is arguing that you have to put all your eggs in the Irish commercial property basket. But the value proposition is a good deal better than in the mid-2000s, and it makes sense to consider it at this point in time. Each to their own in terms of percentage allocation.