on the pulse of the property world market segmentation and portfolio management luigi pischedda...
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On the pulse of the property world
Market segmentation and portfolio management
Luigi PischeddaDavide ManstrettaRoberto Martinez Diaz
An analysis of the Italian property market
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On the pulse of the property world
Sources: IPD
Aim of the study
Real estate investors use diversification as a risk-reducing factor when deciding their portfolios’ asset allocation.
Market segmentation is a way of determining the asset allocation which will diversify the portfolio, that is, minimise the overall risk of the portfolio at the expenses of the smallest possible reduction in returns.
The way in which market segmentation achieves this result is by grouping together assets with similar return profiles. The assets thus clustered together will show a small variance in returns within each of the segments, which will in turn differ greatly from one another, as far as performance is concerned.
IPD provides the market with a standard segmentation from which institutional investors who own one or more balanced portfolios can draw inspiration for their investment strategies.
The present study shows the explanatory power of the IPD standard segmentation with respect to the variability of returns for the Italian market, and explores a few alternative segmentations.
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The IPD Italian universe
Main sector weights as a %age of market value
44%40%
11%4%1%
0%10%20%30%40%50%60%70%80%90%
100%
2003 2004 2005 2006 2007 2008 2009
0%
10%
20%
30%
40%
50%
60%
70%
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90%
100%
2003 2004 2005 2006 2007 2008 2009
Retail Office Industrial Residential Other
As at the end of 2009, the databank included circa 1,600 properties, for a total market value of over Euro 19bn.
Traditionally, the office sector has been the main focus of institutional investors’ asset allocation.
2009 year end Since index inception
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The IPD standard segmentation for the Italian property market
Once again, a focus on the office sector
No. Segment name1 Shopping Centre2 Other Retail3 Office: Central Milan4 Office: Milan Other5 Office: Central Rome6 Office: Rome Other7 Office: NW8 Office: NE9 Office: C&S
10 Industrial11 Hospitality12 Residential13 Other
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The IPD standard segmentation for the Italian property market
Once again, a focus on the office sector
The amount of office data collected led the IPD standard segmentation to a greater breakdown for offices:
No. Segment name1 Shopping Centre2 Other Retail3 Office: Central Milan4 Office: Milan Other5 Office: Central Rome6 Office: Rome Other7 Office: NW8 Office: NE9 Office: C&S
10 Industrial11 Hospitality12 Residential13 Other
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The IPD standard segmentation for the Italian property market
Explanatory power (R2, 1yr total return)
R2 indicates the proportion of variability in returns explained by the chosen segmentation. The average R2 for the 13 segments of the standard segmentation over the 6 years considered is 9.7%.
0.0%
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4.0%
6.0%
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10.0%
12.0%
14.0%
16.0%
2003 2004 2005 2006 2007 2008
Standard
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The trade-off: explanatory power vs. complexity
Standard segmentation, minimum and maximum breakdown
We expect that increasing the number of segments the explanatory power of the segmentation increases too, and vice versa:
No. Segment name1 Shopping Centre2 Other Retail3 Office: Central Milan4 Office: Milan Other5 Office: Central Rome6 Office: Rome Other7 Office: NW8 Office: NE9 Office: C&S
10 Industrial11 Hospitality12 Residential13 Other
No. Segment name1 Shopping Centre: Large2 Shopping Centre: Medium3 Shopping Centre: Small4 Hyper/Super5 Other Retail6 Office: Central Milan7 Office: Milan Hinterland8 Office: Milan Other9 Office: Central Rome
10 Office: Rome EUR11 Office: Rome Other12 Office: NW13 Office: NE14 Office: C&S15 Distr. War. Lombardia16 Distr. War. Emilia Romagna17 Distr. War. Rest of Italy18 Light Industrial19 Other Industrial20 Hospitality21 Residential22 Other
No. Segment name1 Retail2 Office3 Industrial4 Hospitality5 Residential6 Other
But are investors ready to deal with the amount of complexity caused by an extremely detailed segmentation?
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The trade-off: explanatory power vs. complexity
Standard segmentation, minimum and maximum breakdown
The three segmentations behave as expected:
Min breakdown: average R2 = 6.3%Standard: average R2 = 9.7%Max breakdown: R2 = 18.6%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
2003 2004 2005 2006 2007 2008
Standard Max breakdown Min sector breakdown
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The trade-off: explanatory power vs. complexity
Standard segmentation, minimum and maximum breakdown
The results are confirmed using 3yrs rolling average
Min breakdown: average R2 = 10.8%Standard: average R2 = 16.5%Max breakdown: R2 = 26.9%
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15.0%
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25.0%
30.0%
35.0%
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45.0%
2003-2005 2004-2006 2005-2007 2006-2008
Standard Max breakdown Min sector breakdown
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Introducing alternative segmentations
Detailed breakdown for offices & retail and offices & industrial
What happens to the explanatory power of the segmentation if we slightly increase the number of segments?
No. Segment name1 Shopping Centre2 Other Retail3 Office: Central Milan4 Office: Milan Other5 Office: Central Rome6 Office: Rome Other7 Office: NW8 Office: NE9 Office: C&S
10 Industrial11 Hospitality12 Residential13 Other
No. Segment name1 Shopping Centre: Large2 Shopping Centre: Medium3 Shopping Centre: Small4 Hyper/Super5 Other Retail6 Office: Central Milan7 Office: Milan Hinterland8 Office: Milan Other9 Office: Central Rome
10 Office: Rome EUR11 Office: Rome Other12 Office: NW13 Office: NE14 Office: C&S15 Industrial16 Other
No. Segment name1 Retail2 Office: Central Milan3 Office: Milan Hinterland4 Office: Milan Other5 Office: Central Rome6 Office: Rome EUR7 Office: Rome Other8 Office: NW9 Office: NE
10 Office: C&S11 Distr. War. Lombardia12 Distr. War. Emilia Romagna13 Distr. War. Rest of Italy14 Light Industrial15 Other Industrial16 Other
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Introducing alternative segmentations
Detailed breakdown for offices & retail and offices & industrial
Offices & retail vs. Offices & industrial:
Standard: average R2 = 9.7%Offices & retail: R2 = 15.3%Offices & industrial: R2 = 10.3%
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15.0%
20.0%
25.0%
2003 2004 2005 2006 2007 2008
Standard Offi ces and retail Offi ces and industrial
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Introducing alternative segmentations
Detailed breakdown for offices & retail and offices & industrial
Offices & retail vs. Offices & industrial:
Standard: average R2 = 16.5%Offices & retail: R2 = 23.8%Offices & industrial: R2 = 18.7%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
2003-2005 2004-2006 2005-2007 2006-2008
Standard Offices and retail Offices and industrial
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Conclusions
IPD provides the market with a standard segmentation from which institutional investors who own one or more balanced portfolios can draw inspiration for their investment strategies.
The explanatory power of the IPD standard segmentation can be improved by adding as many as 9 segments (given the current size of the databank), but the price of explaining up to 27% of the variability in returns (R2 3yrs rolling average) is an increased complexity.
An R2 of nearly 24% (3yrs rolling average) can be achieved by a small increment in the number of segments if we consider a relatively detailed breakdown for offices and retail.
Future improvements to the study might include the geographic segmentation for the retail sector and the calculation of the probability of outperformance when stock-picking within the segments.
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On the pulse of the property world
Intellectual Property Rights and use of IPD statistics as benchmarksWhether in the public domain or otherwise, IPD's statistics are the intellectual property of Investment Property Databank Limited.It is not permissible to use data drawn from this presentation as benchmarks.
© Investment Property Databank Limited (IPD) 2008. Database Right, Investment Property Databank Limited (IPD) 2008. All rights conferred by law of copyright and by virtue of international conventions are reserved by IPD
Luigi Pischedda
IPD1 St John’s LaneLondon EC1M 4BLUnited Kingdom
Direct: +44 (0)20 7336 9303Mobile: +44 (0)20 75080 10900Fax: +44 (0)20 7336 9399Email: [email protected]
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