Risk and return in real estate: Lessons from the listed market

Listed real estate data are a rich source of information.  But how can it be use to analyse risk and return in the broader real estate market?  

14th December 2015

Listed real estate data are a rich source of information for direct real estate markets.  This article examines how listed real estate data can be used in an analysis of risk and return in the broader real estate market.

Continue to the other two articles in this edition of Global Outlook.

Positive economic outlook but divergence continues.

The global economy has continued to grow at a steady but underwhelming pace through 2015. What are the expectations for 2016? Graham Parry, Group Research Director, Grosvenor Group, shares his views. Click here to read more. 

European urban retail investment has been increasing, what is driving investors' interest? 

Urban retail is a sector that is expected to fare well in Europe over the long term. In this month's 'Questions & Answers', Simon Chinn, Research Analyst, Grosvenor Group, explains why. Click here to read more. 

Risk and return in property

Several key real estate markets have witnessed a strong recovery over the past five years.  In many markets, property yields are now close to or even below their all-time lows.  With the US widely expected to raise interest rates in December, investors are questioning whether current pricing still represents fair value or whether there has been an increase in property sector risk.

Given the uncertainty over the current stage of the cycle, timely measures of market conditions are more important than ever for property investors. Unfortunately, property is an illiquid and data-poor asset class, making real-time risk measurement difficult.  Appraisal-based valuations are a smoothed, lagging reflection of market conditions and individual property assets are much more idiosyncratic than traditional equity and fixed income investments.  The time lag between measurement, compilation, and delivery of real estate data can reduce the value of even the most current data when the market is moving fast.

One potential answer is to use listed property stocks to gain insights into emerging real estate sector risks. Listed real estate equity data are free from many of the shortcomings of those in the direct market. Listed real estate trades in real time, is actively priced, and is less idiosyncratic as an investment compared with direct property. While listed real estate is subject to greater short-term volatility than direct property, over the longer-run listed real estate returns are closely related to direct real estate returns*.

In addition, there is some empirical evidence that the listed sector data leads direct real estate, by between six and 24 months. Thus, listed real estate offers a potential way to measure real-time risk and required returns in direct property.

Listed real estate betas as a risk-return measure

One tool for measuring sector risk is to look at the equity beta of companies in that sector.  The equity beta is a measure of how volatile the returns on a specific company or sector are relative to the equity market as a whole. A beta of 1 indicates that the asset’s returns are identical to the market’s returns, while a beta greater than 1 means that the asset’s returns are more volatile than returns on the market as a whole.  Because it is a measure of sector specific risk, beta is also a key component of an investor’s required returns.  One of the fundamental assumptions of the capital asset pricing model (CAPM) is that the required return on any asset depends on that asset’s beta.  Thus, an asset with a higher beta (i.e. higher risk) warrants a higher required return by investors.

What drives property betas?

Betas tend to move through time and are ultimately a reflection of the underlying uncertainty in the cash flows of individual property companies in the sector. There are several broad factors that determine riskiness in the real estate sector:

  • One of the primary drivers of risk of cash flow to equity is the loan-to-value (LTV) ratio.  This is due to the amplifying effect of leverage on returns, both gains and losses. Another feature of debt financing that accentuates risk is debt covenants.  If underlying cash flows fall significantly, investors could be required to sell asset and monetise the equity value of property early to avoid violating their covenants.
  • Development exposure is another driver of beta.  Property development requires large up-front expenditure without immediate returns, sometimes for several years.  Market conditions can change dramatically over the development cycle.  Together these features of development increase the range of uncertainty over future cash flows and elevate beta.
  • Finally, the transparency and accessibility of a real estate market partly determines beta.  The more opaque and closed the market, the more uncertainty over future cash flows and the higher the risk, required returns, and beta.  Prevailing legal, regulatory, and data conditions in local real estate markets are important here.

What have property betas done historically?

To understand what betas are now telling us about the current real estate market, it is worth reviewing the recent performance of global property stocks.  Following their debt-fuelled bull run through the mid-2000s, many real estate equity indices have still not recovered from the correction that accompanied the financial crisis (Chart 1).  Indeed, the only countries where listed property returns have surpassed their previous peak are in Canada, France, and the US.

The scars from the property market crash are still reflected in today’s betas.  Chart 2 shows the average betas across a sample of regions broken down by time period.  As can be seen, prior to the 2003-7 global debt binge, listed property had been a relatively low-beta asset class.  On average betas were significantly lower than 1, indicating that listed real estate returns were less volatile than returns on the broader equity market.  Over this period, leverage was relatively conservative and listed real estate were essentially cash flow pass-through vehicles, focussed on collecting and distributing rents.

Betas started to trend upwards in the mid-2000s as listed real estate vehicles took on increasing leverage to enhance returns, with betas peaking at between 1.4 to 1.9 — indicating the listed real estate returns were between 40% to 90% more volatile than global equity returns — during the crisis and remained there for the next several years.


Betas started to come down materially first in the US.  This reflects that US companies as a whole deleveraged quickly and the US economy began its recovery ahead of other developed markets.  Betas in the UK and the Eurozone remained high throughout the sovereign debt crisis period of 2010-2012.  In the UK, the beta began to trend downward in late 2013 as the broader economy began to turn the corner.  More recently, betas in the Eurozone have been falling in light of the recovery of embattled peripheral Eurozone countries and the ECB’s QE programme.  Across the regions, listed real estate betas are below 1 again.  Still, none have returned to their pre-crisis levels yet, with the US being the closest.


On the surface, the message from the listed sector is that property has de-risked.  Much of this has been driven by de-levering since the financial crisis.  Although it is too early to say so definitively, property could be returning to being a relatively low risk, low beta asset class.

As risk and beta have fallen, so have required returns to equity in real estate, all else equal.  At current levels of government bond yields and assuming a risk premium of 5%, today’s betas imply required returns on real estate investment varying between 5% and 7% in major developed markets.  In this return environment, investors should not expect to enjoy high returns simply by following the market.  Going forward, higher returns will depend on investment-specific outperformance (or “alpha”).  This means more emphasis on asset and sub-sector selection going forward.

One potential shortcoming of beta analysis stems from the fact that LTVs are pro-cyclical and mask a build-up in risk if asset values are in a bubble, artificially reducing LTVs**.   This problem is even more acute in a QE world; one of the ways QE works is to stimulate the economy by increasing asset prices.  So while beta is a more timely measure of risk in real estate markets, it can be biased if assets are overpriced.  But with existing data, it is difficult to identify the impact of debt versus asset values in LTV movements.  This reinforces the need for better aggregate data on commercial real estate debt, something the Bank of England has acknowledged and started developing for the UK.  Once available,
this information will improve the use of beta as a real-time risk indicator.

*See the April 2015 Global Outlook article “Investing in real estate equities – can the market volatility be mitigated?”.

**Investment Property Forum (2014) “A Vision for Real Estate Finance in the UK”.  Debt coverage ratios, such as net debt to EBITDA, can be used instead but also suffer from pro-cyclicality, albeit to a lesser degree than LTV.

View all Grosvenor contacts

Grosvenor Europe Disclaimer

Use of this Grosvenor Europe section of the grosvenor.com website (the “Grosvenor Europe Website”) is subject to the following terms and legal notices (“Conditions”).  You are being asked to agree to these Conditions because:  (a) you are accessing the Grosvenor Europe Website for the first time or (b) you are accessing the Grosvenor Europe Website from a different section of the grosvenor.com website.

The information in the Grosvenor Europe Website was prepared by Grosvenor Europe only for, and is directed only at, the limited categories of persons described under “LEGAL NOTICES” below.  The information in this Grosvenor Europe Website is not intended for the use of and should not be relied on by any other person.

Grosvenor Europe Limited is registered in England, with Company Number 04056191 and its registered office at 70 Grosvenor Street, London W1K 3JP.
This Grosvenor Europe Website contains general information about Grosvenor Europe and related entities and is intended for informational purposes only. The information contained on this Grosvenor Europe Website is not an offer to sell or a solicitation of an offer to purchase interests in any fund managed by Grosvenor Europe or a related entity, nor  is it intended to provide, and should not be relied on for, investment, tax, legal or financial advice.  Investors should seek applicable professional advice for their particular situation.  The information contained herein is a summary only, is not complete, and does not include certain material information, including potential conflicts of interest and risks associated with an investment with Grosvenor Europe and its related entities.

No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in the enclosed materials, including hyperlinks or references to other sites, by Grosvenor Europe or its related entities, and no liability is accepted by such persons for the accuracy or completeness of any such information or opinions, to the fullest extent permissible by applicable law.  Users are responsible for evaluating the adequacy, accuracy, reliability, merchantability, non-infringement, and/or completeness of any information or the content available on this Grosvenor Europe Website or fitness for any particular purpose with respect to this Grosvenor Europe Website or any of its content.  The estimates, strategies, and views expressed herein are based upon past or current market conditions and/or data and information provided by unaffiliated third parties (which has not been independently verified) and is subject to change without notice. An investment with Grosvenor Europe is speculative and contains significant risks, including the risk of loss of some or all of an investment, and is intended only for sophisticated investors who meet certain eligibility criteria.  Such investments are not deposits or obligations of, or guaranteed or endorsed by, any bank and are not insured or guaranteed by any government or any other agency.


Information displayed on this Grosvenor Europe Website may contain material that is interpreted as a financial promotion for purposes of the Financial Services and Markets Act 2000 of the United Kingdom (the “FSMA”).  Grosvenor Europe is not an authorised person for purposes of the FSMA, and accordingly, the communication of information on this Grosvenor Europe Website is provided only for and is directed only at persons in the UK reasonably believed to be of a kind to whom such promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”).  Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion.  Any investment opportunities mentioned in this Grosvenor Europe Website are available only to such persons, and persons of any other description in the UK may not rely on the information in it.  Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.

Grosvenor Europe is established in the United Kingdom, which is a member state of the European Economic Area (the “EEA”).  Accordingly, this Grosvenor Europe Website is issued by Grosvenor Europe to the categories of persons described in the paragraph above that are both resident in and accessing this Grosvenor Europe Website from any member state of the EEA in reliance on its rights under the Directive on Electronic Commerce (2000/31/EC).  The member states of the EEA are:  Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, Sweden and the United Kingdom.

If you are not resident in an EEA member state or you are viewing this Grosvenor Europe Website in a country that is not an EEA member state, information displayed on this Grosvenor Europe Website contains material that may be interpreted by the relevant authorities in the country from which you are viewing the Grosvenor Europe Website as a financial promotion or an offer to purchase securities. Accordingly, the information on this Grosvenor Europe Website is only intended to be viewed by persons who fall outside the scope of any law that seeks to regulate financial promotions in your country of residence or in the country in which the Grosvenor Europe Website is being viewed. Examples of such persons may be governmental agencies, persons sufficiently experienced in investment business to appreciate the risks associated with investment services promoted on this Grosvenor Europe Website, large corporations and trusts and high net worth individuals. These examples are not country specific, may not be relevant to the country in which the Grosvenor Europe Website is being viewed and are provided for illustration purposes only. If you are uncertain about your position under the laws of your country of residence or the country in which the Grosvenor Europe Website is being viewed then you should consult your legal adviser.

Notice to Persons in the United States:

With respect to U.S. investors, investments in funds managed by Grosvenor Europe or a related entity are restricted to institutional investors who meet certain eligibility requirements.  Any potential investor should satisfy him or herself that an investment in any product of Grosvenor Europe or a related entity is permissible under the rules and regulations of his or her domicile.  This Grosvenor Europe Website is not directed to any person in any jurisdiction where the publication or availability of this Grosvenor Europe Website is or would be prohibited.


The related entities of Grosvenor Europe include Grosvenor Investment Management Limited, which is registered in England (Company Number 02774291) with its registered office at 70 Grosvenor Street, London W1K 3JP and which is authorised and regulated by the Financial Conduct Authority.

By ACCEPTING this disclaimer, you consent to the above Conditions and, in particular, you confirm that either:

(a)     you are resident in and accessing this Grosvenor Europe Website from one of the United Kingdom or another member state of the EEA and you qualify as an exempt category of person under the FPO (such as an Investment Professional or High Net Worth Business, as described under “LEGAL NOTICES” above); or

(b)     you fall outside the scope of any law that seeks to regulate financial promotions both in the country of your residence and in the country in which you are viewing this Grosvenor Europe Website, and therefore by accessing this Grosvenor Europe Website you will not contravene or cause Grosvenor to contravene any such law.