PROPERTY PORTFOLIO CONSTRUCTION USING THE MARKET MODEL

Abstract

Modern portfolio theory, which revolutionalised the traditional approach of investment management, is concerned with the classification, estimation, and control of the sources of investment risk and return. Since its inception, the theory has undergone major breakthrough in its implementation. It is now easily understandable through the use of simple computational procedure. The amount and types of inputs needed to solve portfolio problem have also been greatly reduced. The goal of this dissertation is to evaluate the applicability of portfolio theory in real estate investment. It describes the basis of the theory which includes: (1) the classification, estimation and measurement of the risk and expected return; (2) the establishment of risk-return relationship through Sharpe's single index model and its use in forecasting the future performance of the investment; (3) the formation of optimal portfolio by adopting a suitable criterion to include or exclude an investment in the portfolio; (4) the calculation of percentage investment for each asset in the portfolio; (5) the delineation of the efficient frontier, which is a set of efficient portfolios with different risk-return tradeoff; and (6) the description of rational investment decision making to maximise an investor's utility. A case study of real estate investment portfolio is done based on the single index model. The results show firstly, the model can be used to explain significantly the risk return relationship of the investment, and secondly real estate investments have a high proportion of unsystematic risk which makes them attractive to be part of a portfolio. However, it must be qualified that this study is not without its setbacks and limitations, the major ones being the reliability of the data and the samples of the property used.