REAL ESTATE PORTFOLIO DIVERSIFICATION BY SOURCES OF RETURN

Abstract

Traditionally, real estate diversification strategies have focused on diversification by type, region (geographic or economic) or various combinations of them. Williams (1995) was the first to demonstrate that diversification by sources of return, with regards to operating and reversion income can produce a more diversified portfolio. He provides a new dimension to real estate diversification strategies. Various studies have then been carried out to ascertain if diversification by sources of return can improve portfolio performance (see Pua, 1998; ser 1999; Addae-Dapaah et al. 2002) However, their studies were founded on Williams' study and focused on diversifying by balancing the rental and capital income of a portfolio. In the finance literature, contrarian investment strategy has shown that value stock can outperform growth stock. In the context of real estate literature it implies that value properties might outperform growth properties. Value properties are akin to high income producing properties and growth properties can be thought of as properties with relatively low initial yield. Growth properties have high capital appreciation and are favored by investors traditionally. With regards to diversification by sources of return and the contrarian investment strategy that high income producing properties can outperform growth properties, this study seeks to examine if diversification by rental source can improve portfolio performance. An empirical case study was carried out to examine if real estate portfolio diversification by rental is superior to total return in 7 cities of the Asia Pacific region over the period Q1 1993 through Q4 2001. It is observed that real estate diversification by rental return is superior to total return, offering better risk-return benefits.