Homogeneous Commercial Property Market Groupings and Portfolio Construction in the United Kingdom

Abstract

Property portfolios are traditionally constructed by diversifying across geographical areas, property types, or a combination of both. In the United Kingdom it is normal practice to use regions rather than towns or local market areas as the geographical divisions. The authors use cluster analysis to construct homogeneous groups from 157 UK local markets, by means of commercial property returns. The results show strong property-type dimensions and only very broad geographical dimensions in the clusters. These clusters are found, in general, to have temporal stability with changes in cluster membership being explained by the changing economic geography of the United Kingdom. The cluster-derived groupings are used to derive efficient investment frontiers and are compared with frontiers based on conventional heuristic groupings. It is shown that strategies based on parsimonious cluster-based groupings, appropriate for smaller investors, generate results that are comparable with those of conventional groupings and capture the main drivers of property performance.

Distance and diversification

“…The first approach is based on geographical (urban) areas while the second approach is based on the economic function of cities or spatial areas. Of the two approaches the consensus among academics is that real estate diversification strategies based on economic structure have achieved better diversification benefits than strategies based on geographical classification (see inter alia, Lee and Byrne, 1998;Hamelink, et al, 2000;Veizer, 2000 andKatzler, 2005 for extensive reviews).…”

“…Lastly, we examine the rental growth correlation coefficients between the City of London office market and 27 Local Authorities (LAs) in the UK, rather than for pairs of cities, as it is well known that institutional investors, insurance companies and pension funds, have a bias towards the City of London office market (see inter alia, Cullen, 1993;Hoesli et al, 1997;Hamelink et al, 2000;Henneberry et al, 2004;Andrew et al, 2005;andLee, 2006 andByrne et al, 2013). At least three reasons exist for this focus by institutional investors on the City of London office market.…”

Bias or rationality? The case of UK commercial real estate investment

“…The metrics used are Ward's method of clustering and the squared Euclidian distance measure, seeking to maximise both within-cluster homogeneity in area characteristics and between-cluster heterogeneity. These metrics replicate those used to cluster local property markets, proxied by Local Authority (LA) areas, in studies by Jackson (2002) and Jackson and White (2005a, b) and, in part, Hamelink et al (2000) who use Ward's method as the amalgamation rule. The method of analysis begins with 432 separate clusters (each comprising one LA area) and ends with one cluster containing all 432 areas.…”

“…In terms of the total UK direct property market, it was estimated at the end of 2003 (the date of the empirical data utilised in this study) that the capital value of the commercial property market was £611 billion, with 80 percent (£489 billion) in the largest retail, office and industrial sectors (Key and Law, 2005 Hamelink et al, 2000;Jackson, 2002;and Lee and Byrne, 1998, in the UK, the latter also using local economic fundamentals) and local economic characteristics. In the US similar studies are found in Hartzell et al, 1986Hartzell et al, , 1987Malizia and Simons, 1991;Mueller and Ziering, 1992;Mueller, 1993;Goetzmann and Wachter, 1995;and Ziering and Hess, 1995.…”

The impact of real estate portfolio composition on the Italian real estate funds performance

“…According to the results of numerous studies, the general consensus is that property type diversification is preferable to geographical diversification in terms of risk reduction (Viezer, 2000 andHamelink et al, 2000) There are several studies of regional and sectorial diversification in literature, such as Eichholtz et al(1995) who have analyzed data from the USA and UK to determine whether diversification within a region by property-type is better than diversification between regions within a property type, using a set of methods including correlation analysis and mean-variance analysis. The choice of diversification at sectorial or geographical level varies in relation to both the market studied, and the type of property considered.…”