When to Own Real Estate -- And When Not to Own It
Another vexing topic tackled by Portfolio Alliance researchers was how to assess property and other real estate asset value so as to determine what stays in the portfolio and what does not. Just as important to the portfolio management function is determining whether to own real estate at all and if so, how much to own. Dr. Joseph Gyourko, professor of real estate and finance and director of the Zell/Lurie Real Estate Center at Wharton School of Business at the Univ. of Pennsylvania, and Dr. Youghen Deng, who is now a professor at the Univ. of Southern California, turned to Wall Street to research whether firms that owned more than average amounts of real estate had lower returns over a 10-year holding period.

"The answer is, yes they did," says Gyourko. "How much less? If you owned a lot more real estate than your competitors over a 10-year holding period, then you had between a 5 and 10 percent lower total return over the 10 years. It was statistically significant, and I consider that difference economically significant, too."

Corporate participants had a range of opinion surrounding the appropriate amount of real estate to own, and the ideal amount to own vs. lease depends on too many factors for the academics to suggest one rate. "All regression results are for average effects, and not all firms are near the mean," Gyourko points out. "So I can believe that in some industries owning a lot of real estate is not a problem. But for the average, I consider the result pretty robust. It is important to note that this result does not say owning real estate per se is bad. It says owning more than average is harmful -- harmful in the sense that there really is a penalty in the capital markets."

Gyourko emphasizes that the result applies primarily to risky, high-cost-of-capital firms. By risky Gyourko means a company's cash flow is very positively tied to the business cycle. The company's fortunes do well sometimes and poorly at other times. Consequently, such companies' demands for real estate vary over the course of the cycle. If risky firms own too much real estate, they are committing scarce corporate capital to a very fixed, long-lived asset, or real property. At times, the firm will need that capital for other purposes, but it's tied up in real estate.

"The return penalty exists for these firms because they can't get out of real estate quickly enough to take advantage of a business opportunity," Gyourko explains. "In finance, it's called a poor duration match with their business needs."

Kevin Deeble, TITLE at TriNet Corporate Realty Trust, constructed a new approach to looking at the own versus lease issue, and concluded that "Should we own or lease?" is the wrong question to ask. The real issue is one of matching durations and whether corporations should be in the business of making real estate bets. (Deeble's thinking on this issue and corporate Portfolio Alliance members' insights will be covered in a future issue of Site Selection.)