London / Paris: Diversification Benefits through Intracity Diversification

London / Paris: Diversification Benefits through Intracity Diversification

Florian Heydenreich, Daniel Kohlert and Andreas OehlerBamberg University, GermanyChair of Finance

ERES conference 200924th – 27th of July

Stockholm

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(1) Introduction

Researchers have made great efforts to refine real estate portfolio

diversification strategies under risk-return considerations.

Within geographic diversification, risk reduction can be achieved

through different strategies. (e.g. international, national, regional)

Only few studies have examined benefits of intracity diversification.

Real estate markets are local markets and assets in local submarkets

of a city may behave differently than the city in which they exist.

We examine intracity diversification opportunities for two of the most

important real estate investment markets in Europe, London and Paris.

Heydenreich, Kohlert, Oehler


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(2) Data and Methodology

DataIPD Investment Property DatabankAnnual Total return data for office buildings London: Return information for eight central postcode

districts Time period covered: 1981-2006 Paris: Return information for eleven submarkets Time period covered: 1998-2006



MethodologyMean-variance efficiency theory is used to analyze risk-return optimization opportunities through intracity diversification for both cities.

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London Office Total Return Statistics 1981-2006

Paris Office Total Return Statistics 1998-2006



(3) Results: Descriptives

Øρ = 0,92, Øµ = 11,30%, Øσ= 13,36%

Øρ = 0,82, Øµ = 12,10%, Øσ = 6,60%

EC1 EC2 EC3 EC4 WC1 WC2 W1 SW1Mean 10,94% 10,39% 9,46% 10,70% 12,77% 11,43% 12,33% 12,41%Std. Dev. 13,42% 11,92% 12,07% 12,19% 14,57% 14,45% 14,47% 13,82%

1e 2e 7e 8e 9e 10eMean 11,63% 11,28% 11,91% 12,00% 11,27% 11,31%Std. Dev. 6,23% 5,14% 5,00% 5,94% 7,15% 6,64%

12e 15e 16e 17e 19eMean 13,91% 11,22% 12,91% 12,47% 13,22%Std. Dev. 6,29% 5,54% 7,54% 9,02% 8,05%

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(3) Results: London 1981-2006

Efficient frontier:



Risk-return characteristics can be improved by intracity diversification.

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(3) Results: Paris 1998-2006

Efficient frontier:



Strong diversification benefits through optimally weighting the districts.

Benefits of well structured diversification strategy become more visible.

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(3) Results: London / Paris 1998-2006

Efficient frontier:



Combining the submarkets of both cities lead to much better risk

adjusted returns than the one-city strategies.

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(4) Conclusion

Intracity diversification can reduce unsystematic risk.

Portfolio managers, concentrating their investments in fewer markets,

benefit from reduced information and management costs.

Further research on the topic of intracity diversification: Other time periods, cities and property types should be

covered, as allthree variables may have important influences on the

obtainablediversification benefits.



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Thank you

for your

comments!



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References

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Return Information

London Office Total Return Statistics 1981-2006



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Return Information

Paris Office Total Return Statistics 1998-2006



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London and Paris Submarket Overview

London Postcode Areas & Districts Districts of Paris

Data available for the following submarkets:

EC 1-4 (East Central), WC 1-2 (West Central), 1, 2, 7-10, 12, 15-17 and 19

SW 1 (South West) and W 1 (West)



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London submarkets

London postal areas

East London (E)East Central London (EC)North West London (NW)South West London (SW)West London (W)North London (N)South East London (SE)West Central London (WC)



Relevant London postal districts

EC 1EC 2EC 3EC 4SW 1

W 1

WC 1WC 2

Clerkenwell, Finsbury, Barbican area North eastern area of The City South eastern area of The City Western area of The City Westminster, Belgravia, Pimlico,

Victoria area West End, including Mayfair, Soho

and south Marylebone Bloomsbury & Gray's Inn areaHolborn / Strand / Covent Garden

area

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Paris submarkets



Submarket Name Submarket Name

1 Louvre 11 Popincourt

2 Bourse 12 Reuilly

3 Temple 13 Gobelins

4 Hôtel-de-Ville 14 Observatoire

5 Panthéon 15 Vaugirard

6 Luxembourg 16 Passy

7 Palais-Bourbon 17 Batignolles-Monceau

8 Élysée 18 Butte-Montmartre

9 Opéra 19 Buttes-Chaumont

10 Enclos-St-Laurent 20 Ménilmontant

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Correlation Analysis

London submarkets – Correlation coefficients (1981-2006)



EC1 EC2 EC3 EC4 WC1 WC2 W1 SW1

EC1 1,00

EC2 0,92 1,00

EC3 0,91 0,97 1,00

EC4 0,92 0,96 0,99 1,00

WC1 0,94 0,81 0,82 0,85 1,00

WC2 0,95 0,91 0,91 0,92 0,96 1,00

W1 0,95 0,89 0,89 0,91 0,96 0,99 1,00

SW1 0,93 0,85 0,88 0,90 0,96 0,97 0,97 1,00

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Efficient frontier

London – Percentage allocation of submarkets



Portf. Return 10,19% 10,25% 10,50% 10,75% 11,00% 11,25% 11,50% 11,75% 12,00% 12,25% 12,50% 12,75% 12,77%

Portf. Std. Dev. 11,77% 11,77% 11,79% 11,84% 11,93% 12,09% 12,31% 12,59% 12,92% 13,31% 13,76% 14,48% 14,57%

Districts Percentage Allocation

EC1

EC2 53,19% 53,97% 57,38% 59,97% 53,79% 47,62% 41,44% 35,26% 25,85% 14,65% 3,44%

EC3 28,53% 25,47% 12,15%

EC4 17,61% 18,60% 22,89% 26,40% 20,34% 14,28% 8,23% 2,17%

WC1 1,25% 7,18% 13,10% 19,03% 24,96% 31,22% 37,67% 44,12% 94,47% 100,00%

WC2

W1

SW1 0,67% 1,96% 7,58% 12,38% 18,69% 24,99% 31,30% 37,61% 42,93% 47,68% 52,44% 5,53%

No entry: District not relevant in the calculation of the efficient frontier.

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Paris submarkets – Correlation coefficients (1998-2006)



1e 2e 7e 8e 9e 10e 12e 15e 16e 17e 19e

1e 1,00

2e 0,72 1,00

7e 0,79 0,68 1,00

8e 0,93 0,91 0,83 1,00

9e 0,87 0,95 0,76 0,96 1,00

10e 0,89 0,87 0,72 0,93 0,92 1,00

12e 0,86 0,79 0,65 0,88 0,90 0,81 1,00

15e 0,86 0,83 0,69 0,92 0,93 0,87 0,87 1,00

16e 0,72 0,80 0,48 0,81 0,85 0,72 0,95 0,84 1,00

17e 0,67 0,89 0,66 0,83 0,92 0,72 0,85 0,85 0,86 1,00

19e 0,84 0,86 0,82 0,93 0,89 0,89 0,67 0,87 0,60 0,74 1,00

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Efficient frontier

Paris – Percentage allocation of submarkets



Portf. Return 11,58% 11,75% 12,00% 12,25% 12,50% 12,75% 13,00% 13,25% 13,50% 13,75% 13,91%

Portf. Std. Dev. 4,51% 4,53% 4,58% 4,65% 4,76% 4,91% 5,09% 5,34% 5,65% 6,02% 6,29%

Districts Percentage Allocation

1e

2e 37,44% 34,53% 30,87% 24,12% 15,11% 6,10%

7e 48,56% 50,21% 51,17% 51,22% 50,59% 49,96% 45,50% 33,02% 20,53% 7,05%

8e

9e

10e

12e 6,14% 15,25% 24,66% 34,30% 43,94% 54,50% 66,98% 79,47% 90,08% 100,00%

15e 14,00% 9,13% 2,71%

16e

17e

19e 2,87% No entry: District not relevant in the calculation of the efficient frontier.

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London / Paris Paris submarkets – Correlation coefficients (1998-2006)



EC1 EC2 EC3 EC4 WC1 WC2 W1 SW1 1e 2e 7e 8e 9e 10e 12e 15e 16e 17e 19e

EC1 1,00

EC2 0,92 1,00

EC3 0,91 0,97 1,00

EC4 0,89 0,97 0,99 1,00

WC1 0,96 0,95 0,93 0,90 1,00

WC2 0,94 0,97 0,97 0,96 0,96 1,00

W1 0,90 0,91 0,94 0,94 0,92 0,98 1,00

SW1 0,87 0,92 0,95 0,95 0,92 0,98 0,99 1,00

1e 0,74 0,75 0,80 0,81 0,74 0,81 0,83 0,83 1,00

2e 0,73 0,77 0,67 0,73 0,71 0,73 0,68 0,70 0,72 1,00

7e 0,72 0,84 0,88 0,87 0,81 0,88 0,87 0,92 0,79 0,68 1,00

8e 0,78 0,81 0,78 0,82 0,79 0,84 0,83 0,85 0,93 0,91 0,83 1,00

9e 0,77 0,80 0,75 0,78 0,75 0,78 0,74 0,74 0,87 0,95 0,76 0,96 1,00

10e 0,61 0,70 0,67 0,74 0,58 0,69 0,70 0,71 0,89 0,87 0,72 0,93 0,92 1,00

12e 0,75 0,74 0,69 0,68 0,73 0,74 0,71 0,68 0,86 0,79 0,65 0,88 0,90 0,81 1,00

15e 0,58 0,58 0,55 0,58 0,59 0,60 0,59 0,61 0,86 0,83 0,69 0,92 0,93 0,87 0,87 1,00

16e 0,68 0,60 0,51 0,51 0,63 0,61 0,58 0,53 0,72 0,80 0,48 0,81 0,85 0,72 0,95 0,84 1,00

17e 0,73 0,74 0,64 0,64 0,74 0,68 0,58 0,60 0,67 0,89 0,66 0,83 0,92 0,72 0,85 0,85 0,86 1,00

19e 0,66 0,70 0,70 0,77 0,67 0,72 0,74 0,78 0,84 0,86 0,82 0,93 0,89 0,89 0,67 0,87 0,60 0,74 1,00

ØρL,P = 0,72

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Efficient frontier

London / Paris Percentage allocation of submarkets



Portf. Return 11,58% 11,75% 12,25% 12,75% 13,25% 13,75% 14,25% 14,75% 15,25% 15,75% 16,00% 16,19%

Portf. Std. Dev. 4,51% 4,53% 4,65% 4,91% 5,27% 5,70% 6,19% 6,74% 7,44% 8,38% 8,92% 9,35%

Districts Percentage of allocation

EC1

EC2

EC3

EC4

WC1 7,53% 17,29% 27,06% 36,83% 58,74% 80,67% 91,64% 100,00%

WC2

W1

SW1

1e

2e 37,44% 34,52% 24,12% 6,10%

7e 48,56% 50,21% 51,22% 49,96% 41,59% 27,73% 13,88% 0,03%

8e

9e

10e

12e 6,14% 24,67% 43,94% 50,89% 54,98% 59,06% 63,15% 41,26% 19,33% 8,36%

15e 14,00% 9,13%

16e

17e

19e

London / Paris: Diversification Benefits through Intracity Diversification

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