The Right Tool: How Suitable is Your Real Estate Benchmark?

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Amit Nihalani

Amit Nihalani
Vice President, Global Real Estate Research

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The Right Tool: How Suitable is Your Real Estate Benchmark?

THE RIGHT TOOL: HOW SUITABLE IS YOUR REAL ESTATE BENCHMARK?

 

You don’t have to be a master craftsman to appreciate the benefits of using the right tool for the job. Even the most casual do-it-yourselfer has experienced the frustration of using the wrong screwdriver for a particular job — one that doesn’t quite fit the screw properly and shreds the head, leaving it uselessly stuck in the wood without fixing anything.

As with tools, so with real estate benchmarks. Due to the heterogeneity of the asset class and the way strategies for investing in property vary widely, finding the right benchmark for different portfolios can be a major challenge. In a recent paper, we highlighted the importance of having an appropriate benchmark.1 Depending on the nature of the investing entity and its investment objective, there are a range of potential benchmarks that can serve different purposes. One of the many distinctions between some of these benchmarks is the difference between a broad-market benchmark versus a more focused peer-group benchmark.

 

A EUROPEAN EXAMPLE

Broad-market benchmarks can represent an investor’s full opportunity set and provide a better understanding of a portfolio’s position against broad market movements. For example, the MSCI European Property Index measures aggregated asset-level performance across the whole region. This benchmark may be most useful for relatively unconstrained investors who can invest directly in assets.

For those investors without the capacity to invest directly, a fund-level benchmark may be more appropriate. Nonetheless, a broad index composed of pooled funds only (rather than assets in segregated mandates or held directly by investors) may be more relevant. For investors who require core, open-ended exposure with quarterly reporting, the European sleeve of the MSCI Global Property Fund Index has more restrictive inclusion rules. Investors hoping to carve out their European fund exposure by selecting a number of country- and/or sector-focused vehicles may find such benchmarks useful for understanding the impact of their choices versus the fund opportunity set. They may benefit more from using this benchmark as part of a broader framework, alongside more focused benchmarks that reflect the narrower set of countries and sectors they have strategically chosen to invest in, as well as a suite of benchmarks aligned with the strategy of each individual invested fund.

Other investors may choose a less resource-intensive approach and seek a single provider to measure the performance of their European exposure. The MSCI Pan European Property Fund Index (PEPFI) can provide a more focused peer-group analysis by further limiting inclusion to funds with an intended strategy of investing in at least three different regions within Europe. Although PEPFI is smaller and narrower in scope than a broad-market benchmark, it provides greater alignment with the strategy in question. Comparing the invested portfolio with this benchmark can provide insight into the funds’ performance given the choice of investing in pan-regional funds. Further, comparing the portfolio and the PEPFI benchmark to a broader European benchmark can illustrate the impact of choosing a single pan-European fund versus other routes for their European exposure.

 

EUROPEAN INDEXES — FROM BROAD-MARKET TO FOCUSED PEER-GROUP BENCHMARKS 
EUROPEAN INDEXES — FROM BROAD-MARKET TO FOCUSED PEER-GROUP BENCHMARKS

The full names of the indexes in the exhibit are the MSCI Europe Annual Property Index, MSCI Global Quarterly Property Fund Index and MSCI Pan-European PFI Funds Quarterly Property Index.

 

A similar logic works in the U.S. with broad-market benchmarks and a more focused peer-group benchmark such as the MSCI Core, Diversified Open-End Funds Index (ACOE). The ACOE is limited to funds adhering to the strict rules of inclusion on a consistent basis, with an internal governance body maintaining observance. Further, quarterly results are verified by an internal data team and reported to managers for their sign-off. The ACOE’s rules of inclusion subsequently distinguish between core and noncore funds.

 

US INDEXES — FROM BROAD-MARKET TO FOCUSED PEER-GROUP BENCHMARKS  
US INDEXES — FROM BROAD-MARKET TO FOCUSED PEER-GROUP BENCHMARKS

The full names of the indexes in the exhibit are the MSCI U.S. Annual Property Index, MSCI U.S. Quarterly Property Index, MSCI/PREA U.S. AFOE Quarterly Property Index and MSCI/PREA U.S. ACOE Quarterly Property Index.

 

CHOOSING THE RIGHT TOOL FOR EACH BENCHMARKING JOB

Real estate portfolios vary widely along a number of dimensions, depending on the nature and objectives of the investing entities. However, all real estate portfolios result from an investment process, which starts from a broad allocation to real estate and ends with individual investment decisions and an invested portfolio. Benchmarks help investors understand the impact of each individual investment decision. To be useful, benchmarks must align with investors’ characteristics and objectives and help provide the analytical insight needed at each stage of the investment process. Strong governance and robust inclusion rules may be considered particularly important for peer-group benchmarks by investors. Investors benchmarking their real estate portfolios may want to consider whether they have the right tool for the job.

 

 

1Robson, W. and B. Reid. (2018). “Benchmarking in Private Real Estate: Beyond Performance Measurement.” MSCI Research Insight.

 

 

Further Reading

MSCI Real Estate

Benchmarking in Real Estate: Beyond Performance Measurement