While we normally do not stray far from the stock market, an article on the forecasting ability of commercial real estate gurus relates strongly to our ongoing investigation of investing expertise. Do these experts add value for investors in the relatively illiquid real estate market? In his 2005 paper entitled “A Random Walk Down Main Street: Can Experts Predict Returns on Commercial Real Estate?” David Ling examines the ability of institutional owners and managers to predict commercial real estate investment performance for various property types across major metropolitan markets. Using (1) predicted relative property returns (desirability rankings) for nine property types and 16 metropolitan markets from the Real Estate Research Corporation’s (RERC) quarterly Real Estate Investment Survey over a thirteen-year period and (2) corresponding National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index returns, he concludes that:
- There is no evidence that consensus opinions on real estate conditions are useful in forecasting subsequent commercial property investment returns. Contrarian investment strategies are at least as likely to outperform as consensus strategies.
- Real estate expert survey results are backward looking. The average correlation between current quarter investment desirability rankings and returns in the prior two years is 0.39. However, there is considerable variation in backward-looking correlations, and these correlations drift downward in recent years.
- There is no positive correlation between consensus expert predictions and actual returns across the nine property types (see table below). Portfolios of high-ranked property types do not outperform portfolios of low-ranked property types.
- There appears to be no correlation between consensus expert predictions and actual returns across the 16 metropolitan markets. There is some weak evidence that portfolios focused on high-ranked metropolitan areas outperform portfolios focused on low-ranked areas, although there is a substantial variation in results. Moreover, quarterly portfolio rebalancing costs would eliminate the small outperformance of high-ranked portfolios.
- Real estate investors should not depend on consensus expert forecasts of commercial property desirability by property type or metropolitan area in making investment decisions.
The following table, taken from the paper, is representative of results. It shows the correlations between surveyed desirability rankings and actual returns across the nine commercial property types for four, six, eight, and ten-year holding periods. The average for all forecasts and all holding periods is -0.22. Results demonstrate that there is no positive correlation between the consensus predictions of survey respondents and the actual returns across the nine property types. A similar table in the paper presents correlations for desirability rankings and actual returns across 16 metropolitan areas.
In summary, it is doubtful that commercial real estate experts can accurately forecast returns from investments in commercial properties by type or location.
