Defining the three Rs of commercial property market performance. Return, risk and ruin
| DOI | https://doi.org/10.1108/JPIF-08-2014-0054 |
| Date | 07 September 2015 |
| Pages | 481-493 |
| Published date | 07 September 2015 |
| Author | David Higgins |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
Defining the three Rs
of commercial property
market performance
Return, risk and ruin
David Higgins
School of Property Construction and Project Management,
RMIT University, Melbourne, Australia
Abstract
Purpose –Modern property investment allocation techniques are typically based on recognised
measures of return and risk.Whilst these models work well in theory under stable conditions, they can
fail when stable assumptions cease to hold and extreme volatilityoccurs. This is evident in commercial
property marketswhich can experience extended stableperiods followed by large concentratednegative
price fluctuations as a result of major unpredictable events. This extreme volatility may not be fully
reflected in traditional risk calculations and can lead to ruin.The paper aims to discuss these issues.
Design/methodology/approach –This research studies 28 years of quarterly Australian direct
commercial property market performance data for normal distribution features and signs of extreme
downside risk. For the extreme values, Power Law distribution models were examined as to provide a
better probability measure of large negative price fluctuations.
Findings –The results show that the normal bell curve distribution underestimated actual extreme
values both by frequency and extent, being by at least 30 per cent for the outermost data point. For the
statistical outliers beyond 2 SD, a Power Law distribution can overcome many of the shortcomings of
the standard deviation approach and therefore better measure the probability of ruin, being extreme
downside risk.
Practical implications –In highlighting the challenges to measuring property market performance,
analysis of extreme downside risk should be separated from traditional standard deviation risk
calculations. In recognising these two different types of risk, extreme downside risk has a magnified
domino effect with the tendency of bad news to come in crowds. Big price changes can lead to market
crashes and financial ruin which is well beyond the standard deviation risk measure. This needs to be
recognised and developed as there is evidence that extreme downside risk determinants are increasing
by magnitude, frequency and impact.
Originality/value –Analysisof extreme downside riskshould form a key part ofthe property decision
process and be included in the property investment manager’s toolkit. Modelling techniques for estimating
measures of tail risk provide challenges and have shown to be beyond traditional risk management
practices, being too narrow and constraining a definition. Measuring extreme risk and the likelihood of
ruin is the first step in analysing and dealing with risk in both an asset class and portfolio context.
Keywords Desmoothed commercial property data, Extreme financial risk, Power law distribution,
Property market performance, Standard deviation, Unexpected events
Paper type Conceptual paper
1. Introduction
As part of the capital markets, the performance of commercial property is principally
measured by recognised mathematical models of return (mean) and risk (standard
deviation). These statistical approaches provide the backbone for the banking and Journal of Property Investment &
Finance
Vol. 33 No. 6, 2015
pp. 481-493
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-08-2014-0054
Received 18 August 2014
Revised15February2015
Accepted 28 May 2015
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
The author is grateful to Michael Cohen, pure mathematician, for his contribution and insights
into the unorthodox theory of fractal geometry and tests for probability.
481
Three Rs of
commercial
property
market
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