Property investment: gearing and portfolio returns
| DOI | https://doi.org/10.1108/JPIF-11-2020-0133 |
| Published date | 15 December 2020 |
| Date | 15 December 2020 |
| Pages | 609-615 |
| Author | Nick French,Michael Patrick |
Education Briefing
Property investment: gearing and
portfolio returns
Nick French
Real Estate Valuation Theurgy, Chichester, UK, and
Michael Patrick
Real Estate and Construction, Oxford Brookes University, Oxford, UK
Abstract
Purpose –The aim of this study is to comment upon the relatively straightforward but often misunderstood
role of gearing (or leverage) on the potential equity return of a property investment portfolio.
Design/methodology/approach –This education briefing is an explanation of the how the addition of
individual assets to a portfolio can, with gearing, impact upon the portfolio return.
Findings –Although, this case study is relatively straightforward, it shows how portfolios can be geared to
give enhanced returns at differing, aggregate and levels of risk.
Practical implications –The process of borrowing at a bank rate below the return rate on an investment
project can increase the equity return of the project as long as all incomes and discount rate remain at
appropriate levels.
Originality/value –This is a review of existing models.
Keywords Gearing, Leverage, Equity rate of return, Portfolio rate of return, Investment risk, Bank debt
Paper type General review
“Real estate portfolio managers conduct asset allocation and asset selection by being experts in real
estate property fundamentals”Stephen D. Simpson (2017 [1])
Introduction
In the previous education briefing (French, 2019) looking at gearing and property returns, it
was shown that a geared investment will give higher equity returns as long as the expected
cash flow, income and capital is as predicted or greater. However, the downside risk is that
when the market declines or, at worse, crashes then the cash flows will all decline accordingly
and, depending upon the exposure to the market and the degree of debt being serviced, then
the equity returns will fall and quickly become negative.
The example illustrated was a very simple “monopoly”style housing example with non-
market related prices and rents. In this second briefing, we develop those themes to look at a
“real life”example of building a geared commercial property portfolio. That said, for
education briefings, it is best to keep the modelling relatively straightforward, so we are
restricting the model to only three properties and assuming that all incomes and capital
receipts are net of costs including the fund management cost. More complex examples can
build in these costs as separate columns before determining the expected net cash flow.
Portfolio construction
An investment portfolio is simply a collection of individual investments.All investments will
give an expectedreturn at any given level of risk.Generally, the greater therisk perceived in an
investment, the higher the required rate of return to compensate the investor for taking that
additionrisk relative to lessrisky investment. In practice,the role of the propertyfund manager
Property
portfolio
gearing
609
This paper forms part of a special section “Education Briefing”.
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1463-578X.htm
Received 25 November 2020
Revised 25 November 2020
Accepted 25 November 2020
Journal of Property Investment &
Finance
Vol. 39 No. 6, 2021
pp. 609-615
© Emerald Publishing Limited
1463-578X
DOI 10.1108/JPIF-11-2020-0133
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