From a small northwestern observatory…

Finance and economics generally focused on real estate

Repeat Sales Analysis

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It’s always nice to be cited in someone else’s research paper! Case in point, a nicely done real estate paper written by three young scholars out of U. Aukland and U. Hong Kong just hit my desk, and much to my enjoyment, they cited my Journal of Housing Research piece on Repeat Sales Analysis. Intriguingly, my original work was on the use of this technique to identify the negative impact of environmental contamination on property prices. Conversely, their work was on the positive impact of water views on property prices. Indeed, this illustrates the fact that, at the far ends of the valuation spectrum, the same methodologies can prove useful.

After exploring repeat sales as a potential tool, the three authors ended up opting for a weighted least squares regression, noting (and I agree with them on this point) that repeat sales models have a “well known error distribution characteristic.” The simple fact is, parametric models, with which most real estate students are familiar, are usually not handy for dealing with real estate data, which is highly non-parametric. However, parametric models (such as regression analysis) require lots of data, and real estate analysis problems are often challenged with thin data sets. There are good non-parametric methodologies out there (such as repeat sales) for such limited data situations, but the statistical properties are not well characterized. However, they were able to incorporate repeat sales into their hedonic regression model. At Greenfield we’ve similarly used nonparametric methods to inform instrumental variables in a method that emulates 2-stage least squares.

As the demands for reliability of valuation models increase, finding ways to better characterize the reliability and confidence of appraisal methods deserves increasing attention. Academic research scholars are used to using large data sets and parametric methods with well-defined statistical characteristics. Practitioners — a category that includes both appraisers and investors — are usually faced with poor data sets and traditional, somewhat heuristic models which work well in practice but have little in the way of statistical characterization. Some academic organizations, such as the American Real Estate Society, strive to span the gulf between research and practice, but more remains to be accomplished in valuation modeling.

The paper, by the way, is “An Empirical Study of Sea View Value by Repeat Sales Method” authored by Edward Chung Yim Yiu (U. Aukland) and Chau Kwong Wing and Siu Kei Wong (U. Hong Kong). Their study was supported by the Research Group on Sustainable Cities and the CRCG Conference Grant for Teaching Staff of the University of Hong Kong, and their findings are available on the Social Sciences Research Network and on Researchgate.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Written by johnkilpatrick

July 23, 2021 at 11:25 am

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More liquidity, fewer RE deals

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There is a lot of attention on the owner-occupied housing front, with costs/prices skyrocketing and affordability tanking. However, COVID has had complex and somewhat unpredictable impacts on the commercial real estate (CRE) market.

First to set the stage, commercial lenders became much more conservative after the 2008/10 debacle, even though most of that was felt in the residential sector. Non-performing commercial real estate debt was a manageable 0.86% among the nation’s 325 largest banks at the end of 2020, albeit up from 0.41% at the end of 2019. By comparison, at the peak of the previous recession, this stood at 8.6%. Banks have largely focused on lower-leveraged loans and kept higher reserves. Indeed, the lack of distressed inventory has put distressed buyers in a position of having too much money chasing too few deals. Distressed buyers are hoping for discounts in the 30% range, but having to settle for 10% to 18% discounts.

Even in the non-distressed arena, there is a lot of capital (both debt and equity) in the market. Surprisingly, a lot of this is coming from debt funds, which leverage returns by getting an equity slug on top of the dent. As of early May, 2021, there were about 130 such debt funds in the market place chasing fewer and fewer deals. By the end of 2020, CRE sales had fallen by 32% from 2019, according to Real Capital Analytics. In the month of January, 2021, sales were down 58% year-over-year. Among the investments of choice, save sectors (multi-family, industrial, self storage) are getting even better terms than they were pre-COVID. However, lenders are asking more detailed questions now about minutia such as collections and tenant financials. Nonetheless, there is money to be had, even for distressed deals, and while banks are holding out for 60% – 70% LTVs on construction lending, some borrowers are getting as much as 90%. Some development companies are finding success raising equity for pipeline deals, rather than traditional property-by-property investments.

One of the more interesting twists has been the movement of foreign investors from major markets into smaller markets. In 2011, for example, 76.9% of foreign investment in the US was in Top-10 markets, according to a recent study from Marcus and Millichap. However, thus far in 2021, this has declined to 58.5%. More striking — in 2011, about a third of foreign investment went to one city, New York. Today, only about 10% of such investment is flowing into The Big Apple. Not surprisingly, that same study finds that retail and hotel investment has declined precipitously, while multi-family and industrial have taken up the slack. Interestingly enough, office investment has varied widely over the past five years, down somewhat from 2019.

Graphic from Marcus Millichap, Data from Real Capital Analytics

Much of this information came from two great studies in the current edition of Real Estate Forum, one by Erika Morphy titled “An Abundance of Liquidity” and another by Erik Sherman titled “Distressed Real Estate Doubles But It’s Still Not Enough for a Buying Spree”.

Written by johnkilpatrick

July 9, 2021 at 2:00 pm

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ACCRE Report, June, 2021

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It was a very good month, but a hard one to figure out. ACCRE again outperformed the S&P on a monthly basis, but we’re still playing catch-up from the very uneven first quarter. That said, ACCRE’s total return was 7.93% for the month, and so a dollar invested at the inception (April, 2017) would now be worth $1.74. In comparison, the S&P 500 gained a not unrespectable 2.22%, and so if that same dollar had been invested in an S&P Index Fund bat the inception, it would be worth $1.82 today. Global real estate continues to lag, returning only 0.84% in June (again, not bad), and so that same dollar invested in the S&P Global Real Estate index would be worth $1.35 today, including both price and income returns.

As you know, we also track the Sharpe Ratio and correlation statistics to see how ACCRE performed as a diversifier for a broader portfolio. Here’s where things get interesting — we shoot for a 50% positive overall correlation coupled with a lower standard deviation of returns, which should allow ACCRE and the broader market to generally point in the same direction but to attenuate sudden market shifts. For the life of the fund, we are right at the 50% mark, and ACCRE’s standard deviation of excess returns is indeed lower than the broader market. However, in June, the correlation went nearly to zero. Now, both return streams were overall positive, but in very different ways. Note that 30 days is a fairly short time to consider correlations of returns, but it does point to something we’ll want to keep an eye on — buried in these prices are market reactions to a host of complex sector fundamentals. We’ll explore this later in the month.

By the way, this month I’ve included a day-to-day graph of daily returns for ACCRE and the S&P just to visually demonstrate the lack of daily correlation.

S&P 500
Average Daily Excess Returns0.0505%
Standard Deviation of Excess Returns1.2795%
Sharpe Ratio (Life of Fund)3.9456%
ACCRE Fund
Average Daily Excess Returns0.0453%
Standard Deviation of Excess Returns1.1912%
Sharpe Ratio (Life of Fund)3.8060%
Correlation (Life of Fund)51.3918%
Monthly Correlation (June, 2021)1.9972%
ACCRE Metrics as of June 30, 2021

As always, if we can answer any questions about REITS or real estate in general, please reach out. We look forward to hearing from you.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Written by johnkilpatrick

July 2, 2021 at 1:14 pm

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Inflation and Real Interest Rates

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This morning, the Philadelphia FED released an “update” to their periodic inflation report. “Updates” should always get your attention, and this one is particularly loaded with questions and, perhaps, a few answers.

First, the Phily FED’s forecasts interest rates over the next 10 years using a hybrid model that combines information from the yield curve plus a Delphi-type survey of professional forecasters. A year ago (June, 2020), their model forecasted very low short-term inflation, rising to about 2% – 2.1% in the longer term. However, inflation fears led to revisiting the model in May, and at that time, the inflation curve had flipped — somewhat higher short-term rates (about 2.4+%) and then calming down to about 2.3% in the longer term. Today (June, 2021), the short-term inflation rate is still expected to come out in the 2.4% range, but inflation should settle out a bit lower (roughly 2.25%) in the future.

However, this model is highly dependent on real versus nominal interest rates, and right now, under any reasonable estimates of inflation, real rates are negative. Indeed, for the past 20 years, real rates have generally trended downward, with some occasional hic-cups into positive territory. While the outlook for real rates is somewhat more positive than it was a year ago, forecasters still see negative rates for the coming decade.

Before returning to the topic of inflation, it may be useful to explore how and why real rates would be negative. This may seem counter-intuitive — why would I PAY YOU to borrow my money? To consider that, it’s helpful to recall from ECON 101 the four principal factors of production: Land, Labor, Capital, and Entrepreneurship. The value of any of these at any point in time is dictated by its marginal productivity. For example, the marginal productivity of labor is the amount of value-added to the system by an additional unit of labor. Unfortunately, not all labor has the same value. Right now, for example, there is a high value-added for truck drivers, skilled trades persons (e.g. — electricians, plumbers) and health care workers. Conversely, there is very little value-add for unskilled (counter staff at a fast food joint). As such, employers for unskilled workers have little incentive to pay a penny higher than minimum wage, and employees have little incentive to work for those minimum wages. Hence, we have the paradox of a shrinking workforce and unfilled jobs.

As for interest rates, the system is awash with funds. Automation has made production extremely efficient, and so a lot of money gets spent — and thus multiplied in the system — with little demand for borrowing or investment. Even though returns to equity have been quite good of late, and are forecasted to continue to be good, there are lots of structural reasons why some tranches of capital need to go into bonds. Hence, there is a surplus of lendable capital and surprisingly little demand for that capital, driving down real interest rates. If nominal short-term rates are, say, 0.5%, but inflation is 2%, then the real rate of interest is (0.5 – 2.0 = ) negative 1.5%. That’s the world we live in today, and the world that market participants forecast for the next decade at least.

But, back to inflation. If the Phily FED has a model that depends on the somewhat flawed yield curve as well as a Delphi-like survey of forecasters to guess at inflation, how good can that model be? Yes, it’s the model we all use, but anecdotal evidence suggests some contrarian thinking may be deserved right about now. While models like this are used to forecast inflation, the actual measure of inflation comes from the Consumer Price Index, which tracks the prices of a basket of goods and services used by a typical household. Certainly, there are discussions about what goes into that basket and how those constituents ought to be weighted. Nonetheless, this is supposed to reflect how a consumer experiences actual pocketbook issues. Unfortunately, it’s not an instantaneous measure, and so we don’t actually know what inflation was until a while after it happens. However, we can examine anecdotal evidence and perhaps understand why both consumers and sophisticated researchers and investors are raising the red flag.

Clearly, some components of the basket of goods and services are all over the map. Gasoline is most likely just a rebound from a year ago when no one was on the road. Coffee is a head scratcher (although my local grocery is running a sale, so go figure…) and certainly residential real estate is giving us all pause.

So, is inflation a problem or are the models correctly forecasting that the shorter-term spikes will ameliorate over time? One thing that is obvious is that a lot of capital is being converted into real estate right now. In part this is a flight to safety, but in part it is simply a reflection of the negative returns in to bonds.

As always, if I can elaborate on any of this, or answer any of your questions, please let me know.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Written by johnkilpatrick

June 30, 2021 at 1:25 pm

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Real Estate Investing 101

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OK, maybe not 101… but certainly this is a pretty basic primer. Real estate is an excellent inflation hedge and provides diversification to a broader portfolio of assets. If you want liquidity (and this is true with any sort of investment) you may have to give up some potential returns by investing in publicly traded REITs. If you are willing to give up liquidity, you can potentially achieve higher returns with either direct investments or some pooled investment, such as a private equity or hedge fund. Either way, higher potential returns usually entail higher risks, and so diversification is key. I frequently use the word “curated” to describe a carefully selected and managed portfolio of real estate assets.

There’s more, but that’s a good start. So if this is so basic, why was the market shocked — SHOCKED, I say! — when Scotland-based Aegon shut down it’s £381 million property fund last week and Aviva shut down its £367 million fund due to liquidity problems. It comes as no surprise that Brexit has been a real mess for investments in the UK, and coupled with the pandemic, liquidations in British property funds have outstripped new investments. Aegon said last week that they hoped to begin distributions in the 3rd quarter, and it would take a year or two to get the money out to everyone. Apparently the same is expected for Aviva.

This says a lot about investments in the UK in general, and particularly the future of real estate in the UK in the post-Brexit, post-Pandemic world. It also says something about whomever had been investing in these funds in the last year or two. However, it says very little about real estate in general.

Here in the U.S., we know that some sectors are having some problems. Retail, for example, looked like it was going to completely tank last year, but then rebounded this year after we started making some headway on COVID. Of course, some funds are dug in too deep (see my recent commentary on Washington Prime Group, here) but we’ve been fully invested with ACCRE throughout the pandemic, and while this hasn’t always been a smooth ride, care and caution have paved the way. However, even an index fund of REITs this year has outperformed other indices, as shown below from the Financial Times FTSE index:

Data courtesy NAREIT and FTSE

I hope this helps a bit. As always, if I can answer any questions, please let me know.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Written by johnkilpatrick

June 28, 2021 at 2:46 pm

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US Global Leadership Coalition

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This may sound wildly off the subject, but last week I had the very real privilege of attending (via Zoom) the US Global Leadership Coalition’s annual Global Impact Forum, followed up by a day-long “virtual” visit to Capitol Hill to meet with several members of Washington State’s congressional delegation and/or their staffs. I was invited to join the Advisory Council for USGLC back in 2020, and I’ve thoroughly enjoyed and appreciated the interaction.

Yes, my focus is on real estate finance and economics, and we usually think of real estate as being highly localized. However, real estate finance and investment is truly global. Just take a peek at a the holdings of any random sovereign wealth fund to confirm this. The vigor and vitality of America’s real estate market depends in no small part on America’s economic leadership in the world, and USGLC is focused directly on that.

Speakers at the Forum included a panoply of luminaries, such as former NATO commander Admiral Jim Stavridis, CEO of “Save the Children” Janti Soeripto, Deputy Sec. of State Wendy Sherman, Sen. James Risch (R-Id), “CARE” CEO Michelle Nunn, UN Foundation CEO Elizabeth Cousens, among many others. USGLC brings together more than 500 businesses and non-profit organizations to engage policymakers in D.C. and around the country to build support for America’s International Affairs Budget. “In today’s interconnected world, America must use all its instruments of national security and foreign policy to ensure we keep our citizens safe, strengthen our economy, and save lives. Our nation’s civilian tools of diplomacy and development are underfunded and undermanned, which is why the USGLC supports a strong and effective International Affairs Budget.” Former Sec. of State Gen. Colin Powell (USA-Ret) heads up the Advisory Council, and Admiral Jim Stavridis (USN-Ret) and Gen. Anthony Zinni (USMC-Ret) head up the National Security Advisory Council.

America’s international aid budget takes up a surprisingly small portion of our overall fiscal picture — less than 1%. However, we gain enormous leverage via that chunk of the budget, and any top military leader will tell you that diplomacy is cheaper than bullets. Our strong military, coupled with our international leadership, sets the stage for America’s powerful economy. “America’s diplomats and development workers help put the building blocks in place so that U.S. companies can expand their exports, reach new markets, and create more jobs here at home. With 95% of the world’s consumers outside of our borders and the fastest-growing markets in developing countries, it’s vital that we stay competitive in the global marketplace, ensure a level playing field for American businesses, and reach more customers.”

John A. Kilpatrick, Ph.D. — john@greenfieldadvisors.com

Written by johnkilpatrick

June 23, 2021 at 8:58 am

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Monday, Monday…

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Washington Prime Group (WPG) filed for Chapter 11 reorganization late last evening, saying that COVID-19, “created significant challenges.” The stock dropped 55% in early trading this morning (although had rebounded somewhat by mid-day), and is down almost 60% on the year.

This apparently came as a bit of a surprise to the market. While equity REITs in general had a down year in 2020 (-5.12%), retail REITS performed the worst of any sector, down 25.18% overall, with regional malls leading the way at negative 37.15%. However, as of the end of the 1st quarter (the most recent data available to us), retail REITs were back on track, having clawed back most of their 2020 losses. (Overall, US Equity REITS had a total return of 8.32% in the first quarter, 2021.) WPG had a lackluster year, and from Dec 31 to May 28 was down 56%. However, it was in a rebound mode in June, having tripled in price by the beginning of last week. No analysts were rating WPG as a “buy”, but two were rating it a “hold” as of two weeks ago. Intriguingly, since the first of the year, numerous class-action suits had been filed against WPG, alleging they concealed the true financial picture from shareholders. Notably, as of their annual report in March, they had disclosed some “potential deleveraging or restructuring transactions” with certain holders of senior notes.

WPG owns about 100 shopping malls throughout the US., but mostly east of the Mississippi. They invest in a variety of retail malls, including both open-air and enclosed malls. Major tenants include Signet Jewelers, Dick’s Sporting Goods, Footlocker, Jared’s, Kay Jewelers, and ales Jewelers. As of their annual report, 59 stores comprising 4% of total rents were on their high credit watch list.

At Greenfield, in our in-house REIT fund “ACCRE”, we have purposely avoided long positions in retail since the beginning of the pandemic. For those of you tracking ACCRE, I might note that as of mid-day today. ACCRE was up 7.5% for the month, compared to less than 1% for the S&P 500.

As always, if you have any questions regarding real estate in general or your real estate investments, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI — JOHN@GREENFIELDADVISORS.COM

Written by johnkilpatrick

June 14, 2021 at 11:57 am

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ACCRE Report, May, 2021

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We have mixed emotions when ACCRE beats the S&P 500. ACCRE is a diversifying adjunct to a well rounded portfolio. Hence, we want to see both ACCRE and the broader index do well each month. After a rocky year, ACCRE put together two great months — April we were up 2.94% followed by a 3.25% return in May. While the broad index had a super April (up 5.62%) it was flat in May, only up 0.55%. The global real estate metric has been positive for four months in a row, most likely emblematic of the continued positive sentiment for real estate as the economy gets back on its feet.

A dollar invested in ACCRE at the inception would be worth $1.61 today. Of course, that same dollar invested in the S&P 500 would be worth $1.78, having enjoyed the great “bull” run that started about 14 months ago. If you had invested that dollar in the S&P Global Real Estate index, you’d have $1.34 today. ACCRE is a carefully curated fund of REITS, with a goal of achieving liquidity, diversification, and superior returns.

Thanks also to the 14-month bull market, the risk-adjusted returns for the S&P continue to dominate, as evidenced by the Sharpe Ratio, as shown below. Again, the Sharpe Ratio measures the average daily returns (daily return minus the T-bill rate) divided by the standard deviation of those returns. In short, it tells you how much return you get for every unit of risk. In long bull markets, with little variation over time, the Sharpe Ratio is expected to be highly positive, as we see below. The correlation between ACCRE and the S&P over time is about 50%. This is our goal — to move in more-or-less the same direction but to offer some portfolio attenuation via diversification.

S&P 500
Average Daily Excess Return0.0494%
Standard Deviation1.2908%
Sharpe Ratio3.8296%
ACCRE
Excess Return0.0389%
Standard Deviation1.1947%
Sharpe Ratio3.2572%
Correlation (life of the fund)51.8333%
Correlation (month of May, 2021)43.0532%
Accre Metrics as of May 28, 2021

As always, if you have any questions about ACCRE, about REIT investing, or real estate investing in general, please drop us a note. We’re always glad to hear from you!

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Written by johnkilpatrick

June 1, 2021 at 10:43 am

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Inflation and Real Estate

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First and foremost, I came of age in the 1970’s, a period that gave rise to the term “stag-flation”. Significant inflationary pressure was real not just in the U.S. but across the globe, and for a variety of reasons. The complexity of the 1970’s is well beyond the scope of a single simple article, but suffice it to say, the past 40-ish years of relatively mild year-over-year price inflation has put the problem out of sight and out of mind for most economists.

That said, the Labor Department reported that April’s consumer price index rose by an annual rate of 4.8%. According to a great article in the Wall Street Journal yesterday by Konrad Putzier, most analysts think this is transitory. I tend to agree. None-the-less, savvy investors should properly be asking the question, “what if?”

Real estate has historically been considered a nearly perfect hedge in times of heightened inflation. Even for the past 40 years, real estate prices/values have out performed the CPI year after year. For example, the median price of a single family home in America in 1970 was $17,000. I’ll let that sink in for a minute. Now, let’s compare the 50-year return on that home to the consumer price index (CPI) as well as the S&P 500 (all three at the end of the respective years).

 House PricesCPIS&P 500
1970$17,00039.8092.15
2020$269,000261.563756.07
Compound Annual Change5.7%3.8%7.7%

Wow. Plus, this doesn’t come close to telling the whole story, If you had invested in that house, you’d either enjoy rents (net, on average, around 5% – 7% per year) or alternatively you would forego having to pay rent to someone else. Further, there have been and continue to be enormous tax advantages to real estate ownership.

Now, here’s the problem, as well described by Mr. Putzier. An inflation hedge, like insurance, is something you want to have BEFORE the wreck happens. Today, we see investors rushing out to bid-up the prices of every piece of property that comes on the market. It’s likely that some of these purchases will be ill-advised and not justified by future rents. Indeed, as I’ve noted on this blog before, wages since 1970 have not kept up with real estate prices, and given the cost of housing today, it would not be surprising if rent increases in the future lag inflation in general.

Nonetheless, existing, well-curated real estate portfolios will undoubtedly be positive compliments to an overall diversified portfolio of investments. Even with the hot-bid market today, we continue to stay active in this market, looking for value opportunities.

If you have any questions about your real estate portfolio, please don’t hesitate to reach out. We look forward to hearing from you.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com


Written by johnkilpatrick

May 26, 2021 at 11:24 am

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ACCRE Report, April, 2021

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Not a bad month, as all things go, and certain a great month to own the S&P. With that in mind, the real estate sector continues to “figure out” what the post-pandemic world will look like. After two “down” months, ACCRE rebounded nicely in April, although we’re still behind the S&P both on a single-month basis and cumulatively. Nonetheless, some of our metrics (particularly diversification) make us continue to stay the course. So, on with the report…

As shown, a dollar invested in ACCRE at the inception (four years ago) would be worth $1.56 today. For most of the last four years, ACCRE has handily beaten the S&P, but the strong bull market for the past year has really turned that around. Conversely, the S&P Real Estate index languished for most of the last four years, but has performed nicely in the last 12 months.

One of our main goals with ACCRE is to provided positive-return diversification with a fairly low-risk portfolio. Most months, we demonstrate this with a Sharpe Ratio — this is a measure of the average daily excess return (fund return minus the T-Bill return) divided by the standard deviation of those returns. In short, it tells us how much return we are buying proportional to the risk we are taking. A higher Sharpe Ratio means we’re doing well, and if our Sharpe Ratio consistently beats the S&P, it means we’re providing more return than the market as a whole relative to the risk we’re taking.

S&P 500
Average Daily Excess Return0.0498%
Standard Deviation1.2977%
Sharpes Ratio3.8369%
ACCRE
Average Daily Excess Return0.0365%
Standard Deviation1.2010%
Sharpes Ratio3.0393%
Correlation (life of the fund)51.9182%
Correlation (month of April)16.3113%
ACCRE Metrics as of April 30, 2021

The Sharpes Ratios are calculated for the life of the fund, as is the overall correlation. Most months, ACCRE beats the S&P, but as we all know, the S&P has been on a very real bull tear this past year. Certainly, we all hope that continues! The overall correlation (life of the fund) is just where we want it, but the correlation for April, while positive, is surprisingly low. Digging into the data a bit further, we find that the S&P, while doing great, nonetheless had some bounces during the month. ACCRE, on the other hand played the “slow and steady wins the race” game.

We may reconsider some of our positions this month, and of course our subscribers will get immediate notification of any trades. In the meantime, if I can answer any questions about REITs or Real Estate Finance in general, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D. — john@greenfieldadvisors.com

Written by johnkilpatrick

May 5, 2021 at 10:21 am

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