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Paper eres2006_137:
LEVERAGE IN REAL ESTATE INVESTMENTS - AN OPTIMISATION APPROACH

id eres2006_137
authors Bostwick, Jesse and Nick Tyrrell
year 2006
title LEVERAGE IN REAL ESTATE INVESTMENTS - AN OPTIMISATION APPROACH
source Book of Abstracts: 13th Annual European Real Estate Society Conference in Weimar, Germany
summary Real estate investments are frequently leveraged. Leverage is an important tool for any real estate investor whose target return exceeds the expected return on core, unleveraged assets since it increases potential returns -- although at the cost of increased risk. It therefore competes with other means of raising risk and returns -- in particular, buying riskier real estate assets -- as a method of improving the performance of a portfolio. This paper looks at the risk/return trade-off to leverage from a theoretical perspective, and the risk/return trade-off from in real estate asset space from an empirical perspective. A theoretical model of equilibrium leverage is developed. In this model leverage is preferred so long as the marginal increase in expected return per unit of extra risk from leverage exceeds that obtained from buying riskier assets. Since there are diminishing returns to leverage -- primarily because financing costs rise as borrowing levels rise relative to value -- this trade-off will become less attractive as leverage rises leading to an optimal level of leverage. If all investors face the same opportunity set, then one implication of the model is that all investors should leverage core investments up to either the optimal point or their target return, whichever is lower. This is clearly out of line with observed practice. However, it is difficult to calibrate the model accurately since, while it is relatively straightforward to calculate the trade-off between risk and return to leverage, little is known about the trade-off between risks and returns in real estate space.
keywords leverage; real estate; property; investment; risk; return; trade-off; optimisation
series ERES:conference
type normal paper
discussion No discussions. Post discussion ...
ratings
session 3-C
last changed 2008/11/01 09:47
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