Maarten van der Spek: Not location, location, location, but strategy, strategy, strategy!

December 20, 2023

^{This column was originally written in Dutch. This is an English translation.}

By Maarten van der Spek, Spek Advisory

The real estate market mainly emphasizes the importance of building selection. But for a well-diversified real estate investor, strategy is much more important.

The average real estate investor or real estate manager has the majority of their staff involved in the purchase and sale of the right buildings. Given all the technical, fiscal and legal aspects, this is certainly understandable. After all, the motto in real estate, 'location, location, location', is not based on nothing. The efficiency of one building can differ enormously from that of the building around the corner.

Everyone on the stock market knows that every share moves and returns differently. However, by combining different shares in one portfolio, the share-specific risk is reduced. Academic research has shown that the majority of the return from such a portfolio is determined by the market and the strategy and not by stock selection. It almost goes without saying that a larger portion of the staff is involved in determining the right strategy. Is this different when investing in real estate? No.

Such an analysis has been carried out often enough for investing in shares.^[1] In general, the majority of stock returns are driven by the market and strategy, with at most 10% driven by stock selection. A comparable analysis for real estate investments has been difficult in the past due to limited data. However, that excuse no longer applies. After all, there is now enough information available about European private real estate funds (via INREV^[2]).

By means of a relatively simple regression analysis^[3] the returns of unlisted real estate funds can be divided into three important components: market return, fund strategy (country and sector allocation) and asset selection. The results clearly show that the importance of asset selection within real estate is very great if the fund only consists of a number of buildings.

However, as the portfolio grows, the relevance of asset selection decreases and that of fund strategy increases. With a portfolio of more than 30 buildings, strategy determines returns more than building selection. Moreover, for institutional investors investing in multiple funds, it can be shown that the strategy is a stable component that determines 25-30% of the return, regardless of the size of the portfolio. Fund selection, on the other hand, has a similar degree of explanation for small portfolios, but is significantly less important for large portfolios.

Such analysis provides clear guidance to fund managers and investors on the essential skills their teams need to possess. Large funds should have a greater need for strategists, while small funds should focus mainly on selecting the right buildings. Real estate investors, on the other hand, should spend more time on strategy than on fund selection. If the portfolio is sufficiently large, the motto should not be 'location, location, location', but 'strategy, strategy, strategy'.

Spek Advisory is an independent consultancy firm that focuses on helping investors and managers optimize the strategy of the private investment portfolio, with the aim of improving the return risk profile.