Leverage almost doubles negative performance in declining markets, according to research published by Investment Property Databank Japan. The research, which will be presented by Professor Shimizu to the IPD Japan's Annual Seminar 2010 at Tokyo's Belle Salle Yaesu, quantifies the difference between direct real estate investment returns and the Net Asset Value (NAV) returns.
Leverage almost doubles negative performance in declining markets, according to research published by Investment Property Databank Japan. The research, which will be presented by Professor Shimizu to the IPD Japan's Annual Seminar 2010 at Tokyo's Belle Salle Yaesu, quantifies the difference between direct real estate investment returns and the Net Asset Value (NAV) returns.
The analysis reveals that over the 12 months to June 2009, a direct property level return of -7.3% was eroded to a leveraged return of -13.4%. At this point, the average LTV was 42% - much too high for this phase in the cycle. As the real estate market turned downwards from the middle of 2008, average debt levels continued to rise because asset values fell faster than the managers could de-lever portfolios. The average fund, in fact, increased its overall debt level at precisely the point when managers should have been de-leveraging.
'The message is clear, but already well known,' says Toshiro Nishioka, managing director at IPD Japan, 'at some points during a market cycle, the use of debt can significantly enhance the asset level return, but at other points its effect can be devastating. The best fund managers will use debt on the upswing, but will deleverage before the market reaches its peak. In fact, far too many were taking on additional debt at precisely the point they should have been reducing it.'
The research is based on Japanese REITs data including direct property assets, other investments, cash holdings, borrowings and interest payments, as well as portfolio costs and fees. However, Nishioka argues that the lessons can be applied across listed and unlisted property funds in Japan and even globally.