Applying BBST Investment Strategies in Commercial Real Estate
by Petros S. Sivitanides, Ph.D.
Selecting appropriate investment strategies is the first and, perhaps, the most crucial step in real estate investing. Given the cyclical nature of the real estate market one would argue that the ideal strategy is to Buy at
Looking at historical investment performance of the major commercial property types, that is, office, retail, industrial and apartments, over the period 1978-2004, we examined the investment returns that would be achieved if an investor bought one year after the market bottomed out and sold one year after it peaked (the one-year delay in market entry and exit relative to bottom and peak is required in implementing such a strategy to allow identification of such points). We also examined “Buy at the Bottom and Sell Soon” (BBSS) strategies, assuming only a 3-year holding period, would have provided higher returns than BBST strategies. In order to calculate the returns for these investment strategies we used the value and income NCREIF indices for each property type. The main conclusions of our analysis regarding commercial real estate investment behavior, which are not so obvious, are the following:
Ø When property values start rising, just after they bottom out, they keep rising for at least two to three years at an accelerating rate, in most instances. This suggests that short-term hold investment strategies may be more profitable than long-term hold strategies. Ø If the future behavior of property values is similar to the one registered over the period 1978-2004, investors will be able to take advantage of the real estate cycle to achieve high returns by applying BBST strategies, but higher returns are most likely achievable by applying BBSS strategies. More importantly, profits and benefits from such strategies can be maximized by combining them with the purchase of assets at the most advantageous and supply-restrained locations, which are destined to benefit the most from strong demand increases as the economy and real estate market comes out of a downturn. Ø Application of BBST investment strategies in the past would have provided investors with double-digit annual returns ranging between 13% and 15%, in the case of office buildings and super-regional shopping centers, and between 11% and 13%, in the case of warehouse buildings, apartments, and neighborhood and community shopping centers. Ø Application of BBSS investment strategies in the commercial real estate market would have produced even better results than BBST. In the case of office and warehouse properties, as well as super-regional centers, such strategies would have achieved considerably higher annual returns, ranging between 15% and 20%. In the case of neighborhood and community centers, the superiority of BBSS strategies over BBST strategies is not consistent; in the case of apartments the difference between the two strategies, in terms of investment performance, it is small. Ø Cyclical movements triggered by the 2001 recession were shorter, indicating, perhaps, that the real estate market is becoming more efficient and less cyclical. It is quite likely, however, that the mild impact of the 2001 recession on property values was due primarily to the very low interest rates prevailing during that period, rather than a reduction of the inherent cyclicality of the real estate market. Ø The shortening of real estate cycles, especially it’s climbing phase, if indeed such is happening, is another reason why BBSS investment strategies should be preferred over BBST strategies. The above conclusions demonstrate that understanding at what stage of the real estate cycle the market is can provide important clues with respect to the potential of significant value gains ahead and the effectiveness of alternative investment strategies. 1This is an excerpt from the book Profitable Real Estate Investing: A Value Growth Approach by Petros S. Sivitanides, Ph.D. Return from Investment Strategies to Real Estate Articles
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