Investing in Real Estate. Glenn Mueller, Ph.D. Real Estate Investment Strategist Dividend Capital Group. Professor University of Denver

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1 Investing in Real Estate Glenn Mueller, Ph.D. Real Estate Investment Strategist Dividend Capital Group Professor University of Denver

2 Dr. Glenn Mueller Real Estate Investment Strategist Dividend Capital Group Professor University of Denver Franklin L. Burns School of Real Estate & Construction Management Visiting Professor - Harvard University, & summer executive education semesters Ernst & Young Visiting Professor European Business School, fall 2004 & spring 2005 semesters Previous Experience Legg Mason Real Estate Investment Strategist PriceWaterhouseCoopers National Director of Real Estate Research Alex. Brown Kleinwort Benson Head of Real Estate Research Prudential Real Estate Investors Vice President of Real Estate Research B.S.B.A. in finance from the University of Denver MBA from Babson College Ph.D. in Real Estate from Georgia State University 2

3 Under ALL is the LAND EVERY productive activity requires: Land + Labor + Capital People need a place to: Work, shop, eat, play, sleep Real estate demand grows with employment and population growth 3

4 The Importance of Asset Allocation Contributing Factors of Portfolio Performance Variation Source: Brinson, Gary P., et al. Determinants of Portfolio Performance, Financial Analysts Journal, July/August 1986 (for 10-year time period of ). Updated in Financial Analysts Journal, May/June 1991 (for 10-year time period of ). March 1, Copyright 2004 Ibbotson Associates Inc. In this study, Gary P. Brinson, et al. assessed the impact of passive (benchmark) and active asset allocations and security selection on 82 large pension plans over a 10-year period and found that on average, benchmark asset allocation (allocation policy) explained 91.5% of the variation in quarterly returns. Past performance is no guarantee of future results. 4

5 Why Real Estate Fits a Portfolio = SIZE U.S. Real Estate vs. Other Asset Classes December 2006 Source: Pension & Investments, October 30, 2006 and Prudential Real Estate Investors, December This investment is subject to real estate risks associated with operating and leasing properties. Additional risks include changes in economic conditions, interest rates, property values, and supply and demand, as well as possible environmental liabilities, zoning issues and natural disasters. 5

6 U.S. Real Estate Asset Class U.S. Real Estate Values = $33.3 Trillion Source: Prudential Real Estate Investors, December This investment is subject to real estate risks associated with operating and leasing properties. Additional risks include changes in economic conditions, interest rates, property values, and supply and demand, as well as possible environmental liabilities, zoning issues and natural disasters. 6

7 Portfolio Diversification Stock and Bond Investor January 1972 to December 2005 Stocks and Bonds with 10% REITs with 20% REITs Return 10.7% Risk 11.0% Return 11.0% Risk 10.7% Return 11.4% Risk 10.6% Source: Morningstar Inc., Financial Communications All rights reserved. Used with permission. Past performance is not a guarantee of future results. This material is for informational purposes only, and does not reflect the actual performance of any specific investment. Stocks are represented by the S&P 500; Bonds are represented by a 20-year U.S. Government Bond; T-Bills are represented by a U.S. 30-day T-Bill; REITs are represented by the NAREIT Equity REIT Index, an unmanaged index reflecting performance of U.S. real estate investment trust market. The REITs included in this index are publicly traded. Risk is represented by standard deviation, which is a statistical measurement that depicts how widely returns varied over time. The measurement is generally used to predict and understand the range of returns that are most likely for a given investment. Investors cannot invest directly into any index. Dividend Capital Total Realty Trust is a non-traded REIT; therefore, this data should not be used as a comparison to, or an implication of, non-traded REIT performance. Investments in real estate may be subject to special risks associated with operating and leasing properties, as well as risks due to changes in economic conditions, interest rates, property values, and supply and demand, in addition to possible environmental liabilities, zoning issues and natural disasters. 7

8 25-Year Risk Reward Efficient Frontiers 25-Year Returns 15 Efficient Frontiers 25 Year Returns w/ R.E. & REITs w/ R.E. REITs S&P 500 NASDAQ Russell 2000 Utilities Stocks & Bonds D.J Ind w/ REITs Mtg NCREIF Bonds Source: A.G. Mueller & G.R. Mueller, Journal of Real Estate Portfolio Management,

9 The Modern REIT Era Beginning in the early 1990s, the real estate asset class has grown from a sector market capitalization of around $10 billion to approximately $400 billion today. 9

10 Growth of the REIT Market Market Capitalization Growth of Public Equity REITs Source: NAREIT data as of 03/31/2007. Past performance is not a guarantee of future results. This is for illustrative purposes only and is not indicative of any investment. The NAREIT data shown reflects market capitalization of the public U.S. real estate investment trust market. REITs included in this data are publicly traded. 10

11 Growth of the REIT Market Growth of Public REIT Market Ownership 1 1 Source: Prudential Real Estate Investors. Past performance is not a guarantee of future results. This is for illustrative purposes only and is not indicative of any investment. 11

12 Average Annual Dividend Growth per Share and Consumer Price Index REIT Dividend Growth vs. CPI Source: NAREIT (REIT dividends) and U.S. Department of Labor (CPI). Past performance is not a guarantee of future results. This material is for informational purposes only, and does not reflect the actual dividend growth of a specific investment. REIT dividends are represented by the NAREIT Equity REIT Index, an unmanaged index reflecting performance of the public U.S. REIT market. REITs included in this index are publicly traded. Companies included in this index must pay 90% of their taxable income to shareholders in the form of dividends. There is no guarantee that REIT shareholders will receive dividend distributions from such an investment. Investors cannot invest directly into any index. The Consumer Price Index is an indicator of inflation that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food and transportation. 12

13 REIT Leverage Low and Conservative Composite REIT Leverage ( ) Source: SNL Datasource. 13

14 Historic Effect of a Two-Year Down Market 28-Year Compound Annual Total Returns Standard Deviation of Annual Returns Source: National Association of Real Estate Investment Trusts, Ibbotson Associates, NASDAQ since it is the year the NAREIT Index started. NCREIF and NASDAQ series began January Equity REITs are price appreciation only. This is for illustrative purposes only and is not indicative of any particular investment or future results. 14

15 Historic Effect of a Two-Year Down Market 30-Year Compound Annual Total Returns Standard Deviation of Annual Returns Source: National Association of Real Estate Investment Trusts, Ibbotson Associates, NASDAQ since it is the year the NAREIT Index started. NCREIF and NASDAQ series began January Equity REITs are price appreciation only. This is for illustrative purposes only and is not indicative of any particular investment or future results. 15

16 Risk = How Much Loss Index Return Comparisons Sources: NCREIF, SLH Corp Bond Index, NAREIT, S&P, Frank Russell, NASDAQ. Particular investments may contain risks not illustrated by its associated index. This is for illustrative purposes only and is not indicative of any particular investment or future results. 16

17 REITs Exhibit Consistent Performance Return Performance Volatility through 2006 Sources: NASDAQ, Frank Russell, Dow Jones, S&P, NAREIT. Particular investments may contain risks not illustrated by its associated index. This is for illustrative purposes only and is not indicative of any particular investment or future results. 17

18 Strong and Consistent Dividend Yield 26-Year Equity REIT Return Composition Source: NAREIT, SNL Datasource and Mueller Past performance is not a guarantee of future results. The NAREIT Equity REIT Index is an unmanaged index reflecting performance of the U.S. real estate investment trust market. REITs included in this index are publicly traded. This is for illustrative purposes only and is not indicative of any investment. Investors cannot invest directly into any index. 18

19 Positive FFO Growth 26-Year Equity REIT Price Change Composition Source: NAREIT, SNL Datasource and Mueller Past performance is not a guarantee of future results. The NAREIT Equity REIT Index is an unmanaged index reflecting performance of the U.S. real estate investment trust market. REITs included in this index are publicly traded. This is for illustrative purposes only and not indicative of any investment. Investors cannot invest directly into any index. 19

20 Fundamentals Drive Earnings Demand for real estate Occupancies expected to rise all sectors Occupancies drive rents Rents expected to rise all sectors Positive leverage increases earnings to equity Interest rates expected to stay moderate Investing in real estate entails certain risks, including changes in: the economy, supply and demand, laws, tenant turnover, interest rates (including periods of high interest rates), availability of mortgage funds, operating expenses and cost of insurance. Some real estate investments offer limited liquidity options. There is no guarantee that shareholders of a REIT will receive dividend distributions from such investments. Increased positive leverage increases risk in periods of high interest rates and refinancing needs. 20

21 Occupancy Cycle and Rent Growth Office Source: Property and Portfolio Research, Grubb & Ellis, Mueller

22 Occupancy Cycle and Rent Growth Industrial Source: Property and Portfolio Research, Grubb & Ellis, Mueller

23 Occupancy Cycle and Rent Growth Retail Source: Property and Portfolio Research, Grubb & Ellis, Mueller

24 Occupancy Cycle and Rent Growth Apartment Source: Property and Portfolio Research, Grubb & Ellis, Mueller

25 Bond Values DROP as Interest Rates Rise 10-Year Treasury Yield Source: U.S. Treasury - Federal Reserve Bank of St. Louis. 25

26 Conclusions Real estate is a separate asset class Historically stable earnings and price growth Positive diversification benefits Public and private investments available Equity and debt investment available Fundamentals positive in all 4 major property sectors 26