Benchmarking in real estate is the standard of measurement used to analyze the financial aspects of a real estate investment property. In broad sense, real estate benchmarking refers to the comparison of potential real estate investment properties against a predetermined framework of measurement.
An appropriate benchmark is an important factor in assessing the return and risk of a given portfolio or fund manager strategy, as it allows investors to compare the performance of that portfolio or strategy over time against a market standard.
There are several challenges in real estate markets in coming up with a reliable benchmark as compared to other investment classes such as bonds and stocks which are traded frequently. Despite the challenges, benchmarks that represent a reasonable proxy for the performance of institutional real estate investments are necessary to provide investors with important information about the quality of their investments.
A good benchmark is one which can be able to offer the following qualities;
- Transparent – names and weights of individual investments/securities in the benchmark have to be clearly known.
- Investable – investors must the potential to forgo active management and hold the benchmark.
- Measurable – the performance of the benchmark has to be calculated on a frequent basis
- Appropriate – the benchmark should be consistent with the investment style of the portfolio being measured
- Specified in advance – the benchmark should be chosen prior to the beginning of an evaluation period
Institutional investors such as pension funds, insurance companies and mutual funds consider various benchmarks in coming up with their investment decisions. Individuals also but to a lesser extent consider these benchmarks in making investment decisions. In comparison to other investment classes, there is no a widely accepted benchmark for real estate investments in Zimbabwe.
The market should therefore, embrace reputable and independent benchmarks or indices to cover the gap. Indices which can be used as benchmarks can be derived and adopted at different levels of the market to cater for different needs of investors. Notable indices worldwide are derived mainly based on the concepts below.
Property Level Indices
Property level indices measures returns for individual properties or property classes and then aggregated to create a total return for the index. The properties in this index are primarily defined as “core,” meaning the properties are high-quality, multi-tenanted and located in major cities. Majority of their investment return is derived from rental income as they are generally fully leased. A good example of this type of a benchmark is the IPD Index which measures performance for commercially held properties across the globe.
Fund Level Indices
Fund level indices are based on the performance of real estate investment funds such as REIT’s, listed funds or unlisted funds say for example having a Property Index based on the performance of property counters on the ZSE. Unlisted funds such as pension funds, insurance companies and private or individual funds can be the source of information to build such an index.
Transaction based Indices
Transaction-based indices are based on actual property sale prices recorded in transactions, rather than a hypothetical appraised value. Investors can use these as a proxy for property prices and as a reference point for transaction activity in the market. Investors may use this information to determine regional and sector pricing indicators for their real estate portfolio and valuers can also use the same information for comparables in the valuation process. A major source of information to building such an index is the Deeds Registry which has the records for all property transactions carried out.
DisclaimerFrancis Chinjekure writes in his capacity as the Research Officer of The Real Estate Institute of Zimbabwe (REIZ). The views expressed in this article are his personal views and do not necessarily represent the views of his employer unless or otherwise stated. The article is for informational purposes only, for investment advice you can consult with your usual advisors. The Real Estate Institute of Zimbabwe and the writer do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this article, whether such loss is caused by negligence or otherwise. For feedback on this article you can get in touch with him on firstname.lastname@example.org