Real Estate Profitability in three European cities : A quantitative study of risk adjusted returns from real estate investments

Abstract: This is a study of the profitability of three European real estate markets. The returns from real estate investments in Stockholm, London and Paris are compared on a risk-adjusted basis. The study takes the perspective of a corporate real estate investor, an investment bank, insurance company or other actor who whishes to invest in real estate. Real estate consists of land and any buildings or improvements located on the land. The real estate market has a few characteristics that differentiate it from other markets. The planning and construction of buildings is a time consuming process. This makes the supply of real estate slow moving and unable to quickly adjust to changes in demand. Because of real estate’s importance for the economy at large and for society, the real estate markets of most nations are highly regulated by governments. Real estate investments are mostly long term and extensive use of debt is common. The real estate market has a business cycle of its own. These characteristics give rise to numerous investment opportunities for the well-informed investor. The time frame of this study is 20 years in order to cover several business cycles. The source of data is the Investment Property Databank (IPD). The results show that Stockholm is the high-risk alternative and Paris is the low-risk alternative of the three markets in the study. The total return consists of income return and capital growth. The average annual returns ranged from 7.5% in Paris to 11.2% in Stockholm. By including debt the returns of Stockholm and London could be leveraged to approximately 20% per year. Use of debt can also destroy value when the cost of capital exceeds the return on the investment, as would be the case for Paris. No significant correlation between the returns of London and Paris was found, while the returns of Stockholm and London were highly correlated. The risk adjusted returns of the three markets as measured by the Sharpe ratio show that Stockholm is the most profitable market, closely followed by London and Paris being the least profitable market.