Question

How well do portfolio theory and capital market theory work for commercial real estate? Explain

Answer 1

To answer this question, we first need to understand about the Capital Market theory and Portfolio theory.

Capital market theory: It deals with the analysis of the security. It tries to explain and predict the progressive nature of the capital markets based on some mathematical models.

Capital market theory deals with the following things:

• Major capital markets.
• Role of Federal Reserve System
• Role of securities
• IPOs
• Regulatory requirements.

Portfolio theory: It is ainly concerned with risk and the expected return on the investments. Investors are only concerned with expected values of investments and expected values of the portfolio.

Thus, Portfolio theory only deals with the maximizing the return considering the risks involved in that.

Commercial real estate: It is the property which is only used for business purposes which includes, retail property, property leased to tenants for business, office space, hotels etc.

Commercial real estate can be categorized into following classes:

ClassA: includes best buildings in terms of age, quality and location.

ClassB: Older than class A buildings and usually lowered priced than class A buildings.

ClassC: usually over 20 years old buildings, located in less attractive areas, huge maintenance cost.

Now, if we consider the portfolio theory and capital market theory which is totally based on the investment in securities nd which involves lesser investments than commercial real estate, these theory some what describes about the commercial real estate and how it works.

There are many factors which keeps commercial real estate separate but there are some factors which describes CRE.

Commercial real estate involves huge investment, thus have the potential to give huge return.

There are not as many regulations as in securities market.

We can invest both directly and indirectly, but not in securities market.

Hence, these are the things that works and some doesn't for the commercial real estate.