House prices are in trouble in many, but not all locations. Nationally, house prices are down. The S&P/Case-Shiller house price index gets the headlines, but a related and less noticed index measures price changes for commercial real estate, which is still in pretty good shape — at least for now.

Houses exist in a private market. Commercial real estate exists in both private and public forms.

The S&P/GRA Commercial Real Estate Index (”SPCREX”) tracks the price level (not total return) of closed commercial real estate transactions, whether in a private or public transaction.

The FTSE/NAREIT index provides both a price index and a total return index of equity REITs. The price, however, is not a real estate closing price, but the share price of the REIT that may be at a premium or a discount to the appraised or estimated market value of the real estate held by the trust.

The commercial types in the SPCREX include; retail, office, apartment and warehouse. Minimum sizes are 10,000 square feet for retail and over 20,000 feet for the others.

The mix of assets in REITs may or may not be the same as the mix of assets in the overall public and private assets covered by the SPCREX index.

Representative overall market equity REIT funds are: VNQ, RWR and IYR.

Domestic sector REIT funds are REZ (apartments), FIO (industrial/office) and RTL (retail).

The chart shows the price return of houses, public and private commercial real estate for the last approximate 15 years.

Houses have declined. REITs have declined. Commercial real estate closing prices have held up fairly well.

Futures for the S&P/Case-Shiller index and the SPCREX index show the decline in housing values and the steady level of commercial real estate values. The housing futures were launched in May of 2006. The SPCREX futures were launched in October 2007.

REITs show the fickleness (or interest rate or stock market sensitivity) of public real estate.

Houses show above trend line appreciation over the last approximate 5 years. We are witnessing a reversion to mean return in housing prices. It may over correct, but it will probably ultimately track the historic long-term trend line.

An important problem with comparing house prices with commercial prices is the cash flow difference.

Individual houses produce negative cash flow for owner-occupants, and in the aggregate probably produce negative cash flow for investors who buy single-family homes or condos as investments. Commercial real estate in the aggregate, on the other hand, produces positive cash flow (yield) — total return that differs significantly from the price return.

S&P does not publish total return data for SPCREX (because the data is not available), but FTSE/NAREIT publishes total return data for equity REITs. The chart shows the dramatic difference between equity REIT price return and total return.

Yield is critical to investment real estate, particularly in today’s yield-starved market. We have written several articles about REIT yields that can be accessed here.

Real estate is not monolithic. There are imporant country, domestic location and type differences. Do not let house price headlines dominate your thinking. The house price situation is important, but it is not the totality of the real estate market.

Our very rough estimate is that 75 million private homes are owned in the U.S. with a median value in the vicinity of $200,000 each. If that is approximately true, then the market value of all U.S. private homes is in the vicinity of $15 trillion. That estimate is not verified and needs to be looked into more closely, but it may not be a bad ballpark number.

According to S&P, global direct commercial real estate is a $15+ trillion market; domestic direct commercial real estate is a $5+ trillion market; and domestic equity REITs are a $300+ billion market.

Richard Shaw
QVM Group LLC

There are 67 countries between the United States, Canada, EAFE, emerging market and frontier market countries. It may be helpful to you if you visualize the geographic relationship between those countries when you think about making country, region or development stage country investments.

The pie chart shows the relative market cap size of the US, Canada, the 21 EAFE (Europe, Australasia, Far East) countries, and the 25 emerging market countries. The stock market capitalization of the 19 frontier market countries is essentially negligible in comparison to the other market categories.

The map color codes the location of Canada, EAFE countries, and the emerging and frontier market countries. The US in not color coded.

It is interesting to note that the square area of the emerging markets is quite large in comparison to the US, or the EAFE developed non-US markets. That is the opposite of the relative market cap sizes.

China and India, which are within the emerging markets, also hold more than 1/3 of the world’s 6 billion population. The US, Canada, and EAFE combined have about 1/6 of the world’s population.

You can see from the map that most of the frontier market countries are adjacent to emerging countries. It will probably be just a matter of time before they emerge as well.

Some experts say that the frontier markets are today where the emerging markets were 15 years ago. If that is true, then there is a quite volatile, but wealth producing opportunity ahead in those markets — seat belts and air bags are recommended for that trip.

Most of Africa has not yet developed tradable stock markets, as you can see by the large area without color coding.

There are no frontier market ETFs or CEFs currently available in the US on a major exchange. That is likely to change, but for now there are limited opportunities, such as the T. Rowe Price Africa and Middle East mutual fund (TRAMX).

Because there will be frontier investment products coming along, we think it is a good idea for investors to begin to familiarize themselves with those markets. Toward that end, we have previously published articles about them — two of which we mention here on the topics of Country Risks and Macroeconomics.

The tables list the countries in the MSCI indices and identify an ETF (or CEF, if no ETF available) for each country for which one of those investment fund types is available.

Richard Shaw
QVM Group LLC

Security symbols mentioned in this article:

VTI EWC EWA EWO EWK EWQ EWG EWH IRL EWI EWJ EWN EWS EWWP EWD EWL EWU EWZ ECH FXI GXC INP IF EWY EWM EWW RSX EZA EWT THD TUR TRAMX

Portfolio management involves more than research, understanding investment trends, choosing an asset allocation, rebalancing and making security buy and sell decisions. Periodically, you need to measure how well you are doing.

To evaluate how well you are doing, you need to calculate your rate of return.

To know whether your rate of return is “good” or “bad”, you need to compare it to the return of a benchmark. Your benchmark could be some absolute number, but it typically consists of an index or an allocation of several indices.

However, many investors fall down on the job — they don’t do a return calculation, because they don’t know how.

Calculating investment return is a simple matter if your cash flows are simple. The calculation is more complicated if you have money flowing into, out of, or into and out of your investment account during the period your wish to measure.

For example, if you begin the year with $1 million, deposit no new money and make no withdrawals, and end the year with $1.1 million; your 10% return is obvious.

However, if you deposit an additional $5,000 per month to your account, that same $1.1 million ending account value does not represent a 10% return. The return is actually 3.4% due to the different time values of the twelve periodic deposits (you had more than $1 million invested during the year).

Similarly, if you withdrew $5,000 per month instead depositing new money, the ending $1.1 million does not represent a 10% return. The actual return was 17%, due to the time values of the withdrawals (you had less than $1 million invested all year).

More complicated yet is if you are both depositing and withdrawing during the period. For example, if you are depositing $5,000 each month and then withdraw $30,000 for income taxes in April and $100,000 in July for a down payment on a vacation home, you have a definitely complex calculation to perform. The return in that example was 17.7%.

All of these examples are best handled with a computer of some sort.

You can do the calculation with various sophisticated hand held calculators, but then you don’t have a permanent record.

As a practical matter, you need to use a computer spreadsheet, such as Excel, to record the amount and date of all the cash flows into and out of your investment account, as well as the beginning and ending value to determine how well you did.

We use Excel for that, and the XIRR math function. A hypothetical 2-year analysis of annual and cumulative investment return for cash flows with irregular dates and irregular amounts is illustrated in the chart.

The “trick” to remember to make the calculation work is to enter your portfolio value at the end of the period as cash flow back to you (as if you had sold the entire portfolio).

Then, calculate the IRR (using the function XIRR for irregular cash flows) including the row for that imaginary portfolio sale.

On the line after the imaginary portfolio sale, using the same date as the imaginary sale, make an imaginary reinvestment of your entire portfolio value.

The imaginary reinvestment is the starting point for next year’s return calculation. It will also create a zero net cash flow for the two entries in the overall history. That zero net entry will enable you to do a cumulative IRR from the earliest date in your portfolio cash flow records.

PC (Windows) versus MAC (Leopard) Note: 

The Windows version of Excel can perform the XIRR function.  The MAC version cannot perform the XIRR function. If you have Leopard for MAC on an Intel chip based machine, you can run Windows on the MAC and use the Windows version of Excel for the XIRR function.

Richard Shaw
QVM Group LLC