Core Real Estate: Do We Perceive A Renaissance Of The Risk Assessment Of An Asset Class?

It is commonly accepted that Core Real Estate means buildings that are located on a prime location and which are of a high quality with long-term lease contracts. Indeed, according to this definition a recently renovated office building in a prime location with only one tenant would get the Core Real Estate label. The authors of this paper argue that this is incorrect since it is now known that these buildings carry much more risk than the typical Core Real Estate. Hence the correct classification should be Opportunistic Real Estate. The argumentation that the classification should be changed centers on the fact that in times of economic crisis, when Core Real Estate should be the ìanchorî in a portfolio, rent in a prime location show much more downward volatility than the average location. Especially during an economic crisis cash flows of a typical tenant of a newly renovated building, for example banks, show a lot of volatility which could impact their ability to pay rents. When coupled to the fact that there is only one tenant, hence there is no diversification within a building, a situation is created that is contradictory to the concept of Core Real Estate, which implies stability. Owners willing to pay a premium for buildings that are erroneously labeled Core Real Estate will in all likelihood not receive the return justifying the higher purchase price. Investors should realize that expensive is not equivalent to low-risk, especially not when the typical lease term is five years and many buildings can become obsolete since tenants are expected to gravitate to so-called green buildings. Upgrading buildings to the latest standards will require expensive investments in the near future, further eroding the perceived benefits of Core Real Estate. The authors will provide the full argumentation supporting their hypothesis in their paper and, based on the classical portfolio analysis, show a re-classification of buildings in terms of risk and return, taking the latest knowledge and experience of the current financial crisis into account.