Real Estate Portfolio Optimal Debt Structure: A Pan-European Approach

This paper presents a methodology to examine real estate portfolioís debt structure. Using Monte-Carlo simulations and real options, our approach refines the analysis of the debt structure applicable to real estate portfolio. More precisely, the volatility of the fund, the loan to value, the default probability as well as the Interest Coverage Ratio are analyzed taking into account the state of the market and the various lease structures. We simulate simultaneously numerous trajectories for both the price and the market rental value and compute for each scenario the evolution of the fundís net asset value given the terms of the loan and taking into account the behavior of the tenants and thus the possible lack in cash flows. We also draw a set of risk levels according to leverage showing how the loan is affecting the overall portfolio risk level. The originality of this paper resides in the forward approach. Instead of relying on historical data, our model makes it possible to take into account oneís beliefs or oneís forecasts. Indeed our model is designed to serve risk management team, credit analyst as well as fund manager. We can use our model as tool to assess credit risk of a given portfolio. Furthermore this paper pave the way of several measurements such as the Credit-Var or the Loss Given Default which are traditionally difficult to compute in real estate finance. First we review the literature on fundís debt structure and on Monte-Carlo methods in real estate finance. Then the paper describes the suggested model. We particularly focus on net asset value and cash flows analysis. Lastly, we proceed to an empirical analysis over the period 2000-2009 using Property Market Analysis for a pan-European portfolio. We conclude by recommendations concerning the optimal debt level.