Duration
Duration
In an effort to reduce risk, institutions are concerned with matching current assets with future liabilities. Two factors assist in determining an investment's liability matching qualities, the concept of duration and the ability of an asset to provide a hedge against inflation. This assumes liabilities are defined in real terms.
While the concept of duration is widely used in the management of fixed-income portfolios, it is only recently that it has been applied to equity investments and, in particular, real estate.26 These papers suggest that a property's duration increases as the length of its underlying lease(s) increases. Sanders, Pagliari & Webb [1995, p. 152] proposed that in the US, properties with 'long-term leases' (7-10 years in the US) can offer durations of three to six years, approximately those found on medium-term bonds. Ward [1988, p. 139] found the duration of properties with `long leases' in the UK (15-25 years in the UK), to be between six and ten years. He argued that theoretically, the duration of real estate should be greater for a given yield when compared to the duration of equities, as the appropriate discount factor is lower than that of equities, and the difference between the discount rate and growth rate is low. This is discussed further in section 6.4.4.
Investors have some control over the duration of their real estate investments. It has
been argued that landlords can alter the stream of income via rent reviews, reletting and refurbishment in order to change the duration of a real estate portfolio (Buxton [1995, p. 36]), however, legal practicalities prevent the ease of use of such controls. The duration of a real estate portfolio can be managed in two ways. Firstly, by selecting those property types with longer or shorter lease terms,27 or secondly, by combining investment with the utilisation of debt financing to shorten the duration of properties encumbered with long-term leases (Giliberto [1992a]). Although, fund management concepts employed in the fixed income market, such as contingent immunisation,28 are beyond the scope of real estate portfolio management; see sections 2.4.4 and 2.4.8.
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26See for example, Hartzell, Shulman, Langetieg & Leibowitz [1988], Ward [1988], Leibowitz, Sorensen, Arnott & Hanson [1989] and Baum & Schofield [1991].
27Brown's [1991a] and Mueller's [1993] findings, as contained in section 2.4.3, should be noted here.
28For example, see Reilly [1994, p. 565].