Jurnal 2

Journal of Valuation
PERFORMANCE ASSESSMENT INDEXES AND CAPITAL ASSET

PRICING MODELS
STUART LOCKE
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PERFORMANCE ASSESSMENT
INDEXES AND CAPITAL ASSET
PRICING MODELS
Received: August 1986

STUART LOCKE
Key Words
Risk analysis — performance measures — valuation — capital asset pricing
Summary
The applicability of capital asset pricing theory to the derivation of performance
measures for real estate is examined. Although risk and return are fundamental
concepts in modern finance they are seldom treated formally in non-academic dis-
cussions of asset performance. An explanation is sought for the apparent failure to
adopt formal models which have been developed and tested in the share markets
for performance assessment in the real property market. The evidence suggests that
it may not be the difference in approach pursued by real estate professionals
toward valuation vis-à-vis share market analysts but rather the inapplicability of
capital asset pricing models to real property returns that is the explanation for the
lack of standardised measures.
1. Introduction
Investment practice, in respect of financial securities, is increasingly influenced by capital
asset pricing theory. This seemingly natural adoption of the modern finance approach,
developed over the last quarter century, has not filtered through to the real estate market
(Hoag, 1980, p. 569). The purpose of this paper is to explore the general applicability of
capital market research to the real property market, and in particular to focus on the question
of performance assessment.
Several measures of performance derived from quantitative estimates of invest-ment
return and risk attributes are discussed in Section 2. The methods proposed below differ
markedly from the usual procedures adopted by media commentators in analyses of
investment performance, where returns often are calculated over an
230
LOCKE
arbitrarily selected time period and then ranked in descending order. The feature
story of the Financial Review, 24th June, 1985, entitled 'Property trusts the top
investment against inflation', is an example of such practice. The period chosen is
June, 1975, to 31st March, 1985. An initial lump sum of $100,000 is invested in a
range of alternative securities and the end amounts accrued after ten years are
compared. Risk is not included in the study and this starkly contrasts with the
academic literature concerned with the performance of investments.
The implementation of quantitative measures, as discussed in the first section, to
real estate is considered in Section 3. The choice of a consistent time-series of rates
of return on real property is reviewed. A series of housing returns is selected as data
for demonstrating the quantitative performance measures. Statistical problems
which are observed point' to deeper conceptual difficulties and the potential causes
are considered.
Section 4 develops the measurement process further with a discussion of listed
property trusts and conflicting reports regarding their performance. Evidence is
represented which suggests that appraisal procedures utilised by professional
valuers do not fit comfortably with the finance notion of capital asset pricing
theory. The cause of the observed divergence is discussed. Finally, a summary of
the research findings is presented. Potential extensions of this enquiry are suggested
in concluding this paper.
2. Performance assessment
Performance assessment is concerned with comparing the return earned on one
form of investment over time with returns earned on other forms of investment. It is
essential for a valid comparison that the investments are comparable in terms of
similar risk and other constraints. Risk may alter over time and usually differs
between alternative investment choices. Accordingly, the explicit inclusion of an
investment's risk over the relevant time periods is the first step in developing a
procedure for making sensible comparisons for performance assessment.
The return (R) is calculated as a single period return which takes into account
both the capital gain component (Pt - P t - 1 ) , where P denotes price and subscript t
indicates the time period, and any net cash flows (Ct), for example rents, interest or
dividends, in the period:
R = (Pt - Pt-1 + Ct )/Pt - 1 (1)
A meaningful comparison of alternative return streams, that is Ri vis-a-vis Rj,
where i and j denote specific investments, requires that returns are risk-adjusted
returns. The variability within a time series of returns is symptomatic of the inherent
risk of gains and losses from holding an investment when the outcome differs from
the expected return, E(R). Where these gains and losses are normally distributed
around the expected (mean) return, the standard deviation (SD) is a convenient
quantitative surrogate for risk. The question as to whether normality is a reasonable
assumption to make is considered in Section 3 below, but in the interim the con-
ventional wisdom, that returns are normally distributed, is implicitly accepted.
231
JOURNAL OF VALUATION: 5
Risk adjustment
The risk adjustment procedure may follow at least two possibilities. First, the
mean return (Ri) of the ith investment may be divided into the standard deviation,
calculated from the time series of returns Rit (t = 1, 2, 3, . . . , n), to obtain the
coefficient of variation (CVi):
CVi = SD(Ri)/Ri (2)
This ratio provides a relative measure of risk and may be used to rank the alterna-
tives available. As such, it provides a relatively simple index of performance assess-
ment. The time period and the periodicity of the data must be the same if the
comparison is to be at all meaningful. Given these basic requirements, the measure

is simple and convenient to use in practice. Of course, very small returns will cause
the CV to approach infinity.
Second, an alternative to this ad hoc measure is the derivation of indexes from
equilibrium models of asset pricing concerned with the two key parameters of
return and risk. In particular the capital market line and the security market line
constructs, which are widely used in finance, provide a framework for the develop-
ment of performance indexes.
The capital market line (CML) depicted in Figure 1 expresses the relationship
between expected security returns and their respective standard deviations. In
equilibrium all assets must lie along the CML. The lower bound is the risk-free
asset and the most efficient diversified portfolio is the market (M).
232
LOCKE
Sharpe (1966) proposes that when investment is concentrated in a single asset or

nondiversified portfolio it is the return to the total variability of the investment which
correctly measures performance. The Sharpe performance index (PIS) is derived from the
capital market line for any efficient investment:
PIS = E(Ri-Rf)/(SD(Ri)) (3)
where E(Ri - Rf) is the expected excess return on asset i (return on asset i less
return on risk-free asset), and SD(Ri) is the standard deviation of returns on
security i.
The security market line, which is the graphical representation of the capital asset pricing
model (CAPM) depicted in Figure 2, shows the relationship between
expected return and a measure of market risk (b) known as beta. Algebraically, the capital
asset pricing model is stated as:
E(Ri) = E(Rf) + bi [E(Rm - Rf)] (4)
Treynor (1965) uses the CAPM relationship to recommend the reward-to-

volatility ratio, commonly termed Treynor's index:
PIT = E(Ri - Rf)/bi (5)
The measure concentrates on adjusting the excess return of the asset for the market risk of the
asset.
A closely related index is proposed by Jensen (1968). He suggests the estimation
of CAPM, equation 4, in terms of excess returns, that is in equation 4 move E(Rf)
to the left hand side, with a constant term Ji:
233
(Ri - Rf) = Ji + bi (Rm - Rf) (6)

where J is the estimated intercept, and b is the estimated market risk parameter. The
index for the ith asset Ji will take either positive or negative values dependent on
whether the return is unusually high or low. Ji is the regression intercept and
measures the vertical height of the estimated line above or below the SML.
McDonald (1974) uses all three indexes in the assessment of the performance of
123 mutual funds. Both the Treyno (PIt) and the Jensen (PIJ) respectively indexes
are appropriate for measuring the performance of either individual assets or
portfolios of assets and accordingly are more useful. It can be shown that Treynor
and Jensen performance indexes are linear transformations of each other (Francis
and Archer, 1979, p:228).
Neither measure is free from criticism. Friend and Blume (1970) show that there
is a bias against high risk investments, and the more general theoretical difficulties
concerned with the two parameter capital market models also are relevant. Three
specific difficulties which relate directly to the model are discussed by Elton and
Gruber (1984, pp. 586-91). First, if the general assumption in CAPM of lending and
borrowing at the same riskless rate does not hold then it is sometimes difficult to be
sure which investment dominates the other investments. Second, the risk level can
alter over time and this is most likely where a managed portfolio is being assessed.
Management may deliberately vary the composition of the portfolio in order to alter
the beta in anticipation of changes in the economy. Third, the market index
composition problem (Roll, 1977) causes difficulty in obtaining an unambigu-ous
risk measure, but this is offset to some extent if the same index is continually used
(Mayer and Rice, 1979; Peterson and Rice, 1980).
3. Real property performance
Conceptually, there appears to be no difficulty in applying one or more of the

performance measures discussed in Section 2 to real property. A major practical
problem emerges with respect to the availability of data, and perhaps even more
fundamentally as to what can be used to measure returns. Individual properties are
not traded frequently enough to work with them as the basic unit of account. Rather
some form of aggregation will be necessary in order to achieve a reasonable data
base.
With equity securities, each company constitutes a unique asset and its shares are
homogeneous elements in that asset. With real property, each property item is itself
unique. This brings to attention the first difficulty confronted in the measure-ment
of real estate performance, viz the categorisation of property into groups in which
differences between each unique element of the group are not significant for risk
and return evaluation. Unlike the majority of financial securities there is no single
characteristic sufficient to ensure homogeneity.
Classification of property by its use and location is likely to be useful in the
development of homogeneous real estate indexes. Valuers suggest these two variables
are important and limited experimentation with regression analysis on property
234
LOCKE
values in Tasmania and South Australia supports this view. Similarly the Valuation
Department in New Zealand uses computerised regression for the valuation of 'houses' by
'suburbs' on the basis of fundamental characteristics of the properties, such as number of
rooms, construction material and so on. Hoag (1980) presents a regression based model
aimed at the development of an industrial property index. The 'technique is specialised to one
particular property classification' (p. 569) and the results show 'the existence of significant
coefficients for the location variables'. These 'detracted somewhat from the regional
economic concomitants since each represents essentially a localised measure of value' (p.
576).
Housing returns
The returns on housing in each of a number of Australian capital cities presents an

interesting case which exemplifies some of the problems which must be addressed. First, a
source of data is required. The Real Estate Institute of Australia (REIA) publishes 11 monthly
issues each year (closed for Christmas) of Market Facts which provides the 'Median Prices of
Established Houses Sold' in Sydney, Melbourne, Brisbane, Adelaide, Perth and Canberra.
These data are plotted in Figure 3. No government or other industry source is currently
available, although several state governments are currently developing computerised
valuation/titles records which will permit them to produce summary sales data.
The REIA figures are based on a monthly survey of a sample of selling agents in each
location. In some months the responses are very thin and at this stage a detailed analysis of
the response profile is not available. Further information regarding the mean and the
dispersion of sales prices is not currently available. Monthly rates of return, Equation 1, are
calculated from the median prices and these are summarised in Table 1. Included with the
housing rates of return for the six cities over the five-year period 1980-84 are the annual
return on the share market and the share market property sector. The Statex Market Price
Index and the Statex Property Price Index respectively are used to calculate returns for the
last two series. These indexes are comparable to the Standard and Poors and the New York
Stock Exchange Indexes in the United States and the Financial Times Actuaries Indexes in
the United Kingdom. The Property Industry is included as a component in the Statex Market
Index. Considerable variability in both the cross-sectional and time-series dimensions of the
reported returns is apparent from the table.
The standard deviation of each investment in each period is calculated and these are
presented in Table 2. The considerable variability in returns seen in Table 1 is reflected in this
statistic. Next, the coefficient of variation is calculated, Equation 2, and the results are shown
as Table 3. The pattern changes from year to year and it is difficult to infer that any particular
city, the share market, or the property sector of the share market is generally faring better than
the others overall. Nevertheless, the measure is useful on a period by period basis to assess
which performance is best.
The use of the standard deviation as a quantitative measure of risk relies on the return
series having an approximately normal distribution. If the return distribution
235
236
LOCKE
Table 1
Average monthly rates of return
Year Sydney Melbourne Brisbane Adelaide Perth Canberra Market Property
1980 2.28 1.25 0.50 - 0 . 10 - 0 . 94 3.10 2.43 -0.26
1981 0.67 1.78 2.76 0.35 0.16 0.39 -1.24 1.58
1982 -0.65 0.31 0.58 0.89 1.51 0.28 -1.26 -0.46
1983 1.88 2.21 0.37 0.99 0.08 2.41 3.37 2.34
1984 0.95 3.10 0.63 2.15 1.13 1.13 -0.72 - 0 . 16
Table 2
Standard deviation of monthly rates of return

1980 4.08 4.24 4.28 4.91 5.31 4.95 5.98 1.86
1981 7.92 5.51 6.64 3.41 3.78 7.27 4.40 3.61
1982 4.86 4.27 4.48 3.49 4.59 3.13 5.34 2.56
1983 5.67 6.04 2.84 2.43 12.41 5.72 4.50 3.37
1984 5.76 4.47 4.68 7.05 2.97 3.36 4.99 3.27
Table 3
Coefficients of variation
1980 1.79 3.39 8.56 -49.1 -5.65 1.60 2.46 - 18 . 69
(2) (4) (5) (8) (6) (1) (3) (7)
1981 10.48 3.10 2.41 9.74 23.63 18.64 - 3 . 55 2.28
(5) (3) (1) (4) (7) (4) (8) (2)
1982 -7.48 13.77 7.72 5.03 3.04 11.18 - 4 . 24 - 5 . 57
(8) (5) (3) (2) (1) (4) (7) (7)
1983 3.02 2.73 7.68 2.45 155.13 2.37 1.34 1.44
(4) (5) (8) (7) (6) (3) (2) (1)
1984 6.063 1.44 7.43 3.28 2.63 2.97 - 6 . 93 - 20 . 43
(5) (1) (6) (4) (2) (3) (7) (8)
is skewed to either the left or the right then the downside risk and the upside risk
(potential) will not be the same. Where skewed distributions are encountered a
higher order moment is required to be incorporated into the analysis to find a
quantitative proxy for risk. In general the returns on financial securities are
approximately normally distributed, especially where the time period over which
the returns are calculated is a month (Fama, 1976). Where the returns are not
normally distributed the calculation of the logarithmic rates of return has been
shown to reduce right hand skewness and assists in forming a normal variable.
To ensure that the standard deviation is a reasonable measure of risk the securi-
ties' monthly returns are tested for normality. A Kolmogorov-Smirnov One-Sample
Test (KS) is undertaken to ascertain 'whether the observed data could reasonably
237
have come from a theoretical distribution' (SPSS update 7-9, p. 224), which in this
instance is a normal distribution. Various alternative procedures are available to test
for normality such as the studentised-range (Fama and Roll, 1971) and chi-square
test. These are neither as precise nor have the same power, in a statistical sense, as
the KS test. The null hypothesis (H 0) compared to the alternative hypo-thesis (H 1)
(H0: the distribution is normal; H 1 : the distribution is not normal) for each return
stream could not be rejected at the 5 per cent significance level. Accord-ingly, there
is no necessity to engage in logarithmic transformations.
The 13-week Treasury Note is accepted as a proxy for the risk-free rate. On a
year by year basis the risk premiums for the above eight alternative investments are
calculated and exhibited in Table 4. The Treasury Note average yield for each year
is recorded in column (1). A division of the risk premiums by the standard

deviations produces the Sharpe Index of return-to-variability, Equation 3, as
recorded in Table 5. Considerable variability over time and between assets
reinforces the necessity to make these comparisons. A general claim such as that
housing offers the best all round investment is not sufficiently precise, as the
national housing market is divided into many submarkets. The correlation of rates of
return on housing in each city is presented in Table 6.
It is apparent from the correlation coefficients that there is considerable dis-
persion in the movement of returns in the various cities. With the exception of
Table 4
Risk free rate and risk premiums
rf
1980 1.22 1.06 0.03 -0.72 -1.32 -2.16 1.88 1.22 -1.48
1981 1.24 -0.57 0.54 -1.21 -0.89 -1.08 -0.85 -2.48 0.34
1982 1.25 -1.90 -0.94 -0.67 -0.36 0.26 -0.97 -2.51 -1.71
1983 1.22 0.66 0.99 -0.85 -0.23 1.14 1.19 2.15 1.12
1984 1.22 -0.27 1.88 -0.59 0.93 -0.09 -0.09 -1.94 -1.38
Table 5
Sharpe performance index values
Y«ar Sydney Melbourne Brisbane Adelaide Perth Canberra Market Property
1980 0.26 0.01 - 0 . 17 - 0 . 27 -0.41 0.38 0.20 -0.80
(2) (4) (5) (6) (7) (1) (3) (8)
1981 -8.12 0.10 -0.18 - 0 . 26 - 0 . 29 -0.12 -0.56 0.09
(8) (1) (4) (5) (6) (3) (7) (2)
1982 - 0 . 39 - 0 . 22 -0.15 -0.10 0.06 -0.31 - 0 . 47 - 0 . 67
(6) (4) (3) (2) (1) (5) (7) (8)
1983 0.12 0.16 -0.30 - 0 . 09 0.09 0.21 0.48 0.33
(5) (4) (8) (7) (6) (3) (1) (2)
1984 - 0 . 05 0.42 - 0 . 13 0.13 -0.03 -0.03 -0.39 - 0 . 42
(4) (1) (5) (2) (3) (3) (6) (7)
238
LOCKE
Table 6
Correlation of city housing rates of return*
Pearsons correlation
Adelaide Brisbane Canberra Melbourne Perth Sydney
Adelaide 1.000
(0.000)
Brisbane - 0 . 0288 1.0000
(0.420) (0.000)
Canberra 0.1157 0.2800 1.0000

(0.207) (0.022) (0.000)
Melbourne - 0 . 2105 0.101 - 0 . 2745 1.0000
(0.067) (0.472) (0.024) (0.000)
Perth - 0 . 0558 0.0061 0.0315 0.1906 1.0000
(0.347) (0.483) (0.412) (0.088) (0.000)
Sydney - 0 . 1243 0.0453 - 0 . 2209 0.4462 - 0 . 0182 1.0000
(0.190) (0.375) (0.058) (0.000) (0.449) (0.000)
* The correlation coefficient is reported and in brackets underneath is the significance level.
Melbourne and Sydney which are highly correlated (that is they satisfy the test at
the 0.001 signifidance level), there is no strong relationship between the various
capital cities. Although the returns are normally distributed, two nonparametric
correlation tests were also estimated, viz the Kendall and Spearman rank
correlation coefficients. These confirm the parametric estimates made using the
Pearson product moment correlation procedures.
The Treynor index requires an estimation of the beta for each security to be used
as the denominator in the calculations. The market model is typically used to
obtain the best coefficient:
Ri = ai + bi Rmt (7)
Rudd and Rosenberg (1970) discuss the applicability of this procedure for the
estimation of the market risk parameter, beta, and suggest it is an appropriate
method. There is little purpose served in estimating an ordinary least squares
(OLS) regression, which is the preferred method of calculating beta (Matolcsy
et al., 1985) on 11 observations for each year if it is possible to include more data.
The parameter estimates are not particularly robust when the number of degrees of
freedom is small, and the diagnostic statistics tend to be less reliable due to the
limited number of degrees of freedom.
It has been found that beta tends to remain stable over a time period of around
five years (Rosenfeldt, Greipentrog and Pflaum, 1978). Accordingly, the market
model regressions reported in Table 7 are estimated on the full data set from 1981
to 1984 for each security. The expected distortion associated with the problem of
239
Table 7
Ordinary least square regression estimates of the market model*
Adelaide RA = 0.036 - 0.014
(1.746) (-0.687) R2 = 0.009
DW = 1.266
Brisbane RB = 0.049 - 0.01
(1.246) (-0.244) R2 =0.001
DW = 2.182
Canberra 0.026
RC = 0.08 -
(1.36) (-0.437) R2 =0.004
DW = 2.003
Melbourne RMe = 0.089 - 0.008 RM
(1.125) (-0.098) R2 = 0
DW = 2.073
Perth RP = 0.102 - 0.001 RM
(1.033) (-0.011) R2 =0
DW = 2.076
Sydney RM = 0.125 - 0.015 RM
(1.08) (-0.122) R2 =0
DW = 2.011
omitted items and inappropriate weightings in the market portfolios are not a serious cause for concern.
However, sectoral indexes are found to be unreliable as a basis for comparing portfolio performance.
The OLS estimates of the market model* are reported in equation form. The t statistic is shown in
brackets under each coefficient estimate, and the R2 and Durban-Watson autocorrelation statistics are
reported. The results are in many respects interesting. The estimated ai and bi coefficients are not
significantly
* In this paper a broadly representative stock market index, which is readily available, is adopted as
a proxy for the market. This is consistent with traditional research and applications of CAPM. The
Statex Accumulation Index consists of shares in companies listed on the Stock Exchanges. Although
companies hold real estate and property companies, known as property
trusts, are included in the index, real property per se is not a component of the index. While
it is desirable, from an econometric perspective, that the regressand is not included in the
regressor, it may well be argued that the Statex Index is inadequate as a proxy for the market.
The question of what is an appropriate proxy for the market, when applying CAPM to real property,
is a topic which may require further consideration. In particular, matters such as the efficiency of the new
market proxy, potential bias and consistency will need careful attention.
240
LOCKE
different from zero in a statistical sense. The explanatory power of the model is
zero but this is to be expected given the estimates of the coefficients. The series of
housing returns are not correlated with the market as represented by the Statex
Index. The lack of autocorrelation except in the Adelaide return series is at least
pleasing.
Division by zero required to calculate the Treynor index poses a problem. In the
light of the poor market model estimates it is doubtful whether a capital market
derived method of performance is useful at all. However, the rates of return on the
various assets are known to be normally distributed, and the market model may be
derived as a relationship between multivariate normal variables (Fama, 1976, Ch.
3). Nevertheless, if the returns on these securities do not satisfy the requirements of
the weak-form of the efficient market hypothesis (EMH) then little point is served
in applying this model. The weak-form EMH requires that there is no information
left in past prices which can be used to predict future prices. This implies that
charting price movements is no use for predicting the next price. Normality is not a
sufficient condition to ensure a variable is efficient in relation to the weak form test.
There are many alternative approaches available to investigate the weak-form
EMH. An autocorrelation test, which is a standard approach to evaluating the
random walk model, and the less restrictive runs test are applied to the return
streams (Dyckman et al., 1975, p. 17). Formally, the autocorrelation test requires
the correlation at all lags to be zero. However, the choice of a significance level of
5 per cent allows the sample correlations to have non-zero values. These are tested
such that there is 95 per cent confidence that they are not so large as could not have
occurred by chance. The 5 per cent significance level is adopted for testing the two
null hypotheses. A summary of the results of these investigations is recorded as
Table 8.
The respective null hypotheses of no autocorrelation and an adequate number of
runs are not accepted when applied to the returns on housing. The presence of both
serial correlation and an insufficient number of runs suggests that technical
approaches to forecasting price, such as filter rules, will lead to favourable results.
Table 8
Weak-form EMH tests
Autocorrelation
test 5% Runs test 5%
Security significance level significance level
Adelaide housing Reject Accept
Brisbane housing Reject Reject

Canberra housing Reject Reject
Melbourne housing Reject Reject
Perth housing Reject Reject
Sydney housing Reject Reject
241
The implication of these findings is that equilibrium capital asset pricing models are not
appropriate as the basis for performance assessment.
Property indexes
As previously mentioned there are difficulties in obtaining groups of homo-geneous
properties from which a time series of returns may be calculated. Besides the housing series
used for the above discussion several other property value series are available.
Richard Ellis have recently released the Australian Property Index Part 1 Mel-bourne
which includes the years 1970 to 1984. 'The properties included in the analysis have been
selected on the basis that they are representative of a commer-cial property portfolio. Each
property has been valued annually since 1970 and data relating to valuation, market income,
recoverables, gross income, outgoings, reversionary potential, net income and yields are
collected each year from historical records and forms the basis of the analysis' (Richard Ellis,
1984, p. 3).
In terms of basic concept, the Richard Ellis indexes are similar to those that Jones Lang
Wootton produce in Britain. The JLW series of indexes include retail, industrial, agricultural
and office portfolios. An important distinguishing feature of the RE indexes is the choice of
the money weighted rate of return as compared to the time weighted rate of return. JLW state
'the use of time-weighted returns has been the accepted method of comparing various
investment media since its recom-mendation in a paper issued by the Society of Investment
Analysts in 1972 and is the method used for the JLW Index' (JLW, 1984, p. 7).
When the two approaches are expressed in formula form the differences are readily
apparent:
Money-Weighted Total Return (MWR) =
(8)
Time-Weighted Total Return (TWR) =
(9)
Specifically, the MWR incorporates an explicit adjustment for any change to the portfolio
holding through the period.
The AMP publishes the aggregate results for various investment sectors within the No. 2
Fund (AMP, December, 1984). The net investment result is measured by changes in the unit
price. The P Units are the property investment sector and these represent the portfolio of
properties in which the Fund invests. It is possible to utilise the P Units' price as an index and
from this calculate the single period rates of return (Equation 1).
242
LOCKE
An interesting feature which emerges when these aggregate portfolios are used as a proxy
for property values is the lack of transaction data. Very few of the properties which constitute
the regimen of these baskets are ever sold. The values are in fact values ascribed by
professional valuers on either a yearly or two-yearly basis. Thus the returns calculated on
appraised values are one step further removed from the market place. The use of comparable
valuation in place of comparable sale as datum for the appraisal process further distorts any
such series. Serial correlation is very likely to be observed and this indeed is the case.
The Valuer-General of the State of Victoria each year prepares a report on Property Sales
Statistics. This publication contains details of a property trend index for the Melbourne
statistical division. The 'aggregated sales' are used to produce the trend indexes for Dwelling,
Commercial, Industrial, OYO (own your own) Flat and Vac. Res. A. (vacant residential land).
Table 9 presents the results of the two weak-form EMH tests and the normality test,
previously discussed, when applied to the returns calculated from these indexes. Although
the majority of the series satisfy the normality test there are problems, once again, with the
tests of market efficiency. The implications of this are discussed below in the final section of
the paper.
4. Nonmarket performance measures

A Sydney stockbroking firm (Norths, 1984) published in August, 1984, a major review of
Property Trusts. The report attracted considerable interest in the business/ financial press,
especially as a performance ranking of property trusts on a 1 to 10 scale was incorporated in
the report (pp. 37-38). The rankings are based on a number of subjective factors. Norths
state:
Table 9
Weak form EMH and normality test
Autocorrelation Runs test 5%

test 5% Normality test 5%
significance level significance level significance level
Richard Ellis Return Reject Accept Reject
Richard Ellis Capital Accept Accept Reject

AMP P Series Accept Accept Accept
Vic Commerce Accept Accept Accept
Vic Industry Accept Accept Accept
Vic Dwellings Reject Reject Accept
Vic OYO Flat Reject Reject Accept
Vic Vac. Res. A. Accept Accept Accept
243
'We have attempted to rate all or most of the property trusts — listed and unlisted — on
a scale from 1 to 10, and have considered a variety of factors when arriving at the
rating. These factors included the calibre of the manage-ment team, the size of the
trust, quality of properties, leases, and also past performance where applicable' (p. 37).
The actual weightings ascribed to each of these factors are unknown and it is impossible to
ascertain the consistency with which the weights were applied in the evaluation of each trust.
In a reasonably efficient market is it likely that information regarding factors such as

these will be impounded in the price of the security. In the case of listed property trusts it is
reasonable to presume that, in the absence of evidence to the contrary, the requirements of
weak-form market efficiency are satisfied. Accord-ingly, it is appropriate to assume the
market is capable of assessing the performance of each individual trust in determining its
equilibrium price. The results in terms of acceptance or rejection of normality,
autocorrelation and runs tests for the listed property trusts, which have operated continuously
from January, 1981, are reported in Table 10.
Table 10
Listed property trusts EMH tests
Normality Autocorrelation Runs
5% 5% 5%
significance significance signifiance
level level level
ASC Property Yes Yes Yes
Canberra Commercial Yes Yes Yes
Canberra Commercial No 2 Yes Yes Yes
PML Property Yes Yes Yes
Stocks & Holdings Property Yes Yes Yes
General Property Yes Yes Yes
National Property Yes Yes Yes
Equitable Property No 1 Yes Yes Yes
Equitable Property No 2 Yes Yes Yes
Stockland Property Yes Yes Yes
Westfield Property Yes Yes Yes
Terrace Property Yes No No
The Treynor index is calculated using the 41 returns for the period 1st January, 1981, to
31st May, 1984. The average of the 13-week Treasury Note yield, over the same period, is
used as a proxy for the risk-free rate. Table 11 presents a com-parison of the rankings
obtained from the Treynor index and from Norths' study.
244
LOCKE
Only those property trusts listed in the Norths Report which operated continuously from
January, 1981, to August, 1984, are included in the study. This is done so as to ensure that
there are sufficient observations for the estimation of the betas. The comparison in Table 11
shows a significant difference in the ordering obtained from the two indexes, indicating a
difference in the manner in which the market assesses performance as compared with the
Norths' Report.
Table 11
Comparison of Treynor and Norths ranking
Name Treynor North

Canberra Commercial No 2 1 5
Canberra Commercial 2 5
Equitable Property No 1 3 9
Westfield Property 4 2
General Property 5 1
Stockland Property 6 2
Equitable No 3 7 8
ASC Property 8 5
Schroder Darling Property 9 2
There are three plausible explanations as to why this might be the case.
(1) The market may be wrong. If this is the case then it is likely the market will react
quickly to impound the news in the Norths' 'Review' once it becomes available. A study of the
announcement effect based on cumulative abnormal residuals is undertaken in another paper
(Locke, 1985). The market model is used to estimate beta over a 32-month period from
February, 1980, to July, 1983. Abnormal and cumulative abnormal returns are calculated for
the 12 months preceding the publi-cation of the 'Review' in August, 1984, and six months
subsequent to its release. The property trusts are subdivided into two groups, made up of
those receiving favourable and those receiving unfavourable recommendations. The formal
testing of the proposition that there is no reaction is not rejected at the 5 per cent signifi-cance
level.
(2) The weights attached by Norths to the various factors may be inappropriate. A
regression based procedure could be utilised to estimate these factor coefficients empirically
and to ensure internal consistency in the processing of information. Unfortunately, there are
no data available to check the sequential processing accuracy of Norths' analysts but this
could provide an interesting topic in human information processing research.
(3) A combination of (1) and (2) above.
245
Valuation technique
A difference in methodology and outlook between the appraisal procedures of
valuers and the theory of economic value used in finance may contribute to the
explanation of the differing results. Specifically, if valuers ascribe values to assets
which are not reflected in the market price of the securities, then it is likely that a
valuer's approach to assessing the performance of a fund will differ from the market
concensus.
Listed property trusts are in essence property investment companies having
shares traded on the stock exchange, as does any other listed company. The pro-
ductive activity of the company is the ownership of various properties. These
properties are periodically (yearly or two-yearly) revalued by professional valuers

and are appraised at market value 'which can be defined as the money obtainable
from a person or persons willing and able to purchase an article when it is offered
for sale by a willing seller' (Millington, 1982, p. 35). The market value should be at
or near the present value of the asset in a competitive market. As a result, a divisible
proportion, such as a share, in a company which only owns assets valued at market
should be in strict proportion to this valuation. In other words the capitalised value
of a listed property trust should equal the value of its net tangible assets at the time
of valuation.
A comparison of the net tangible assets with the capitalised value of listed
property trusts as presented in Table 12 shows this not to be the case. A difference
in the time at which the valuations are based and the data on which the capitalised
value is calculated may be responsible for some of the difference. The divergence
has also been noticed in Britain. Blandon (1983, p. 117) commenting on this
phenomenon, remarks 'The property valuers are themselves trained more in the law,
technology and institutions regarding property than in theories of financial
economics that are relevant to the rigorous analysis of investment potential in
property'.
The question therefore is to what extent modern financial approaches to valua-
tion are feasible in pricing property. There appears, for example, to be a failure to
recognise the theoretical superiority of NPV in terms of a utility maximisation
approach to investment. The 'professional valuation' literature reveals a failure to
appreciate the importance of risk viewed in a portfolio context.
Sykes (1982, p. 253) argues that there is little evidence to suggest that a concept
of risk is employed by professional valuers. The adoption of sensitivity analysis and
simulation techniques is advocated as an advancement but these still do not address
the issue of how to estimate the risk adjusted rate of return required for the calcula-
tions. Unfortunately, the investigation reported in this paper suggests the market
model is not an appropriate method for estimating an index of market risk for real
property.
246
LOCKE
Table 12
Property trust net tangible assets/price
Property trust 1983 1982 1981

ASC Property 73 77 89
Canberra Commercial No 2 48 85 172
Canberra Commercial 269 85 99
Equitable Property No 1 67 65 91
General Property 80 92 101
Natprops Property 0 110 130

PA Property 0 150 0
PML Property 108 129 114
Schroder Darling Property 155 109 0
Stockland Property 111 131 0
Terrace Property 67 80 90
Westfield Property 100 0 112
Stocks & Holdings Property 74 67 109
5. Conclusion
The current enquiry commences with the presumption that information relating to the
performance of investments is useful for investors. As considerable sums of money are
channelled into the real estate market each year it is desirable to assess the potential for
improving asset performance measurement in this market. However, a number of alternative
measures of performance are available such that selective choice of a specific measure, and
the related time interval, permits the reporting of favourable results at almost any time. To
counter this possibility, the adoption of a standard procedure, founded on appropriate
concepts of risk and return measured over regular intervals, is desirable.
The coefficient of variation is proposed as a useful scaling method to rank alternative

investments in terms of their risk adjusted returns. The theory of capital asset pricing, which
has developed in the financial securities market, provides a framework for the derivation of a
further three performance measures. Conceptually the Jensen and Treynor measures are
considered superior to the Sharpe procedure in regard to individual assets. As the first two are
linearly related the parsimonious alternative of Treynor's index is accordingly preferred.
The practical implementation of this measure for security performance assess-ment

implicitly assumes certain underlying statistical properties in the estimates. These statistical
requirements are in fact external signs of a deeper requirement of fundamental economic
relationships operating in the market, as expressed in the efficient market hypothesis. The
real estate market does not appear to satisfy the
247
basic weak-form EMH tests and this throws serious doubts upon the potential for applying
performance measures derived from the market model.
A conflict is found in terms of the assessed performance of listed property trusts when the
Treynor Index is compared with a reported index prepared according to a professional
valuer's approach. This type of conflict appears to be based on the approach adopted by
valuers in their assessment of risk and their reluctance to reduce valuations. This latter
observation is found in the ratchet effect observed in property price behaviour, where rather
than have the price fall property stays on the market unsold until prices catch up.
Further investigation is warranted into a semi-strong form EMH test of property trust
price response to. the release of valuation reports. More information regarding the approach
adopted by valuers with regard to property appraisal may shed light on the
valuation/performance anomalies observed. One possible way of letting the data describe any
consistent risk factors embodied in the return series is the use of a factor analysis of housing
returns. If stable risk estimates are obtained then a multiple factor performance index may be
developed.
* The helpful suggestions of an anonymous referee are gratefully acknowledged. All remain-ing
errors are the responsibility of the author.
248
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249
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Journal of Valuation

PERFORMANCE ASSESSMENT INDEXES AND CAPITAL ASSET

STUART LOCKE, (1987),"PERFORMANCE ASSESSMENT INDEXES AND

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*Related content and download information

Received: August 1986

comparison is to be at all meaningful. Given these basic requirements, the measure

Sharpe (1966) proposes that when investment is concentrated in a single asset or

Treynor (1965) uses the CAPM relationship to recommend the reward-to-

(Ri - Rf) = Ji + bi (Rm - Rf) (6)

3. Real property performance

Conceptually, there appears to be no difficulty in applying one or more of the

The returns on housing in each of a number of Australian capital cities presents an

Standard deviation of monthly rates of return

Year Sydney Melbourne Brisbane Adelaide Perth Canberra Market Property

is recorded in column (1). A division of the risk premiums by the standard

Canberra 0.1157 0.2800 1.0000

Brisbane housing Reject Reject

Money-Weighted Total Return (MWR) =

Time-Weighted Total Return (TWR) =

4. Nonmarket performance measures

Autocorrelation Runs test 5%

Richard Ellis Capital Accept Accept Reject

In a reasonably efficient market is it likely that information regarding factors such as

Name Treynor North

(3) A combination of (1) and (2) above.

properties are periodically (yearly or two-yearly) revalued by professional valuers

Property trust 1983 1982 1981

Natprops Property 0 110 130

The coefficient of variation is proposed as a useful scaling method to rank alternative

The practical implementation of this measure for security performance assess-ment

2.Colin Lizieri, Louise Finlay. 1995. International property

and the implications of a unitized property market. Land

Development Studies 7, 15-30. [CrossRef]

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