Determination of the Value of Property Investments by Means of the Performance Potential and Risk-Return Improvement Ratio

Willem Keeris and Ruben Langbroek

ERES from European Real Estate Society (ERES)

Abstract: One point of criticism regarding the use of the standard deviation as a measure for risk is that it considers all deviations from the mean return level as risk factors. In this manner, positive deviations are also considered as risks, while actually these deviations offer opportunities. These opportunities must be taken into account throughout the investment decision process. Consequently, development of an effective Potential ratio is considered essential. The Upside Potential ratio of Sortino does not suffice, because it is based on the Minimal Accepted Return (MAR), which has no direct relation with the set targets for the management involved, i.e. the Target Return or T(R). For that reason, the Performance Potential ratio has been developed, which provides an outline of out-performing returns. Nevertheless, the full extent of investment performance is still not comprised completely with this analysis. After all, the balance between risk and return is the starting point of every investment. The added value of an investment is linked to the specific risk-return profile. Consider the following case, two investment options with more or less the same return, but with a different risk level. The investment option with the lowest risk level is preferred and adds more value. Therefore performance is not always a matter of higher returns. The Return/Risk Improvement ratio has been developed to enhance the insight into the added value of an investment. This paper describes the theoretical framework on which the two ratios are based and presents and explains the newly developed ratios.

JEL-codes: R3 (search for similar items in EconPapers)
Date: 2007-01-01
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