The Art of Creating CRE Alpha

SAN FRANCISCO—In modern portfolio theory, Alpha is the excess return of an investment above the market or benchmark return. In the capital markets, Alpha is the excess return of common stocks above a benchmark like the S&P 500 Index or the excess return of a portfolio of corporate bonds above the Barclay’s Capital Aggregate Bond Index. The Alpha for REIT stocks would be the return in excess of the FTSE NAREIT Index. In CRE, Alpha is the excess return generated by the investment owner/manager above a market return like the NCREIF NPI Index. The Alpha return in CRE as opposed to stocks and bonds is primarily generated by the investment owner/manager through its control of the real estate asset. This hands-on control of the real estate asset, leases, income/expenses and capital structure enables the owner/manager to generate an Alpha return.

Each type of CRE, whether an office building, shopping center, industrial property or apartment complex has distinct income and cash flow properties. These properties primarily derive from the tenant leases that encumber the property. The type of lease, duration, rental rate, expense reimbursements and other lease provisions plus additional property income, determine the effective cash gross income of a property. Cash property operating expenses typically include repairs and maintenance, real estate taxes, insurance, management fees, salaries, utilities and administrative costs. The net of the effective gross income and operating expenses is the net operating income or NOI. NOI is considered one of the most important metrics in CRE and is used to apply the capitalization rate to calculate real estate value.