Beta analysis, primarily used in finance, is becoming widely used in the real estate field to understand the characteristics of the real estate return by market and to construct optimal portfolios. Betas are calculated using the formula: 𝛽𝛼 = 𝐶𝑜𝑣(𝑟𝑎,𝑟𝑏)/𝑉𝑎𝑟(𝑟𝑏) ; where 𝑟𝑎 measures the rate of return of the assets in a metro area, 𝑟𝑏 measures the rate of return of the portfolio benchmark, and 𝐶𝑜𝑣(𝑟𝑎, 𝑟𝑏) is the covariance between the rates of return. In this case, Betas represent the performance of real estate investments relative to each other compared to the same criteria for the U.S. In simpler terms, for our analysis, think of Betas as a slope of the market line compared to the U.S.
As a test, we are extending the Beta analysis to dissect economic characteristics of the metropolitan areas. We are mainly using the employment growth relationship between metros and the U.S. Validity of the method could be questioned, but we believe historical relationships are not completely broken and can provide valuable insights for current and future economic analysis.
The U.S. map above, created in BatchGeo, shows 52 metropolitan areas color coded based on their respective Beta ranking. As previously mentioned, we used employment growth by market and the U.S. to calculate the Betas. The higher the Betas, the higher the volatility or risk. In our analysis, higher Betas mean the job growth rate going forward could outperform the U.S. but with higher uncertainty. Summary Analysis:
· Markets that are color coded in red show high Betas. Historically, these markets substantially outperformed during growth years but under-performed at a similar magnitude during recessionary periods.
· Will it be different this recession?
Ø We believe those metros with a highly educated labor force, a large share of office using jobs, and comparatively less “Blue Collar” jobs will fare better than others.
Ø Further, densely populated metros like those in the Northeast will have a harder time than those that are spread out like Dallas.
Ø In the backdrop of our view, Bay Area shows high Betas, but these metros are expected to comparatively lose less jobs, going away from what historical Betas would suggest.
Ø Las Vegas and Orlando, however, shows higher Betas, and does line up with our assumption as the metro is dominated by Leisure and Hospitality jobs and is expected to comparatively lose more jobs and recover slowly. But once the recovery does take hold, we expect it to accelerate as suggested by the Betas. We believe accelerated recovery will take hold in these metros after vaccine is discovered and widely distributed.
Ø Among the Texas markets, Austin shows higher Beta but Dallas-Fort Worth, Houston, and San Antonio show medium Betas. Houston and San Antonio will face slightly more challenges this year to come out of the downturn but how many jobs these metros will lose remains to be seen.
· Intuitively, the economic Betas calculated using job growth tend to line up with real estate Betas calculated using total returns by metros. You can test this by using NAREIT or NCREIF data. Having said that, the economic and real estate Betas tend to be more similar at the very high or very low coefficients. This is another example of job growth being a major driver of real estate, thus reflecting similar characteristics for metros.