Many real estate investors do not fully translate all investment risks

A required return is a necessary tool to determine whether an acquisition is worth the risk or not. It provides a minimum hurdle to give investors comfort. The difficulty is, however, that determining the correct required return is not very simple. It requires 3 fundamental properties. The required return needs to:

1. be linked to the asset allocation;
2. be a reflection of all involved investment risks;
3. be current, reflecting today’s capital market.

These properties might be slightly different from investor to investor, but the principle is always the same. If, for instance, the asset allocation assumes that real estate should be generating a 6% return and bonds a 4% return, then it is necessary to apply a 2% real estate risk premium. This assures that new real estate investments will provide the required return according to the strategic asset allocation.

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