Homogeneous commercial property market groupings and portfolio construction in the United Kingdom

Property portfolios are traditionally constructed by diversifying across ge ographical areas, property types, or a combination of both. In the United K ingdom it is normal practice to use regions rather than towns or local mark et areas as the geographical divisions. The authors use cluster analysis to construct homogeneous groups from 157 UK local markets, by means of commer cial property returns. The results show strong property-type dimensions and only very broad geographical dimensions in the clusters. These clusters ar e found, in general, to have temporal stability with changes in cluster mem bership being explained by the changing economic geography of the United Ki ngdom. The cluster-derived groupings are used to derive efficient investmen t frontiers and are compared with frontiers based on conventional heuristic groupings. It is shown that strategies based on parsimonious cluster-based groupings, appropriate for smaller investors, generate results that are co mparable with those of conventional groupings and capture the main drivers of property performance.