Real Estate Equities – Real Estate or Equities?

Schätz, Alexander and Sebastian, SteffenEuropean Real Estate Society Conference 2009 in StockholmJune 24-27, 2009

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1. Direct Real Estate

- Portfolio Diversification Real estate = alternative investment Real estate = real asset Long-term investment horizons Low correlations and a distinctive risk/return structure Earlier studies found favourable characteristics:

o High stability of value

o Low volatilities

o Hedge against inflation

- „Disadvantages“ of Direct Real Estate Investments Illiquidity: Market volume, market spectrum Low information efficiency, insufficient market transparency High information costs, high transaction costs, reduced profit margins

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1. Listed Real Estate

- Ongoing expansion of securitized real estate

- Consequences: - Additional drivers affect the performance and risk/return structure

- Asset´s performance is dependent on current economic news, incorrect

analyst expectations and valuations,

- Risk: Irrational behaviour on stock markets

Listed real estate companies are faced with the risk that market values

are predominantly driven by developments on general stock markets

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1. General Stock Market Risk and Portfolio Allocation

- Limited benefits of listed real estate in terms of portfolio

diversification

- Risk of an involuntarily increased portfolio risk

- Risk of a portfolio allocation that is riskier than intended

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2. Objectives

Real Estate Equities: Real Estate or Equities?

- Can listed real estate still be characterised as real estate

investments in their primary meaning?

- Do the features as an alternative investment still persist despite

listing on stock exchanges?

- Do real estate investments still provide potential for diversifying the

investors´ portfolios?

- Still no incontrovertible evidence up to now!

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3. Literature: “Features of Real Estate Assets“

Author (Year) Method Findings

Ling and Naranjo (1999)

Real Estate Economics

Multifactor Asset Pricing Model (MAP)

•Exchange-traded real estate and equity markets are integrated

•Degree of integration increased during the 1990s

Glascock et al. (2000)

Journal of Real Estate Finance and Economics

Cointegration •REITs are rather comparable with stocks than bonds

Bond et al. (2003)

Real Estate EconomicsCAPM

•Substantial variation in mean returns and standard deviations across the examined countries

Hamelink and Hoesli (2004)

Real Estate Economics

Cross-sectional regressions

•Dominant role of country factors

•Relevance of size factors and value/growth factors

Westerheide (2006)

ZEW Working Paper

Engle Granger Test, ECM, Johansen Procedure

•In the long run: Real estate equities reflect the direct real estate; (weak) hedge against inflation

Morawski et al. (2008)

Financial Markets and Portfolio Management

Johansen Procedure

•In the short run: Real estate equities follow the general stock market

•In the long run: Real estate equities reflect the direct real estate

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Author (Year) Method Findings

Liu et al. (1997)

Real Estate Economics

According to Fama, Schwert (1977) as well as Geske, Roll (1983)

•Real estate do not represent a better hedge against inflation compared to common stocks

Liang and McIntosh (1998)

Journal of Real Estate Portfolio Management

Regressions and Rolling Correlations

•Positive linkage between employment growth of metropolitan areas and their property markets

Quan and Titman (1999)

Real Estate Economics Regressions

•significant relation between real estate prices and stock prices

•inflation-hedging characteristics in the long run

Sing (2004)

Journal of Property Research

Multifactor Asset Pricing Models (MAP)

•Macroeconomic risk factors are priced different in securitized and direct real estate markets

Hoesli et al. (2008)

Journal of Real Estate Finance and Economics

Vector error correction approach

•positive linkage between commercial real estate and anticipated inflation

•Negative linkage due to inflation shocks

3. Literature: “Real Estate and Macroeconomics“

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4. Methodology: Cointegration and VECM

Cointegration Tests

1. Trace-Test

H0 : There are at most r positive eigenvalues

H1 : There are more than r positive eigenvalues

p

λTrace = - T ∑ ln(1-λi)

r+1

2. Maximum Eigenvalue

H0: There are exactly r positive eigenvalues

H1: There are exactly r+1 positive eigenvalues

λmax = - T ln(1 -λr+1)

Vector Error Correction Model (VECM)

∆Y(n x 1) vector of the first

differences of stochastic variables

Гi

(n x n) matrices representing the

short-term dynamics

ß(n x r) matrix representing the r

cointegrating vectors

α(n x r) matrix containing the loading

parameter

μ (n x 1) vector of constants

εterror term

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5. Empirical Results: VECM (β – vectors)

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5. Empirical Results: VECM (β – vectors)

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0

10

20

30

40

50

1 2 3 4 5 6 7 8

NCREIF NAREIT CPIINTER GDP SP500

Variance Decomposition of NAREIT

5. Empirical Results: Variance-Decomposition

United States

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0

10

20

30

40

50

60

70

1 2 3 4 5 6 7 8

IPD RESTOCK CPIINTER GDP FTSE

Variance Decomposition of RESTOCK

5. Empirical Results: Variance-Decomposition

United Kingdom

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Thank you for your attention!