What Factors Determine International Real Estate Security Returns?

We use constrained cross-section regressions to disentangle the effects of various factors on international real estate security returns. Besides a common factor, pure country, property type, size, and value/growth factors are considered. The value/growth measure that is used in this paper provides for each security the relative importance of the value and growth components, rather than a binary classification. The value/growth factor is found to be volatile and to have a substantial effect on returns over the analyzed period February 1990-April 2003. Country factors are the dominant factors, and size is shown to have a negative impact on returns. Statistical factors derived by means of cluster analysis explain about one third of specific returns on international real estate securities. The implication for portfolio managers is that failing to recognize the importance of the various factors leads to the portfolio being exposed to systematic risk.securitized real estate, international diversification, multi-factor model, value/growth

The Integration of Securitized Real Estate and Financial Assets

Empirical evidence suggests that U.S. REITs are integrated with common stocks, but not with bonds. The design of the real estate security is likely to impact upon results, however, and it would seem important to analyze the topic of integration for another type of real estate security. Swiss real estate funds constitute an ideal candidate for such an examination as their institutional and legal setup differs substantially from that of other countries. We analyze the integration of such funds with both the stock and bond markets using an APT framework. We employ both the Xu (2003) method and an innovative procedure to determine endogenous and exogenous factors, respectively. Integration is assessed by means of two alternative tests. Our results suggest that Swiss real estate funds are more integrated with stocks than with bonds. Further, we show that the degree of integration between real estate and stocks is due to a stock market factor and changes in expected inflation. No integrating factor is found between real estate and bond funds. Finally, it is found that unexpected inflation is a segmenting factor between real estate securities and financial assets.Securitized Real Estate; Statistical APT; Macroeconomic APT; Market Integration; Risk Factors

Maximum Drawdown and the Allocation to Real Estate

We investigate the role of real estate in a mixed-asset portfolio when the maximum drawdown (hereafter MaxDD), rather than the standard deviation, is used as the measure of risk. In particular, we analyse whether the discrepancy between the optimal allocation to real estate and the actual allocation by institutional investors is less when a Return/MaxDD framework is used. The empirical analysis is conducted from the perspective of a Swiss investor using international data for the period 1979-2002. We show that most portfolios optimised in Return/MaxDD space, rather than in Return/Standard Deviation space, yield a much lower MaxDD, while only a slightly higher standard deviation (for the same level of return). The reduction in MaxDD is highest for portfolios situated half-way on the efficient frontier, typically close to those held by pension funds. Also, the reported weights for real estate are much more in line with the actual weights to real estate by institutional investors.Maximum Drawdown, Downside Risk, Portfolio Diversification, Real Estate

House Prices, Disposable Income, and Permanent and Temporary Shocks

This paper specifies a two-variable system of house prices and income for N.Z., U.K. and the U.S., covering periods from 1973:4 through 2008:2. The analysis allows the identification of differences in house priceincome relationships over sub-periods and, using an SVAR approach, compares the responses of house prices when faced with permanent and transitory shocks to income. It continues by decomposing each historical house prices series into their permanent, temporary and deterministic components. Our results suggest that while real house prices have a long-run relationship with real income in all three economies, the responsiveness of house prices to innovations in income will vary over both time and markets depending on whether the income disturbances are viewed as permanent or temporary. The evidence suggests that N.Z. and U.K. housing markets are sensitive to both permanent and transitory shocks to income while the U.S. market reacts to temporary shocks with the permanent component having a largely insignificant role to play in house price composition. In N.Z. the temporary component of house prices has tended to be positive over time, pushing prices higher than they would have been otherwise while in the U.K. both permanent and temporary components have tended to reinforce each other. Overall, there is no clear consistent global pattern regarding the importance of these shocks which implies that housing markets will react differently to the vagaries of global and domestic economic activity driving such shocks

International Evidence on Real Estate as a Portfolio Diversifier

This paper provides an international comparison of the benefits of including real estate assets – both domestic and international – in mixed-asset portfolios. Data from seven countries on three continents are considered for a common time period (1987-2001) to facilitate comparisons. Real estate returns are desmoothed using a variant of the Geltner (1993) approach, and Bayes-Stein estimators are used to increase the stability of portfolio weight estimations. Both unhedged and hedged analyses are conducted. Real estate is found to be an effective portfolio diversifier, and even more so when both domestic and international real estate assets are considered. The optimal allocation to real estate is in the 15 to 25% range, and remains remarkably constant in the various analyses. The breakdown of the real estate allocation between domestic and non-domestic assets, however, is found to vary substantially across countries and depending on whether returns are hedged or not.

Further Evidence on Debt-Equity Choice

Using a large sample of 5,365 European firms,we document the driving factors of debt-equity choices. Adjustments to a target debt level play a modest role except when debt exceeds an upper barrier, a result that underlines the importance of debt capacity. Preference for internal financing, leverage deficit prior to equity issues, as well as a high level of slack of firms seeking to reduce equity constitute further evidence in favor of pecking order models. It is also found that managers try to time the market by issuing shares when returns are high, but that there is a link between financing and investment activities as predicted by agency models.Dynamic capital structure; Debt-equity choice; Tradeoff models; Pecking order models

The Determinants of Stock Returns in a Small Open Economy

This paper examines the determinants of stock returns in a small open economy using an APT framework. The analysis is conducted for the Swiss stock market which has the particularity of including a large proportion of firms that are exposed to foreign economic conditions. Both a statistical and a macroeconomic implementation of the model are performed for the period 1986-2002 with monthly returns on industrial sector indices. The results show that the statistically determined factors yield a better representation of the determinants of stock returns than the macroeconomic variables and that stock returns are influenced by both global and local economic conditions. This suggests that the Swiss stock market is an internationally imperfectly integrated market.Statistical APT, Macroeconomic APT, Market integration, Risk factors

Monte Carlo Simulations for Real Estate Valuation

We use the Adjusted Present Value (APV) method with Monte Carlo simulations for real estate valuation purposes. Monte Carlo simulations make it possible to incorporate the uncertainty of valuation parameters, in particular of future cash flows, of discount rates and of terminal values. We use empirical data to extract information about the probability distributions of the various parameters and suggest a simple model to compute the discount rate. We forecast the term structure of interest rates using a Cox et al. (1985) model, and then add a premium that is related to both the real estate market and selected property-specific characteristics. Our empirical results suggest that the central values of our simulations are in most cases slightly less than the hedonic values. The confidence intervals are found to be most sensitive to the long-term equilibrium interest rate being used and to the expected growth rate of the terminal value.Real estate valuation; Monte Carlo simulations; Adjusted Present Value (APV)

Response speeds of direct and securitized real estate to shocks in the fundamentals

This paper contributes to the literature by identifying the response patterns of direct and indirect real estate returns to shocks in the market fundamentals. The response speeds are estimated with vector autoregressive models using TBI and NAREIT returns for the period 1994-2009 in the United States. To avoid the potential influence of different property mixes and of leverage on the dynamics, we use sector level data and deleveraged NAREIT returns. The findings indicate that REIT returns lead direct real estate returns even when catering for the property type and for leverage. Our estimations suggest that this lead-lag relationship is due to the sluggish reaction of direct real estate prices to unexpected changes both in the fundamentals and in REIT prices. The findings further suggest that the perceived lead-lag relations are not only due to the slow adjustment of sellers' reservation prices, but also due to the sluggish reaction of demand in the direct real estate market.Vector Autoregressive Models, Generalized Impulse Response Functions, Direct Real Estate, Securitized Real Estate, Dynamics

The Inflation Hedging Characteristics of US and UK Investments: A Multi-Factor Error Correction Approach

Historic analysis of the inflation hedging properties of stocks produced anomalous results, with equities often appearing to offer a perverse hedge against inflation. This has been attributed to the impact of real and monetary shocks to the economy, which influence both inflation and asset returns. It has been argued that real estate should provide a better hedge: however, empirical results have been mixed. This paper explores the relationship between commercial real estate returns (from both private and public markets) and economic, fiscal and monetary factors and inflation for US and UK markets. Comparative analysis of general equity and small capitalisation stock returns in both markets is carried out. Inflation is subdivided into expected and unexpected components using different estimation techniques. The analyses are undertaken using long-run error correction techniques. In the long-run, once real and monetary variables are included, asset returns are positively linked to anticipated inflation but not to inflation shocks. Adjustment processes are, however, gradual and not within period. Real estate returns, particularly direct market returns, exhibit characteristics that differ from equitiesInvestment Returns, Real Estate, Inflation Hedging, Error Correction Model