Risk-Adjusted Performance of Real Estate Stocks: Evidence from Developing Markets

Journal of Real Estate Research, The,  Oct-Dec 2004  by Ooi, Joseph T L,  Liow, Kim-Hiang

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This empirical study will first examine the historical performance of real estate securities traded in East Asia, and then explain the variations in their risk-adjusted performance. The data shows that the financial attributes of real estate firms in East Asia have indeed undergone major changes post-1997. No significant abnormal returns associated with real estate securities traded in East Asia between 1992 and 2002 were found. However, significant variations in the returns of real estate stocks were observed across different markets as well as across different firms within a country. To examine the determinants of risk-adjusted returns, a series of regressions on the composite and country-specific portfolios were conducted. Unlike previous studies, panel regressions to control for time-varying risk factors were employed. This is important to ensure that any fundamental risk factors that have significant explanatory power are not merely picking up the impact of omitted macroeconomic factors (see Ling and Naranjo, 1998).

The regression results show that macroeconomic factors dominate the fundamental factors in explaining risk-adjusted returns of real estate stocks in East Asia. Nevertheless, the findings indicate that significant premiums are attached to small-cap and value stocks, which continue to exist after controlling for market risk factors. The degree of diversification and financial gearing of the individual stocks also play a significant role in explaining their performance. Dividend yields have a limited influence, while asset structure and development exposure do not appear to have any significant impact on the risk-adjusted returns of property companies.

The next section briefly reviews the literature on the performance of securitized real estate. This is followed by a presentation of the research framework and the data source as well as a description of the financial attributes in the sample. Next is an analysis of the historical performance of real estate securities in East Asia and an examination of how the returns are related to the fundamental and market factors. The paper finishes with some concluding remarks.

Literature Review

The performance of real estate-related organizations is a widely researched topic in the real estate literature. Focusing primarily on REITs in the U.S., numerous studies have analyzed the historical performance of real estate organizations as well as tested whether they offer superior returns. Earlier studies, such as Kuhle, Walther and Wurtzebach (1986), Firstenberg, Ross and Zisler (1988) and Sagalyn (1990), came to the conclusion that REITs offered superior returns especially from the late 1970s to the mid-1980s. These findings were often interpreted as evidence that real estate is a particularly good investment that investors should add to their portfolios. However, recent studies employing a multifactor pricing model (as tabulated in Exhibit 1) failed to detect any superior returns. Chan, Hendershott and Sanders (1990) and subsequently, Peterson and Hsieh (1997), show that while abnormal returns could be earned using a simple capital asset pricing model (CAPM) framework, the return evaporates when a multifactor pricing model is employed. Liu, Grissom and Hartzell (1995), in a critical review of the literature on real estate performance, suggested that any superior real estate performance observed may be an illusion arising from an omission of certain fundamental factors in the estimates of risk.