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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Panel B in Exhibit 4 provides a comparison of the performance of real estate securities against the corresponding returns of the market portfolios in each of the market. Based on the earlier observations, it is not surprising to observe that real estate securities in Thailand and South Korea have performed better than the general equities markets. On the other hand, those in Hong Kong, Indonesia, Malaysia, Singapore and Taiwan have fared worse than the general stocks. For example, the Sharpe Ratio of the general stock market in Singapore over the whole period (1992-2002) was 0.227, which is significantly higher than the 0.136 derived from an equally-weighted portfolio of Singapore real estate stocks.7

Determinants of Risk-Adjusted Performance

To identify the determinants of the risk-adjusted returns of real estate securities in East Asia, the Sharpe Ratio of the individual firms is regressed against a set of firm-specific and time-variant variables. For the regressions, all the real estate stocks in the sample are pooled on an equally weighted basis. After omitting observations with missing and extreme values, the final sample has 1,237 firm-year observations. Exhibit 5 tabulates the explanatory variables, the proxies used to measure the explanatory variables, as well as the pair-wise relationships between each of the variables in the regression models.

The parameters of Equation (2) were estimated for the whole sample period (1992-2002), as well as over two sub-periods: 1992-1997 and 1998-2002. In addition, another regression was also conducted that omitted observations that had a property asset intensity ratio of less than 30% from the study sample. This process effectively filtered out sampled firms that do not have substantial real estate assets. Preliminary tests using the Lagrange multiplier and Hausman statistic confirmed that the fixed-effects model is the most appropriate specification for the data set. The estimation results are presented in Exhibit 6. The R^sup 2^ values indicate that the explanatory variables together with the firm dummies were able to explain between 47.7% and 74.3% of the variations in the risk-adjusted returns of real estate stocks in East Asia.

As expected, the three market factors are highly significant in explaining the risk-adjusted performance of real estate securities. The Asian Financial Crisis and interest rate movements have an adverse effect, while the underlying economic performance has a strong positive influence on the risk-adjusted returns of real estate securities in the East Asia region. Consistent with existing literature on asset pricing, size and book-to-market value ratio captured most of the cross sectional variations in the real estate stock returns. The premium attached to small and value stocks persisted even after controlling for the influence of macroeconomic factors. The empirical evidence, therefore, indicates that stocks with small capitalization and high book-to-market value yield higher returns on a risk-adjusted basis.