The diverging role of the systematic risk factors: evidence from real estate stock markets
| Published date | 02 February 2015 |
| DOI | https://doi.org/10.1108/JPIF-05-2014-0032 |
| Date | 02 February 2015 |
| Pages | 81-106 |
| Author | Stephan Lang,Alexander Scholz |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
The diverging role of the
systematic risk factors: evidence
from real estate stock markets
Stephan Lang and Alexander Scholz
IREBS Department of Real Estate, University of Regensburg,
Regensburg, Germany
Abstract
Purpose –The risk-return relationship of real estate equities is of particular interest for investors,
practitioners and researchers. The purpose of this paper is to examine, in an asset pricing framework,
whether the systematic risk factors play a significantly different role in explaining the returns of listed
real estate companies, compared to general equities.
Design/methodology/approach –Running the difference test of the Fama-French three-factor and
the liquidity-augmented asset pricing model, the authors analyze the effect of the systematic risk
factors related to market, size, BE/ME and liquidity in a time-series setting over the period July 1992 to
June 2012. By applying the propensity score matching (PSM) algorithm, the authors bypass the “curse
of dimensionality”of traditional matching techniques and identify a comparable control sample of
general equities, in terms of the relevant firm characteristics of size, BE/ME and liquidity.
Findings –The empirical results indicate that European real estate equity returns load significantly
differently on the size, value and liquidity factor, while the influence of the market factor seems
to be equivalent. In addition, the authors find an economically and statistically significant
underperformance of European real estate equities, after accounting for the diverging role of
systematic risk factors. Running the conditional time-series regression, the authors further reveal that
these findings are predominately caused by the divergent risk-return behavior of real estate equities in
economic downturns.
Practical implications –Due to the diverging role of the systematic risk factors in pricing real estate
equities, the authors provide evidence of potential diversification benefits for investors and portfolio
managers.
Originality/value –This is the first real estate asset pricing study to dissect the unique risk-return
relationship of real estate equities by employing propensity score matching.
Keywords Benchmarking, Performance analysis, Propensity score matching,
Real estate asset pricing, Real estate equities, Systematic risk factors
Paper type Research paper
1. Introduction
One of the most crucial issues in real estate research, and possibly the most contentious, is
the risk-return relationship of real estate investments. Undoubtedly, the significance of
direct property investments in a multi-asset portfolio context is well documented (e.g.
Giliberto, 1992; Hoesli et al., 2004; MacKinnon and Al Zaman, 2009; Brounen et al., 2010),
which can be attributed mainly to its low correlations with stocks and bonds. The potential
diversification benefits are, however, diminished by real estate market imperfections and
the inherent limitations of direct investments in real estate (Haran et al.,2013).Inparticular,
the indivisibility, immobility and heterogeneity of these investments result in a low degree
of liquidity relative to other asset classes, namely equities and bonds. By investing in listed
real estate, investors hope to eradicate this adverse illiquidity, while benefiting, at least in
part, from its diversification potential. Consequently, the market capitalization of European
real estate equities rose from €54 billion (EPRA, 2003) to €121 billion (EPRA, 2013) in the
Journal of Property Investment &
Finance
Vol. 33 No. 1, 2015
pp. 81-106
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-05-2014-0032
Received 15 May 2014
Revised 8 August 2014
Accepted 10 September 2014
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
81
Diverging role
of the
systematic
risk factors
past ten years, reflecting an increased attractiveness of this asset class. Due to the growing
demand of both private and institutional investors to use listed real estate as part of their
asset allocation strategy, a profound understanding of its risk-return behavior is required
(Nelling and Gyourko, 1998).
There has been a long controversy about the nature of real estate equities , thus
raising the question of whether they behave like general equities or more like the
underlying real properties (DeLisle et al., 2013). The integration of listed real estate with
the common stock market was first examined by Liu et al. (1990), applying the
methodology of Jorion and Schwartz (1986). According to this pioneering study, only
the systematic risk associated with the overall market portfolio is a priced determinant
on real estate equity markets, i.e. investors gain the same risk-adjusted returns on both
common stocks and real estate investment trusts (REITs). Based on these results, they
conclude that property shares are integrated with the general stock market, although
the underlying property market is segmented from it. The findings of Li and Wang
(1995) also suggest the existence of an integrated REIT market. First, the predictability
of REIT returns by means of the three forecasting variables of dividend yield, term
premium and default premium, is equal to the predictability of common stock returns.
Second, using a general two-factor model, the pricing errors for REIT returns are not
significantly different from zero. In this regard, several empirical studies support the
integration of listed real estate, by showing that the performance of property shares
closely mirrors the wider stock market (Ross and Zisler, 1991; Ling and Naranjo, 1999;
Clayton and MacKinnon, 2001; Chong et al., 2009). Applying a vector error correction
model (VECM), Sebastian and Schätz (2009), in contrast, argue that trends in the overall
market influence real estate equities only in the short run. In the long-term, the underlying
assets are the key driver of listed real estate returns. This is, the performance of property
sharesultimatelymatchthatofdirectrealestate investments. Furthermore, Wilson and
Okunev (1996), Wilson et al. (1998) as well as Morawski et al. (2008) find no evidence of a
long-run equilibrium between REITs and general stocks, based on co-integration analyses.
This missing link between listed real estate and general equities may result from diverging
risk factors driving real estate equity returns.
There are surely many real estate asset pricing studies which aim at identifying the
risk factors explaining the return variations on real estate equity markets. For instance,
Peterson and Hsieh (1997) demonstrate that US EREIT returns can be determined by
the Fama-French (1993) risk factors related to market (MRP), size (SMB) and BE/ME
(HML), which are derived from the general capital market. This relationship is
confirmed by Serrano and Hoesli (2007), who also find a significant effect of all three
common stock market factors on US EREIT returns. Likewise, in a pan-European
setting, Schulte et al. (2011) state that real estate security returns are significantly
related to market, size and BE/ME factors, a view supported by Scholz et al. (2014).
Using a liquidity-augmented asset pricing model, Scholz et al. (2014) provide evidence
that European real estate equities also load significantly on a liquidity risk factor (IML).
According to their results, the liquidity-augmented model is more appropriate than the
conventional asset pricing model of Fama and French (1993) for determining European
real estate equity returns. Further studies have attempted to determine the appropriate
contribution of market-wide and sector-specific risk factors, influencing the returns of
real estate securities (e.g. Kroencke et al., 2014). Despite the huge body of literature,
none of these studies has succeeded in answering the following questions: Do comm on
risk factors play a significantly different role in explaining the returns of listed real
estate? And if so, how would this affect the performance of real estate equities?
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