The long-term linkages between direct and indirect property in Australia
| DOI | https://doi.org/10.1108/JPIF-01-2015-0005 |
| Published date | 06 July 2015 |
| Pages | 374-392 |
| Date | 06 July 2015 |
| Author | Jaime Yong,Anh Khoi Pham |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
The long-term linkages
between direct and indirect
property in Australia
Jaime Yong
Edith Cowan University, Perth, Australia, and
Anh Khoi Pham
Cushman & Wakefield, Sydney, Australia and
University of Western Sydney, Sydney, Australia
Abstract
Purpose –Investment in Australia’s property market, whether directly or indirectly through
Australian real estate investment trusts (A-REITs), grew remarkably since the 1990s. The degree of
segregation between the property market and other financial assets, such as shares and bonds, can
influence the diversification benefits within multi-asset portfolios. This raises the question of whether
direct and indirect property investments are substitutable. Establishing how information transmits
between asset classes and impacts the predictability of returns is of interest to investors. The paper
aims to discuss these issues.
Design/methodology/approach –The authors study the linkages between direct and indirect
Australian property sectors from 1985 to 2013, with shares and bonds. This paper employs an
Autoregressive Fractionally Integrated Moving Average (ARFIMA) process to de-smooth a valuation-
based direct property index. The authors establish directional lead-lag relationships between markets
using bi-variate Granger causality tests. Johansen cointegration tests are carried out to examine how
direct and indirect property markets adjust to an equilibrium long-term relationship and short-term
deviations from such a relationship with other asset classes.
Findings –The authors find the use of appraisal-based property data creates a smoothing bias which
masks the extent of how information is transmitted between the indirect property sector, stock and
bond markets, and influences returns. The authors demonstrate that an ARFIMA process accounting
for a smoothing bias up to lags of four quarters can overcome the overstatement of the smoothing bias
from traditional AR models, after individually appraised constituent properties are aggregated into an
overall index. The results show that direct property adjusts to information transmitted from market-
traded A-REITs and stocks.
Practical implications –The study shows direct property investments and A-REITs are
substitutible in a multi-asset portfolio in the long and short term.
Originality/value –The authors apply an ARFIMA(p,d,q) model to de-smooth Australian property
returns, as proposed by Bond and Hwang (2007). The authors expect the findings will contribute to the
discussion on whether direct property and REITs are substitutes in a multi-asset portfolio.
Keywords ARFIMA, Cointegration, Commercial property indices, De-smoothing,
Granger causality, REITs, A-REITs
Paper type Research paper
1. Introduction
Australian property has emerged as an important asset class in the investment mandate
of both local and international investors. By December 2012, the total market value of the
Australian commercial property market was estimated to be A$681 billion (Higgins, 2013).
Journal of Property Investment &
Finance
Vol. 33 No. 4, 2015
pp. 374-392
©Emerald Group Publishing Limited
1463-578X
DOI 10.1108/JPIF-01-2015-0005
Received 26 January 2015
Revised 23 April 2015
Accepted 23 April 2015
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
The authors would like to acknowledge the partial funding provided by the Accounting and
Finance Association of Australia and New Zealand (AFAANZ) and the Edith Cowan University
Strategic Research Grant.
374
JPIF
33,4
The indirect market, represented by the listed Australian real estate investment trusts
(A-REITs henceforth), was valued at A$92 billion, representing over 6 per cent of the
Australian equity market by December 2013 (Ferguson, 2014). Globally, Australia is home
to the second largest REIT market in the world, accounting for approximately 10 per cent
of the total global REIT market capitalisation (Macquarie Equities Research, 2011).
For a typical investor, access to direct property can be limited for constructing
a multi-asset portfolio because direct property investment can be capitally intensive,
relatively more illiquid and incur large information and transaction costs. An
alternative to direct property investment is to invest indirectly into property, through a
listed investment vehicle such as a REIT. The attraction to property as a separate asset
class stems from the widely held perception that real estate is a defensive asset
and an effective hedge against inflation. Property investors can seek to protect their
wealth against inflation as such an investment provides not only capital growth, but
also constant rental income returns.
However, REITs trade in the market with stocks and there is some basis to believe
that securitised property will display both characteristics pertaining to real estate
investments, as well as those of general equities. This may undermine the ability
of REITs to completely substitute direct property in an investor’s portfolio. From this,
academics have aimed to determine if direct and indirect property markets are
integrated, and to what extent does information transmit from one market into the
other to influence prices and returns. Complicating matters is the extent to which
information from the financial markets influences the transmission of information into
the pricing of property markets.
The existing literature has acknowledged that though, the pricing mechanisms
of REITs, stocks and bonds are transaction based, the appraisal-based pricing method
for direct property can undermine the true estimate of volatility for property returns.
Attempts have been made to determine unsmoothed direct property returns, and this
paper will aim to address this issue with consideration for three effects when an
aggregate property index data are applied. The first issue we consider is the impact
of an appraisal-smoothing bias, which means that past valuations influence current
prices. The second issue is the impact of nonsynchronous valuations, where ind ividual
constituent properties which make up an index are valued at different points within
a quarter or a year, which then creates a measurement bias. Lastly, we consider the
potential that when individually smoothed property data are aggregated into an index,
the smoothing parameter for the index may be overstated due to averaging.
Our paper aims to study the linkages between the direct property market, A-REITs,
stocks and bonds using quarterly sample data from 1985 to 2013. We use an ARFIMA
(4,d,1) process to determine unsmoothed property returns, proposed by Bond and
Hwang (2007). We determine if there is a lead-lag relationship between asset returns
using Granger causality tests. Then we apply both the smoothed and unsmoothed
property data with A-REITs and other financial assets into the Johansen (1991, 1995)
tests for cointegration to examine the long-run relationships and short-term adjustment
coefficients, where we can then interpret how direct property and A-REITs react to
information transmitted across different asset classes.
The next section will review the existing literature on the integration of direct
and indirect property, with other financial assets, and the various methodologies used
to address appraisal-smoothing bias in real estate data. Then, we outline our sample
data and present the estimation methodologies. This will be followed by a discussion
of our results, and a conclusion.
375
Indirect
property in
Australia
To continue reading
Request your trial