International Real Estate Securities: A Test of Capital Markets Integration

Article excerpt

Executive Summary. The investigation into the crosssectional and time-series differences in correlation coefficients between property stocks and broader equity indices in fourteen countries yields several interesting findings. First, the study found that correlation coefficients in many countries have not been stable over time, and in several of these countries there is a discernable trend toward integration or segmentation of the property sector with the broader equity market. Second, the study explored three hypotheses (Relative Weight, Global and Investment Structure) that would account for these differences and trends. While further quantitative work will be needed, the preliminary findings support two of the three original hypotheses. It appears that both a Global and Investment Structure hypothesis explain a great deal of the variation that is observed in market integration /segmentation across countries. More rigorous statistical tests will be needed to confirm these preliminary observations.

Introduction Real estate securities behave quite differently in each part of the world where they are actively traded. In some countries they exhibit a remarkably stable, high correlation with broader equities indices. In others they perform in ways that set them apart from other stocks. Moreover, as recent experience in the real estate investment trust (REIT) market in the United States shows, these correlations are not always stable-as market caps grow, the degree of integration with the broader equities market also changes.

This study explores the stability of these correlations over a fourteen-year period beginning in January, 1984. This study also proposes a taxonomy to be used in understanding the differences between international real estate securities markets. Finally, this study proposes some testable hypotheses to be used in order to better understand the integration (high correlation) or segmentation (low correlation) of real estate securities with broader equity markets in each of fourteen countries. International real estate securities experienced tremendous upheaval in 1997. The U.S. REIT market grew by an amount greater than its entire market cap in 1994. Asian securities dropped in dollar value by $100 billion, an amount approximately equal to the market cap of the entire European real estate securities market. The European sector came to life after many years of listless performance and produced total returns of 30%, but with relatively few new listings. Literature Review Previous studies have shown how the benefits of international diversification are greater for real estate stocks than for all stocks (Eicholtz, 1996). The most recent data also show that international real estate stocks push out the frontier for dollardemoninated investors who have already gone global with their equity portfolios (Gordon and Canter, 1998). The main reason for the beneficial diversification effect of international real estate securities is the relatively low correlations with the broader stock market in some, but not all, countries (Eicholtz, 1997). However, the authors of this study could find no research that explored the rationale for the variation in these correlations. Thus, this study examines the proposition that the degree of integration or segmentation of a country's real estate securities sector is largely a function of four important factors: * The size of the real estate securities sector relative to the broader equities market. * The degree to which the sector engages in crossborder transactions.

* The tendency of the sector to distribute earnings from lease income (as in an investment trust), or to retain earnings while generating a higher level of revenues from transactions (as in a property company).

* The degree to which the sector generates income from non-real estate activities. Data and Methodology The data set for this study consists of 423 real estate securities in fourteen countries with a combined market cap of $350 billion as of year-end 1997. …