Real Estate Exposure and Asset Intensity

Article excerpt

Executive Summary. Real estate accounts for a signif icant proportion of the corporate assets of publicly listed companies. The real estate exposure of publicly traded companies in land scare economies such as Hong Kong and Singapore is particularly high. This study explores the real estate exposure of listed companies in Singapore where non-real estate companies are classified by their real estate asset intensity- A six-factor Arbitrage Pricing Theory (APT) model, capturing changes in real estate prices, industrial production, expected inflation, unanticipated inflation, risk premium and term structure, shows that real estate exposure is priced. In addition, the real estate risk premium is found to vary across companies with different real estate asset intensity. A close linkage is also established between real estate exposure and various industries. Other than the real estate-- intensive industries such as real estate, hotel and construction, conglomerates and financial companies also have a high exposure to real estate. Interestingly, our analysis shows that real estate exposure, which is computationally tedious to determine, can be proxied by real estate asset intensity, a simple accounting measure. The implications for portfolio management in a land-scare market are examined.

Introduction

Real estate has become an increasingly important component in the balance sheet of publicly traded companies, accounting for a significant proportion of the corporate wealth of these companies. Traditionally, real estate has been dominated by real estate companies, but this is no longer the case as more non-real estate based companies are investing significantly in real estate, be it for operational, investment or development purposes. For instance, real estate accounts for 25% of corporate wealth in the United States (Zeckhauser and Silverman, 1983) and 30% to 40% of total assets in industrial companies in the United Kingdom (Bryne and Lee, 1995; and Currie and Scott, 1991). In addition, real estate companies account for 25% of the Hong Kong stock market capitalization and all but one utility company and most conglomerates are involved in real estate investment and development (Chau, McGregor and Schwann, 1998). A similar case holds for Singapore (Jones Lang Wootten, 1991).

Increasing real estate exposure implies higher exposure to real estate market risk. If so, then according to the Arbitrage Pricing Theory (APT) (Ross, 1976), expected returns on non-real estate but real estate-intensive stocks should be sensitive to real estate market returns. In view of the increasingly significant real estate holdings of publicly traded companies, this study appeals to the APT to investigate if real estate exposure is a priced factor in the Singapore context.

This study extends the work of Chen, Hsieh and Jordan (1997) and Liow (1997). In Chen, Hsieh and Jordan, an APT model for equity real estate investment trust returns is estimated using macroeconomic variables and factor loading approaches. However, real estate was not a specified macroeconomic variable. Liow examined the real estate sensitivity of "real estate intensive" non real estate U.K. stocks and investigated whether this sensitivity is priced. A three-factor (stock market, industry and real estate market) APT model suggests that real estate is a factor priced in the stock market value of these firms.

This study can be differentiated from Liow (1997) in considering a comprehensive coverage of macroeconomic factors to avoid the issue of omitted variables. In addition, low real estate intensive nonreal estate stocks are also included to provide a comparative study. The first objective of this study is to examine whether stock returns on the companies listed on the Stock Exchange of Singapore can be explained by their real estate exposures. The second objective is to analyze the real estate exposure and risk premium of companies stratified by real estate asset intensity and by industry. …