Academic journal article Real Estate Economics

International Real Estate Returns: A Multifactor, Multicountry Approach

Academic journal article Real Estate Economics

International Real Estate Returns: A Multifactor, Multicountry Approach

Article excerpt

We examine the risk and return characteristics of publicly traded real estate companies from 14 countries over the period 1990 to 2001. Our data are monthly country-level commercial real estate indexes constructed by the European Public Real Estate Association (EPRA). We find substantial variation in mean real estate returns and standard deviations across countries. Using various global- and country-level factor models, we find that there is evidence of a strong global market risk component, measured relative to the Morgan Stanley Capital International world index, in most countries. However, even after controlling for the effects of global market risk, an orthogonalized country-specific market risk factor is highly significant, especially for real estate indexes in Asia--Pacific markets. We find that a country-specific value risk factor has some explanatory power in addition to the country-specific market factor, but U.S.-based market, value and size risk factors do not provide any additional explanatory power. These findings imply that the international diversification opportunities with real estate companies are more complex than previously thought.

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The global market for publicly traded real estate companies has grown dramatically over the last decade. According to the European Public Real Estate Association (EPRA), the market capitalization of real estate companies reached almost $300 billion at the end of 2002. Given that the United States alone comprises almost $150 billion, or 50% of this market, it is not surprising that the majority of studies that model commercial real estate returns have been conducted on U.S. securities such as REITs or direct commercial real estate holdings, such as NCREIF indices. However, an increasing number of studies are addressing the risk and return behavior of commercial real estate in Europe and Asia. (1)

The aim of our study is to examine the returns of securitized real estate markets using new data provided by the European Public Real Estate Association. This recently released data set has been developed by a consortium of financial institutions in conjunction with NAREIT to promote awareness of the public real estate market and facilitate research into international real estate investment performance. It comprises monthly historical data on national indexes of almost 300 real estate companies from 14 countries in Asia, Europe, Canada and the United States. It has quickly become a benchmark index for reference in the financial markets in Europe and Asia with updates to the index widely disseminated on electronic data services.

We study the risks and returns of real estate securities in different countries using multifactor models of international asset pricing. These models incorporate not only global market risk factors, but also country-specific market risk factors. In addition, these models allow for extramarket risks, such as value and size risks, in the spirit of Merton's (1973) Intertemporal Capital Asset Pricing Model (ICAPM). We are inspired to investigate the importance of these additional risk factors in part by recent developments in the international finance literature (Fama and French 1998, Griffin 2002, Karolyi and Stulz 2003) and in part by successful applications of multifactor models in U.S. commercial real estate markets (Chan, Hendershott and Sanders 1990, Karolyi and Sanders 1998, Ling and Naranjo 1996, Ling, Naranjo and Ryngaert 2000).

This study makes two important contributions. First, the data reveal substantial variation in mean real estate returns and standard deviations across countries, but there is clear evidence of a common global market risk factor in international real estate returns (as proxied by the Morgan Stanley Capital International world index). We also find evidence of a significant country-specific market risk factor even after controlling for global market risk (Case, Goetzmann and Rouwenhorst 1999, Ling and Naranjo 2002). …

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