Academic journal article Real Estate Economics

What Factors Determine International Real Estate Security Returns?

Academic journal article Real Estate Economics

What Factors Determine International Real Estate Security Returns?

Article excerpt

We use constrained cross-sectional regressions to disentangle the effects of various factors on international real estate security returns. Besides a common factor, pure country, property type, size and value/growth factors are considered. The value/growth measure that is used in this paper provides for each security the relative importance of the value and growth components, rather than a binary classification. The value/growth factor is found to be volatile and to have a substantial effect on returns over the period February 1990-April 2003. Country factors are the dominant factors, and size is shown to have a negative impact on returns. Statistical factors derived by means of cluster analysis explain about one third of specific returns on international real estate securities. The implication for portfolio managers is that failing to recognize the importance of the various factors leads to the portfolio being exposed to systematic risk.

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For stock portfolio managers executing a top-down approach, it is crucial to decide whether the strategy will be based primarily on countries, sectors, industries or some other factor such as size or value/growth. Diversification by sectors is growing in importance, but geographical allocation remains important despite the globalization of international financial markets. In this context, real estate securities are considered as one industry, but they are too often discarded from the strategic portfolio allocation. This is surprising given that real estate securities have been shown to be effective diversifiers of common stock portfolios (Liang, Chasrath and McIntosh 1996, Gordon, Canter and Webb 1998). Moreover, the correlation of U.S. REITs with common stocks has been declining (Ghosh, Miles and Sirmans 1996, Brounen 2003). Also, the market value of publicly traded real estate companies has grown substantially in recent years, with an estimated figure of US$340 billion as of April 2003.

Extensive research has been conducted since the 1970s on the benefits of international diversification for stock portfolios. There is also more recent evidence on the benefits of international diversification for portfolios of both direct and indirect real estate investments. The cross-country correlations are usually lower for real estate investments than for common stocks. There is evidence, however, of an international real estate factor (Ling and Naranjo 2002) and also of continental factors (Eichholtz et al. 1998). Country-specific factors remain important, however, which explains the diversification benefits. Eichholtz and Huisman (2001) show, for instance, that country dummy variables are usually significant in a model that also includes beta, size and interest rate variables.

When constructing a portfolio of publicly traded real estate stocks, much emphasis is placed on the analysis of the correlation coefficients across countries (or across continents). We argue that while these correlations are useful, it would be important to disentangle the effects of various factors on real estate company returns and hence on cross-country correlation coefficients. The aim of this paper is to calculate the pure effects of various factors on international real estate security returns. For this purpose, we use real estate security returns for the 10 countries with the highest market capitalization for the period from February 1990 to April 2003, and we extract such pure effects using a cross-sectional factor estimation technique. The factors that we consider are the following: a common factor affecting all securities, the well-known size effect first analyzed by Banz (1981), the value/growth factor of Fama and French (1992), the main property type in which the company invests and the country of origin of the security. Cluster analysis is used on the residuals of this analysis to ascertain whether an additional factor can be extracted once the effect of the common and pure factors has been eliminated. …

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