Academic journal article The Journal of Real Estate Research

Past and Future Sources of Real Estate Returns in Hong Kong

Academic journal article The Journal of Real Estate Research

Past and Future Sources of Real Estate Returns in Hong Kong

Article excerpt

James R Webb*

K W Chau**

L. H. Li**

Abstract. Historical commercial real estate returns are attributed to three fundamental factors: initial current yield, growth in net operating income, and changes in going-in versus going-out capitalization rates (i.e., pricing movements). Separating returns into these three factors appears to provide more insightful information than the traditionally reported income and appreciation returns. Using this three-factor model, historical real returns and inflation pass-through rates are estimated for each major type of real estate (residential AIB/C, residential DIE, office, retail, industrial).


If aggregate real estate returns have at all been unbundled, it traditionally has been into their income and appreciation components. However, such an approach tends to obscure the fundamental sources of return. Returns from real estate investments can be attributed to three fundamental factors: initial current yield (net operating income divided by beginning value), growth in income (NOI), and changes in the going-in versus the goingout capitalization rates (i.e., price movements). For similar applications, see Graham, Dodd and Cottle (1962), Pagliari (1991) and Pagliari and Webb (1992) among others. The growth of NOI, relative to inflation, may be viewed conceptually as an indication of the property's long-run real (versus nominal) performance. If income growth keeps pace with inflation and the property is sold at or near the capitalization rate at which it was purchased, then the initial current yield is an effective indicator of the property's real yield (see Hartzell, Shulman, Langetieg, and Liebowitz, 1988; Pagliari, 1991). Since pricing movements have a declining importance as the investor's holding period lengthens, the initial current yield and the growth in income are the most important determinants of long-term yield.

Using data from the Hong Kong Government for unleveraged real estate by property type for 1979 through 1995, this study examines the historical performance of these three fundamental factors (current yield, growth in income, and pricing movements) and constructs a framework for evaluating future expected yields on Hong Kong real estate.

The Data

The data used for these analyses are from the Rating and Valuation Department of the Hong Kong Government for the period January 1, 1978 through December 31, 1995. Several different series are available. For purposes of this study, the following series were used: Residential-Class AIB/C; Residential-Class DIE; Office; Retail; Industrial. The data are quarterly total returns separated into their income and appreciation components. Though much has been written-see Geltner, 1989, 1991, and Quan and Quigley, 1991-about the inadequacies of appraisal-based valuations, this study assumes these values to be generated from market-based data and therefore approximately correct. For a discussion on the validity of appraised values, see Cole, Guilkey and Miles (1986).

Research Design


For each property type the nominal and real price changes and incomes are estimated. In addition, an implied capitalization rate is calculated (methodology shown below) for each property type for each year.

Next a performance summary is shown for each property type that is divided into three subperiods (1979-81, 1982-86, 1987-95). Each summary includes an inflation passthrough rate (increase in income as a percent of inflation), nominal and real income growth, initial yield, pricing movement, and nominal yield estimated by the DDM model (explained below).

Finally the nominal and real price indices, nominal and real income indices, and implied capitalization rates are graphed for each property type.

Theoretical Underpinnings

This study reconstructs returns into their underlying nominal income streams and market values. …

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