Impact of Corporate Governance Structures on the Relationship between Direct and Indirect Real Estate in China
Chau, K. W., McKinnell, K. G., Wong, S. K., Wei, Q., Newell, Graeme, Journal of Real Estate Portfolio Management
Executive Summary. While the indirect real estate market has been growing in Mainland China, the issue of corporate governance has emerged as a key concern for investors, as a number of cases involving stock manipulation have been revealed in recent years. This study investigates the degree to which corporate governance structures might be affecting the link between direct and indirect real estate in Mainland China. Based on data from 1994 to 2008, it was found that Mainland-listed property companies had a weaker linkage between direct and indirect real estate than Hong Kong-listed property companies. Regulatory reforms in the Mainland stock markets have, however, tended to improve the linkage, as well as selection returns for Mainland-listed companies. These findings suggest that corporate governance structure is in fact priced, and that it should be an important factor when considering between direct and indirect real estate investment in the PRC.
While indirect real estate is often considered a close substitute for direct real estate, one question that has never been asked is whether the place of listing of the relevant property companies matters. The principal aim of this study is to investigate whether, for real estate in China, there are significant differences in the performance of public real estate companies listed on the Hong Kong Stock Exchange as opposed to those listed on the stock exchanges in the People's Republic of China (Mainland China). The indirect real estate markets on these exchanges are among the largest in the world: Hong Kong ranked second while Mainland China ranked fourth globally by market capitalization, accounting for 19% and 6% respectively in December 2008 (Exhibit 1). The relative performance of these companies listed in the two places may be different for a variety of reasons; for instance, due to different listing rules, different financial systems, a difference between market participants, and/or the relative degree of market maturity to be found in the two markets. In this paper, this variety of institutional differences is combined and represented as differences in corporate governance structure.
In the real estate literature, two fundamental questions concerning direct and indirect real estate markets are often posed: (1) whether investing in indirect real estate is equivalent to investing in direct real estate? (2) whether direct and/or indirect real estate adds diversification benefits to a multi-asset portfolio? These two questions have attracted considerable research interest in recent years, mainly in the United States and the United Kingdom. The major findings can be summarized as follows:
* Direct vs. Indirect: Despite low contemporaneous correlation, indirect real estate performance has been found to lead direct property performance (Giliberto, 1990; and Barkham and Geltner, 1995). Correlation has also been observed after stripping out the equity factor (Giliberto, 1990; and Mei and Lee, 1994). Seeks study (1996) found that the substitutability between direct and indirect real estate investment was limited. However, Clayton and MacKinnon (2003) were able to show that direct real estate performance had become more important in terms of explaining indirect real estate performance post 1993.
* Indirect/Direct vs. Equity: Indirect real estate performance has greater correlation with equity market factors than with direct real estate performance (e.g., Ling and Naranjo, 1999). However, the panel-data analysis of Quan and Titman (1999) revealed a significant positive relationship between direct real estate performance and stock market performance. Mueller and Mueller (2003) suggested that both direct and indirect real estate does add diversification benefits to a multi-asset portfolio.
The above findings would indicate that the directindirect linkage has not necessarily been stable over time, but in general has become stronger as markets mature. …