Measuring Economic Performance of Real Estate Developers in Australia: (A Longitudinal Study)

By Parle, Gabrielle; Joubert, Michelle et al. | The Journal of New Business Ideas & Trends, January 1, 2017 | Go to article overview

Measuring Economic Performance of Real Estate Developers in Australia: (A Longitudinal Study)


Parle, Gabrielle, Joubert, Michelle, Laing, Gregory K., The Journal of New Business Ideas & Trends


Introduction

Real estate is claimed to be a valuable form of investment providing potential for both capital gains (from growth in value) and income (from rental of the property). It is therefore not surprising that real estate assets are viewed as a less risky form of investment. Thus the possibility of investing in the shares of a real estate developer listed on the stock exchange could seem to be alluring to the public. The fact that a real estate developer has a large and potentially diversified portfolio of real estate assets does not necessarily mean that the annual profit (returns) are superior to other sectors. Traditional accounting reports and performance measures derived from them such as return on assets (ROA) fail to consider the cost of capital (Jackson, 1996). Thus the evaluation of profit performance in determining the growth in shareholder wealth may be viewed as misleading.

To better measure the earnings performance in terms of value relevant to the asset base of a firm the economic value added model (EVA) model makes allowances for the cost of capital (Stern & Stewart, 1993; Chen & Dodd, 2001). The economic value added (EVA) model was developed by Stern Stewart & Company and is a metric used to measure residual income (Biddel, Bowen & Wallace, 1999). Residual income considers that a firm creates shareholder wealth by earning more from its total invested asset base than the cost of capital. This overcomes the limitations inherent in traditional accounting measures where net profit is net of interest expense on debt capital (Biddel, Bowen & Wallace, 1999).

Literature Review

Research employing EVA has not been conclusive and although there are studies which have reported finding evidence that validates the use of EVA (Athanassakos, 2007; Kim, 2006; Zaima, Turetsky & Cochran, 2005; Worthington & West, 2004; Lehn & Makhija, 1997; O'Bryne, 1996, 1997; Grant, 1996; Yyemur, Kantor & Pettit, 1996; Walbert, 1994) other studies have reported that EVA is not superior to traditional accounting measures (Palliam, 2006; Tsuji, 2006; Griffith, 2004; Chen & Dodd, 2001; Clinton & Chen, 1998; Ray, 2001; Biddle, Bowen & Wallace, 1997). Chari (2009) attributed the conflicting results to the use of linear models and methods to assess returns and earnings which are not linear, ignoring inflation and failing to isolate the EVA effect when controlling for the economic consequence of the market.

Support for EVA is most commonly derived from research which focuses on comparisons against traditional accounting measures (Laing & Dunbar, 2015; Dunbar, 2013; Worthington & West, 2004) or to determine alternative measures of performance (Ratnatunga & Montali, 2008). Grant (1996) compared the EVA to company valuation and found that EVA had a significant relationship to market value. This was further supported by Uyemura et al (1996) which showed a strong correlation between EVA and market value the reported correlations of which were: EVA 40%, return on assets (ROA) 13%, return on equity (ROE) 10%, net income (NI) 8% and EPS 6%. The research by O'Bryrne (1996) focused on the comparison against net operating profit after tax (NOPAT) and found that EVA was superior in explaining a firm's market value than the NOPAT. Laing and Dunbar (2015) reported finding a strong correlation between EVA and market value in the banking industry but the results did not point to EVA being superior to traditional accounting measures. These results indicate that both EVA and market value added (MVA) are somewhat more relevant long-term measures than traditional accounting measures. This may be explained by the way in which accounting profit is derived by merely deducting interest charges in contrast to economic profit which subtracts the cost of all capital employed (Ooi & Liow, 2002). Subsequently, higher accounting profits are not indicative of an efficient use of capital and therefore may understate the actual cost of conducting business. …

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