Institutional investors have expanded their scope of investments in two important ways during the past 15 years. They have become more active in the direct purchase of real estate and they have become more global in their approach to investing. However, except for a few notable exceptions, U.S. institutions tend to stay close to home when it comes to real estate investments.
The increased presence of real estate and foreign stocks in the portfolios of institutions may have been motivated in part by academic studies that suggest that covariances between U.S. stocks and both foreign stocks and U.S. commercial real estate are quite low, indicating that the latter asset classes provide diversification to portfolios invested primarily in U.S. stocks. The reluctance to purchase foreign real estate directly is probably due to the increased expenses and the information problems associated with purchasing real property outside of the U.S.. In addition, there has been no research that we are aware of that examines the risk/return trade-offs involved in such investments.
In this paper, we take some initial steps towards understanding the relation between commercial real estate returns and stock returns in an international context. The analysis examines the relation between commercial real estate returns and stock returns in 17 different countries. These include the largest industrialized economies as well as some of the smaller economies in Asia’s emerging market. In addition to providing valuable information to institutional investors, we think this study has the potential to shed light on important issues regarding the relation between changes in commercial real estate prices and stock returns more generally. In particular, by examining a larger set of countries, we have sufficient data to examine somewhat longer holding period price changes and thus estimate regressions that we think better account for the smoothed nature of the commercial real estate time series.
Our investigation extends earlier studies which examine the relation between stock returns and price changes of commercial real estate in individual countries. As we mentioned above, academic research suggests that in the US, real estate returns and stock returns are not highly correlated and that the relation may in fact be negative. Using annual US data from 1947 to 1982, Ibbotson and Siegel (1984) found real estate’s correlation with S&P stocks to be -.06 whereas Hartzell (1986), using quarterly data from 1977 to 1986, estimated the correlation to be -.25. Worzala and Vandell (1993), using the Frank Russell Index and more recent quarterly data from 1980 to 1991 estimated the correlation to be -.0971. Geltner (1993), applying a “de-smoothing” procedure which alters the volatility of the real estate return index, reported a correlation of .3.
With respect to evidence from other countries, Lim (1992), using a quarterly transactions based index, estimated the correlation for Singapore to be .43. Worzala and Vandell (1993) estimated the UK real estate correlation with stock returns to be .039 whereas Geltner (1994), once again using a “de-smoothing” procedure reported a .38 correlation with UK data1. Although Stone and Ziemba (1993) documented a strong relationship between Japanese land prices and stock market performance, their study did not include commercial investment grade properties.
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