REAL ESTATE AND STOCK RETURNS: THE ARBITRAGE PRICING THEORY AND PROPERTY EXPOSURE

Abstract

This study explores the property exposure of publicly traded companies in Singapore. The main objective is to apply the Arbitrage Pricing Theory (APT) to investigate if property exposure is a priced factor and to determine the suitability of property asset intensity as a proxy for property exposure. The APT states that expected returns on an individual stock are influenced by a variety of systematic factors. In view of the trend of publicly traded property and non-property based companies investing significantly in real estate resulting in increased property exposure, a six-factor APT model was operationalised to investigate whether property exposure is a priced factor. The six macroeconomic are : Change in Property Price Index, Change in Industrial Production, Change in Expected Inflation, Unanticipated Inflation, Risk Premium and Term Structure. A Fama-MacBeth (1973) 2-stage regression is performed and results showed that property exposure is priced and property risk premium is found to vary across companies with different property asset intensity. In the determination of property exposure, the full and complex APT machinery have to be implemented. This prompted the investigation of the feasibility of using the computationally-simple property asset intensity as a proxy for property exposure. Analysis using Theirs (1966) Decomposition showed that property intensity can be regarded as a proxy for property exposure. This study carries important implication for academics, investors and portfolio managers. For the academics, APT was extended and applied to real estate in the Singapore context. For investors, portfolio managers and analysts, they should include property exposure as one of the factors in their stock returngenerating model and construct their portfolio management strategies accordingly. Investors and portfolio managers who wish to determine the property exposure of their stock could look to the property intensity of the company as a guide.