CORRECTED RETURN AND RISK OF REAL ESTATE

Abstract

Financial and real estate markets are getting increasingly international in recent years. This trend has increased the need for comparative studies and research on investments both locally and globally. Past studies have found real estate to yield higher returns and lower volatility as compared to stocks and bonds. Inevitably, the studies have sought to compare the risks and returns of real estate with that of stocks and bonds on the premise that they belong to the same asset class. Such a direct comparison neglects the unique time-onmarket (TOM) characteristic of real estate. This paper provides an empirical analysis of how TOM affects asset allocation decisions by using an adjustment model to modify real estate returns. Results from both the Markowitz and Downside Risk frameworks indicate that even after TOM adjusting, real estate still played an eminent role in the formation of efficient portfolios. Efficient frontiers plotted under both optimisation models indicate that the removal of TOM from real estate returns also lowered the returns of portfolios which included real estate. A sensitivity analysis was also undertaken by altering TOM and examining the relative movement in the frontiers. Higher TOMs were found to lower the efficient envelopes at every level of return. Furthermore, the stock returns from sixteen property companies were adjusted and their new betas were calculated. The modified betas were found to be overpriced for the level of systematic risk they are exposed to.