DIRECT REAL ESTATE RISK PREMIUMS AND THE INSTITUTIONAL ENVIRONMENT

Abstract

This study examines the relationship between legal origins of a country and the total returns derived from investing in a country’s direct real estate. This is conducted via adoption of a multi-factor model to estimate the coefficient of correlation between the two factors. The study first utilises the quarterly direct real estate data from the Jones Lang Laselle Real Estate – Asia (JLL REIS-ASIA) index. Data from 13 cities in Asia and across 3 sectors (office, residential and retail) is extracted to form the dataset for this study. Findings confirm the existence of smoothing effects that cause temporal bias and seasonal lag. Geltner and Miller’s 1st and 4th order autoregressive model is adopted to de-smooth the direct real estate returns. The de-smoothed data is then used in conjunction with 2 macroeconomic variables (GDP growth rate and interest rate) and 1 real estate risk factor (vacancy rate) to form the structure of a multi-factor model. A pooled-panel analysis is conducted and factor loadings, or the sensitivity of the risk factor to the returns, are obtained. Results from the model estimation show that macroeconomic variables and real estate risk factors do affect the direct real estate investment returns. Vacancy rate commands the most significant premium due to its direct impact on the real estate returns as compared to the GDP growth rate and interest rate. The study then examines the relationship of legal origin and direct real estate returns by inserting dummy variables into the multi-factor model. It is found that both British Common Law and French Civil Law systems have a significant relationship and suggests that legal origin is a variable that will affect the returns of investing in a country.