S-REIT PRICING: FAMA-FRENCH THREE FACTOR MODEL AND LEVERAGE RISKS

Abstract

While REITs differ from other stocks due to limits on their debt levels, leverage could still influence their pricing when markets are credit-constrained. This research investigates if risks related to debt leverage are priced between 2004 and 2010. It uses only captive Singapore REITs (S-REITs) as their management structure introduces information asymmetries and may increase agency costs in financing decisions. As the sample period includes the 2008 Global Financial Crisis, the study also examines if new un-diversifiable risks arose during and were perpetuated after the crisis. The Fama-French Three-Factor Model is adopted as the base model, and is extended to test for leverage effects. The findings show that similar to stocks, small S-REITs outperformed large ones, and S-REITs with high book-to-market ratios outperformed those with low book-to-market ratios. Further, the risks related to leverage are priced in returns, and more leveraged S-REITs outperformed less leveraged ones. Nonetheless, the results do not show that higher risk premiums were required to compensate for leverage risks in the crisis period. This study has two broad implications. Firstly, both the Capital Asset Pricing Model and Fama-French Three-Factor Model are inadequate for S-REIT pricing. Secondly, from an investment perspective, there are common risk factors in REITs that are un-diversifiable. Arbitrage opportunities could be present since the market does not appear to be fully efficient, and investors hold different return expectations of REIT size, value and leverage. Additionally, to an extent, the defensiveness of captive S-REITs seems to hold, and this is likely due to the backing of large sponsors.