REAL ESTATE RISK PREMIUM AND FUNDAMENTALS: EMPIRICAL EVIDENCES FROM SINGAPORE

Abstract

This study examines the time variation of real estate risk premium in Singapore using data ranged from 1990Q1 to 2013Q4. Based on the decomposition of Gordon growth formula and existing theories, this dissertation formulates three hypotheses that propose the time-varying relationship between the change in risk premium and three economic fundamentals, namely inflation rate, interest rate and GDP growth. The relationship is examined via the adoption of a time series multi-factor model to estimate the coefficient of correlation between them. Before testing the hypotheses, risk premium is calculated using long-term expected rental growth and expected inflation that are forecasted using two respective models specified in this study. The main findings show that the change in risk premium varies positively with inflation rate, and negatively with interest rate. However, the relationships are moderate, as the absolute values of most of the correlation coefficients are smaller than 0.5. This is because the impacts of inflation rate and interest rate on real estate risk premium is weakened by the attractiveness of real estate as inflation hedge and the reliance on bank loans of leveraged real estate investments. The change in risk premium appears to be insensitive to the GDP growth. Time variations of real estate risk premium behave differently across different property sectors in Singapore as Inflation rate has the greatest influences on the risk premium in the residential sector while interest rate imposes larger impacts on the commercial properties risk premium.