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“IS PROPERTY A GOOD HEDGE AGAINST INFLATION?
Sing Tien FooCentre for Real Estate StudiesNational University of Singapore3 August 2002
CPF Multiplier Seminar
Outline of Presentation
Investing in Property Market Why invest in Property? Historical performance of property vs. financial assets Is Property a good hedge against inflation?
Evidence in overseas markets Research Methodology
Types of inflation Empirical Results Implications for investors – Diversification Strategies Conclusion
Investing in Property Market
Direct Investment Residential Property, Office, Shop, Industrial Property,
Hotels Lands with development potential (institutional
investors/ collective sale sites) Indirect Investment
Property stocks, eg. CDL, CapitaLand, etc. Asset backed bonds, eg. Raffles City, Robinson Point, 6
Battery Road, Century Square, NOL, etc. Real Estate Investment Trusts, eg. CapitaMall Property
Trusts
Asset-Backed Securitization Deals
Issue
Date
Property Owner Market Value
Mar 99 Neptune Orient Line HQ
NOL $185 mil.
Jun 99 Century Square Shopping Mall
First Capital Corporation
$200 mil.
Jul 99 Robinson Point DBS Land $193 mil.
Sep 99 268 Orchard Road DBS Land $184 mil.
Nov 99 Tampines Centre DBS Land $180 mil.
Nov 99 Six Battery Road DBS Land $878 mil.
Mar 01 Raffles City Raffles Holding/ CapitaLand
$984.5 mil
Other Secondary Property Market Instruments
Hedging instrument Single Property Future
New mortgage instruments (Potential) Mortgage REITs Mortgage Backed Securities Commercial Mortgage Backed Obligations
Operation of Secondary Mortgage Markets
Direct Sale ProgramsMortgage Pools
Originators sell to FNMA.FNMA creates large pools of mortgagesFNMA sells securities from pool.
MortgageOriginator
CreatePool
Issue Securities
Investors
Why invest in Property?
For a wealth maximizing investor:Pride of ownership Desired rate of returnCapital appreciation Risk diversification Hedge against inflation
Historical Performance of Property Market (Q278 – Q498)
Expected Return Risk Correlation
SES-All Share 0.068% 17.908% 0.176
SES All-Property 0.225% 22.421% 0.217
URA All-Property 2.240% 6.761% 0.486
Residential 2.477% 6.538% 0.444
Industry 1.940% 8.859% 0.453
Shop 0.870% 9.721% 0.222
Office 2.081% 10.326% 0.406
Actual Inflation 0.618% 0.863% 1
Expected Inflation 9.185% 4.798%
Unexpected Inflation -8.556% 4.407%
Stock Vs. Property Returns
-160%-140%-120%-100%-80%-60%-40%-20%
0%20%40%60%
SES-All ShareSES-PropertyURA-Property
Property Returns – by sector
-60%
-40%
-20%
0%
20%
40%
60%
ResidentialIndustrialShopOffice
Historical Correlation Coefficients (3Q78 to 4Q98)
SESA SESP URAP RES IND SHP OFF
SESA 1
SESP 0.958 1
URAP 0.528 0.576 1
RES 0.547 0.582 0.980 1
IND 0.357 0.438 0.708 0.632 1
SHP 0.355 0.398 0.603 0.541 0.349 1
OFF 0.376 0.431 0.795 0.722 0.752 0.515 1
Overview of Historical Inflation Rates
Inflation is defined as an increase in general price level in the economy
Measured by CPI, GDP deflator, RPI Inflation rate in Singapore has been relatively
stable, especially over the last 10 years Average 0.62% per quarter (or 2.48%
annualized) 1978-1998
Inflation Rate (1978 – 1998)
-2%
-1%
0%
1%
2%
3%
4%
5%
Year-Qtr
Infl
atio
n R
ate(
%)
Second oil price shock
Mid-80s Recession
Asian Crisis
Is real estate a good hedge against inflation?
Real estate has been widely regarded as a good hedge against inflation vis-à-vis other financial assets
The study aims to empirically test the inflation hedging characteristics of the returns of real estate and other financial assets
Related research questions: Real Estate by sectors: residential, shop, industry, and
office Type of inflation: actual, expected and unexpected Over different sample periods Different inflation regimes Compared with different financial assets
Country-studies on Inflation Hedging
Mainly in US and other countries Comparing real estate and other assets In the US, REITs is used as proxy of real estate Using the classical Fama and Schwert (1977)
framework Serial-correlation is taken care of in the model In general, findings show that real estate is good
inflation hedge
Overseas Evidence (1) – Real Estate
In the US, real estate has positive hedge against expected inflation, but office and industrial property offer no significant hedge against unexpected inflation
In the UK, real estate offer good protection against inflation, and office and shop did not hedge against unexpected inflation
Capital returns hedge against unexpected inflation
Results of studies in Switzerland, Canada, New Zealand an dHong Kong are consistent
Overseas Evidence (2) - Stocks
In the US & UK, studies showed that stocks offer no significant hedge against inflation
In the UK, when returns were decomposed into capital and income returns, income did significantly hedge against inflation
Swiss stock market also offers no hedge against inflation
In New Zealand and Hong Kong, stocks offer negative hedge against inflation
REITs in the US, UK and Australia show no hedge against inflation
Overseas Evidence (3) – Bonds
Bonds offer no hedge against inflation in the US, UK, New Zealand and Australia
In summary, real estate offer good hedge against expected inflation, but not against unexpected inflation
Stock, real estate stocks (REITs), and bonds offer poor hedge against inflation in most of the countries under studies
Inflation & Inflation Hedging
CPI is compiled by the Dept of Statistics (DOS) Laspeye Index – a fixed basket of goods and
services in CPI 7 broad categories of goods & services in CPI basket: food,
housing, transport & communications, clothing, health, education and miscellaneous
Inflation hedging – the real return of an asset is independent of the rate of inflation
An asset is a complete hedge against inflation, if and only if the nominal return of the asset changes in a one-to-one relationship with both expected & unexpected inflation
Definition of terms
Nominal return: Rjt = Log (Pjt/ Pjt-1)
Inflation rate t = [CPIt – CPIt-1]/CPIt-1
Expected Inflation E(t|t-1) = Quarterly lagged T-bill rate
Unexpected Inflation = actual inflation – Expected Inflation: Ujt = t - E(t|t-1)
Data Source
Sample period 1978 Q3– 1998 Q4 URA all property price index and related sub-
indices SES all-share index Consumer Price Index (CPI) Treasury bill rate Nominal return
Rjt = Log (Pjt/ Pjt-1)
Theoretical/ Conceptual Framework
Nominal return of asset = real rate of return + expected inflation + unexpected inflation
Regression model
Positive inflation hedge not rejected: If and only if the nominal return of the asset moves in a
one-to-one relationship with both expected and unexpected inflation
)]|~
([)|~
()|~(),|~
( 1111 tttjtttjtttjt EEERE
jttttjttjjjt EER )]|~
([)|~
( 11
Empirical Models
Test against expected & unexpected inflations
Test against actual inflation Rjt = j + jΔt + jt
Five-yearly sub-period analysis I: 1978 – 1982 II: 1983 -1988 III: 1989 - 1992 IV: 1993 -1998
High vs Low Inflation Periods Analysis
jttttjttjjjt EER )]|~
([)|~
( 11
Empirical Results (1)
Expected Inflation
Asset Type Actual Inflation
Entire Sample Period
Sub-period+
Low Vs. High
Inflation#Real Estate IV
Residential IV
Office I
Shop
Industrial I High
Stocks IV
Real Estate Stocks
IV
Empirical Results (2)
Unexpected Inflation
Asset Type Entire Sample Period
Sub-period+ Low Vs. High Inflation#
Real Estate IV
Residential IV Low
Office II
Shop
Industrial I High
Stocks IV Real Estate Stocks IV
Analysis of Results (1)
See tables Real estate assets (industrial & shop) are better
hedges against inflation compared to financial assets
Industry show significant hedges against expected and unexpected inflations & shop hedge effectively against expected inflation
Residential property offers good hedge against expected and unexpected inflations for sub-period IV (1993-1998)
Analysis of Results (2)
Stock and property stocks also provide good hedge against expected and unexpected inflation in sub-period IV
Office and industrial property perform better in sub-period I (1978-1982)
In high inflation period, industrial is good asset for inflation hedging, whereas residential is more suitable during inflation period.
Industrial Return and Inflation
-30%
-20%
-10%
0%
10%
20%
30%
40%Industrial Actual InfaltionExpected Inflation Unexpected Inflation
Shop and Inflation
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
ShopActual InfaltionExpected InflationUnexpected Inflation
Residential Return and Inflation
-25%-20%-15%-10%-5%0%5%
10%15%20%25%30%
Residential Actual Infaltion
Expected Inflation Unexpected Inflation
Implications for investors’ Strategies
It is strategic to improve hedging capability of institutional portfolio by increasing the asset weight of industrial and retail properties
However, in Singapore, investment in industrial property is limited and dominated by public agency like Ascendas and JTC
Strict restrictions on industrial land uses limit the upside potential
For retail properties, majority of prime shopping centers are developed and managed by institutional investors for long term investment purposes
Implications for Investors’ Strategies
Economies of scale for single ownership for shopping centers – resources could be optimized for implementing crowd-pulling tenant mix strategies
New investment vehicles, new launched retail REITs and the proposed industrial REITs
For residential property, good news for investors/owners of CPF financed private residential property, their property value will be preserved in low inflation period
Residential property has performed well in 1993-1998 period
Stock and property stocks have also performed well against expected and unexpected inflation
Diversification Strategy
How much investment should be allocated to property and non-property assets?
Diversification benefits – not putting all your eggs in one basket
Using empirical returns data from 4Q1993 to 4Q 2000
Using Markowitz’s risk-return optimization framework
Minimizing portfolio risks for a given portfolio return No short-selling and no borrowing in the portfolio
Historical Return (4Q93 – 4Q00)
Expected Return Risk
Residential 1.22% 1.24%
Office 1.42% 1.25%
Shop 0.10% 0.81%
Factory 1.44% 1.20%
Warehouse 1.31% 1.58%
All-Pro 1.17% 1.17%
SES-Prop 2.39% 4.71%
CDL Share 6.30% 5.58%
SES-All 1.88% 3.58%
Optimal Portfolio Composition
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0.1% 0.4% 0.7% 1.0% 1.3% 1.6%
SES-All Share
Warehouse
Factory
Shop
Office
Residential
Optimal Portfolio Composition
0%10%20%30%40%50%60%70%80%90%
100%
OPt
imal
Ass
et W
eigh
t
0.1% 0.3% 0.5% 0.7% 0.9% 1.1% 1.3% 1.5% 1.7%
Portfolio Quarterly Return
SES-All Share Cum Property Weight
Efficient Portfolio Frontier – Risk & Return tradeoff
0.0%
0.5%
1.0%
1.5%
2.0%
0.0% 0.5% 1.0% 1.5% 2.0% 2.5%Portfolio Risk
Portf
olio
Ret
urn
Conclusion
Do not reject the null hypothesis that real estate is a good hedge against inflation
Real estate assets are better hedges against inflation vis-à-vis financial assets
Industrial & shop are good assets for inflation hedging purposes
Industrial and retail REITs offer alternative channels for increasing asset weights in portfolio
Residential property value will be preserved in low inflation regime
Real Estate composition in institutional portfolio is important for risk diversification purposes
Thank you