Dynamic Modelling of Real Estate Investment Ttrusts and Stock Markets

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Dynamic modelling of real estate investment trusts and stock markets

Chien-Chiang Lee

a,

⁎

_{, Mei-Se Chien}

b

_{, Tsoyu Calvin Lin}

c

a

Department of Finance, National Sun Yat-sen University, Kaohsiung, 804, Taiwan

b

Department of Finance, National Kaohsiung University of Applied Sciences, Kaohsiung, Taiwan

c_{Department of Land Economics, National ChengChi University, Taipei, Taiwan}

a b s t r a c t

a r t i c l e i n f o

Article history: Accepted 20 November 2011 JEL classiﬁcation: C32 G12 G15 Keywords:

Real estate securitization Real estate investment trust Stock price

Causality

Generalized impulse response approach

Taiwan launched thefirst case of real estate securitization in 2005. The interrelationship between Taiwan Real Estate Investment Trusts (T-REITs) and the aggregate equity markets and segmented industries has drawn the interests of both investors and academia. This paper employs Toda and Yamamoto's (1995) pro-cedure and the generalized impulse response approach to uncover the extent and the magnitude of the rela-tionship between T-REITs and aggregate and segmented stock prices. We collected daily data of thefirst two issued T-REITs, Fubon No.1 and Cathay No. 1, from March 2005 to March 2010 and October 2005 to March 2010, respectively, to examine their causal relationships with aggregate stock markets, thefinancial sector, and the construction sector. The empirical results indicate that all variables have break points, reflecting shocks from the Subprime Mortgage Crisis or deregulation of the Qualified Domestic Institutional Investors (QDII) for Mainland Chinese to invest in Taiwan. We also discover that an individual T-REIT may lead or lag behind stock price indices due to its capitalization scale or business type. The transitory initial impacts of innovations in T-REITs on stock price indices are observed herein.

1. Introduction

Research studies have broadly explored the price, risk, and return of real estate markets, and the influential factors and interrelationships with other investment vehicles (Sing et al., 2006). Thefirst strand of re-lated research focuses on the in_{fluence of macroeconomic factors, such} as interest rates and inflation on real estate investment trusts (REITs, hereafter).Gyourko and Keim (1992)found that important information about property market fundamentals is impounded in REIT returns, es-pecially when they are adjusted to control for general market factors.

Liang and Webb (1995)further stressed that the market risk of mort-gage REITs (MREITs) is mostly interest rate risk, which is not diversified away.Mei and Gao (1995)also concluded that REITs’ returns could be explained by a function of fundamental economic variables. Most of the research in this strand indicated that the returns of REITs are in flu-enced by some macroeconomic factors, such as inflation, interest rates, and economic growth (Kim et al., 2007).

The second category of real estate literature engages in exploring

the interrelationship between REITs. Nelling and Gyourko (1998)

found that there is only weak evidence of predictability of REIT

returns based purely on past performance.Subrahmanyam (2007)

explored the existence of joint dynamics across the REIT and non-REIT sectors. Impulse response functions and Granger causality tests

indicate the existence of persistent liquidity spillovers running from

REITs to non-REITs. Moreover,Liow and Webb (2009)demonstrated

that the magnitude to which correlations are shown in international securitized real estate markets might largely be through the increas-ing integrated nature of the world real economy, rather than a result of the globalization of_{ﬁnancial markets.}

The third group of related studies attempts to discover the interre-lationship between real estate investment and other vehicles,

partic-ularly stock markets. He et al. (1996) examined the relationship

between REITs’ returns and bank stock returns. They found that

MREIT explains the risks and returns of bank stocks better than equity REITs. Lizieri and Satchell (1997) explored that the wider equity economy leads the real estate market in the short term, however, positive real estate returns may point to negative future returns in the rest of the economy in the long run.Ling et al. (2000)indicated that an out-of-sample prediction of excess returns on an equity REIT has a lower power than an in-sample prediction.Hoesli and Camilo (2007)showed in an international analysis that securitized real estate returns are positively associated with stock and real estate returns, but negatively related to bond returns. More related studies also have shown that REITs and the general stock market are integrated (Ambrose et al., 2007; Laopodis, 2009; Liu et al., 1990). Some studies investigates the impacts of movements or volatilities of stock prices

on REITs (Ambrose and Bian, 2010; Cotter and Stevenson, 2004,

2006; Devaney, 2001; Stevenson, 2002), but their conclusion regard-ing the direction of a causal relationship between real estate markets and stock markets tends to be weak.

Economic Modelling 29 (2012) 395–407

⁎ Corresponding author. Tel.: +886 7 5252000x4825; fax: +886 7 5254899. E-mail address:cclee@cm.nsysu.edu.tw(C.-C. Lee).

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Economic Modelling

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In Taiwan the“Real Estate Securitization Statute” was promulgated in 2003. AsLee and Stevenson (2005)noted, REITs to some extent pro-vide a hybrid investment form, standing between equities and the ﬁxed-income sector. In addition, the asset maintains strong links with the direct real estate market. These inter-linkages provide such assets with unique characteristics. Real estate in Taiwan is extremely impor-tant for people's belief in the traditional notion of‘land is wealth.’1

With the introduction of this new mechanism, real estate can be trans-acted in the form of securities, which in turn increases its liquidity. In-dustries related to real estate in Taiwan have been eager to apply the securitization process for raising funds to liquidate real estate invest-ments. These REITs provide a new alternative for investment in the property market, which is traditionally considered as a secured, scarce, and precious but low-liquid vehicle for most Taiwanese investors. In the Taiwan context, people believe real estate is the most valuable asset, providing an interesting case for the empirical model of REITs.

Prior to the initial public offering (IPO), Taiwan REITs (T-REITs, hereafter) are required to go through an appraisal board meeting held by the government to evaluate the net asset value (NAV) for in-vestor protection. The appraisal meeting helps inin-vestors screen the fundamental value of the object's assets and also limits REITs’ appre-ciation potential. This special characteristic draws our interest to ex-amine the causal relationship of T-REITs with the equity markets, including the overall stock markets, thefinancial sector stocks, and the construction sector stocks.2The reason to examine the relation-ship of T-REITs with both thefinancial and construction sectors is that we want to discover what securitized real estate is like, or which of the following is related:financial vehicles, traditional con-struction, or direct real property investments.

This paper applies the Granger causality test ofToda and Yamamoto (1995; hereafter TY)to draw conclusions with regard to the causal rela-tionships between T-REITs and weighted stock prices. The TY (1995)

method is a modiﬁed Wald (MWALD) test in the VAR framework. The

concept of causality is basically related to the topic of market integra-tion/segmentation. The hypothesis for determining which direction the causal relationshipflows is most likely from stocks to real estate, given the concept that the real estate market is not liquid and may be inactive in prices when compared to the stock market. These move-ments of asset prices may reflect the behaviors of arbitrageurs and in-vestment managers balancing their portfolios. This information may also benefit investors who consider different prices as a part of their overall investment portfolios. Daily data of the first two issued T-REITs, Fubon No.1 and Cathay No.1, cover the periods March 2005-March 2010 and October 2005-2005-March 2010, respectively, and we exam-ine their causal relationships with the aggregate stock markets, and the financial sector and construction sector in Taiwan. The benefit from using the Granger causality test of TY (1995) is that it does not require knowledge as to the cointegration properties of the system and can be applied in the absence of cointegration (Lee and Chien, 2011).

The above method can also be used when stability and rank require-ments are not satisﬁed. The model estimation procedures are indeed quite simple, particularly in cases where there are more than two coin-tegrating vectors and when the OLS is valid. This paper also examines the transmission mechanism between these variables by applying the

generalized impulse response approach (GIRF) ofPesaran and Shin (1998). The impulse response analysis can trace a variable's directional responses to a one standard deviation shock in another variable. This achieves both direct and indirect effects of innovations on a variable of interest, thus enabling us to comprehensively estimate the dynamic linkages between T-REITs and the Taiwan Weighted Stock Index.

The remaining part of this paper is organized as follows. Section 2 introduces the development of real estate securitization in Taiwan. Section 3 brieﬂy describes the econometric methodology. Section 4 presents the empirical results. Section 5 offers the conclusion. 2. Real estate securitization in Taiwan

Up until 2009, a few countries in the Asia-Pacific region have implemented a real estate securitization mechanism, including Aus-tralia, Malaysia, Japan, Singapore, South Korea, Taiwan, Hong Kong, Philippines and India, while the U.K. and Germany in Europe are on their way towards following the mainstream. The REITs provide these countries with a new alternative for direct investment in the property market, which is traditionally considered as a secured, scarce, and precious, but low-liquid vehicle for most Asian investors. In Taiwan the“Real Estate Securitization Statute” was promulgated in 2005. There are two types of vehicles for real estate securitization in Taiwan: real estate investment trust (T-REIT) and real estate asset trust (T-REAT). T-REITs are similar to REITs in other countries and in-volve raising fundsfirst and then acquiring real estate targets. Like stocks, T-REITs have no specific investment period, while the structur-ing of T-REATs is very similar to that of asset securitization. T-REATs are established to_{first hold defined real estate with rental or operating} income for specific periods and then to raise funds in exchange for the particular properties. Capital gains are distributed to investors after the sale of the target properties for REATs. Both REITs and T-REATs are only allowed to operate as closed-end funds, and at least 75% of the funds must invest in existing properties or related rights that generate steady income as follows: asset-backed securities (ABS), bank deposits and acceptance, short-term commercial papers, and trea-sury bonds. Real estate development activities, although under discus-sion, are still prohibited for both portfolios of T-REITs and T-REATs.

Unlike the U.S. and Japan, Taiwan only allows the operation of an in-vestment trust (special-purpose trust) instead of an inin-vestment corpora-tion (special-purpose corporacorpora-tion). The minimum capital requirement for establishing a T-REIT is NT$1 billion and for a T-REAT is NT$300 million. (US$1=NT$30 in 2010 on average). For both T-REITs and T-REATs, any five certificate holders cannot own more than 50% of the total value of the issued certi_{ficates. The T-REIT is allowed to leverage financially for} the purpose of operation or dividend payout, but the maximum percent-age has not been regulated. The income of T-REITs is only required to be distributed within six months after everyfiscal year, but the ratio is not specifically regulated.

After the enactment of the“Real Estate Securitization Statute” in 2003, Taiwan introduced thefirst case of REIT to the public market in early 2005. Up through 2010, the accumulated market capitalization of T-REITs has reached US$1.8 billion, indicating the popular trend of real estate securitization for both investors and issuers in Taiwan. As stated above, T-REITs are required to go through an appraisal board meeting prior to IPO for evaluating the NAV for investor protection. The appraisal meeting helps investors screen the objective assets’ fun-damental value and also limits REITs' appreciation potential. Therefore, the pricefluctuation of T-REITs is smaller than those in the U.S. or in Japan. The low-risk and low-return characteristics of T-REITs also pro-vide investors a secured vehicle in Taiwan, together with the tax-free incentive for the dividends of T-REIT investors. The incentives above have resulted in over 60% of investors being individuals, according to Fubon No.1, thefirst T-REIT introduced to the markets.

The trend of real estate securitization indicates that REITs have suc-cessfully drawn investors' interests in this region, where real estate is

1

According to the census of Taiwan's Ministry of Interior in 2006, the average home ownership rate is over 87% and the average housing unit vacancy rate is 17.6%. These twoﬁgures are far above the average of other countries (Lee and Chien, 2011; Chen et al., 2011).

2

There are some paper discussing the volatility of REITs and stock prices. Most of these papers aim to utilize the GARCH model to analyze the volatility dynamics of REITs, includingDevaney (2001), Stevenson (2002), and Cotter and Stevenson (2004. 2006). A few of them utilize data on REITs to examine the role of stock market volatility on earnings management (Ambrose and Bian, 2010). However, the aim of this paper is to examine the characteristics of T-REITs that lead or lag the stock price index. We fo-cus on the price relationships of these two markets, not the volatility linkages, and the volatility in daily stock market index data is not discussed herein.

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