Abstracts for Vol. 6, No. 1 of the Journal of Real Estate Portfolio Management

Portfolio Variance and Correlation Matrices

Seow-Eng Ong and Malik Ranasinghe

The fact that portfolio variance must be positive implies that the correlation matrix for asset returns should be positive definite. As such, a test for positive definiteness in the correlation matrix should be routinely implemented prior to any portfolio optimization exercise. A program is developed to test for positive definiteness in correlation matrices and to detect correlation coefficients that violate the positive definiteness condition. The correlation matrices from five randomly selected papers are tested and violations revealed in larger correlation matrices. Where violations are detected, the portfolio manager or analyst should proceed with the optimization exercise only if the alternative bounds on the correlation coefficients computed by our program are acceptable.

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Optimal Diversification: Is It Really Worthwhile?

Ping Cheng and Youguo Liang

Recent research has demonstrated that the Markowitz efficient frontier is fuzzy and may consist of many statistically indistinguishable frontiers. Therefore, it opens the possibility that an efficient portfolio developed by mean-variance analysis may not be any more efficient than a naively diversified portfolio. Using an efficiency test developed by Gibbons, Ross, and Shanken (1989), we find evidence to support that an efficient portfolio is statistically more efficient than a corresponding naively diversified portfolio when the portfolio formation period is the same as the period used for testing the efficiency difference. However, no evidence is found to support that an efficient portfolio is statistically more efficient than a corresponding naively diversified portfolio when the porfolio formation period differs from the test period. thus in practical terms, efficient porfolios may not be superior to naively diversified portfolios in a statistical sense.

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Cash Flows vs. Earnings in the Valuation of Equity REITs

Carol M. Graham and John R. Knight

This article examines the incremental information content of net income and cash flows for equity real estate investment and cash flows for equity real estate investment trusts (REITs). REITs provide a natural setting for investigating which measure, earnings or cash flows, provides a better summary statistic of corporate value. No formal empirical analysis has been conducted for REITs however, and existing research for public firms in general provides mixed results.

Using three alternative models, we find funds from operations (FFO) has a higher information content than net income, and contains incremental information beyond that contained in net income. Our results support the usefulness of the FFO measure for REITs.

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Real Estate Exposure and Asset Intensity

Seow-Eng Ong and Yan Yi Yong

Real estate accounts for a significant proportion of the corporate assets of publicly listed companies. The real estate exposure of publicly traded companies in land scare economies such as Hong Kong and Singapore is particularly high. This study explores the real estate exposure of listed companies in Singapore where non-real estate companies are classified by their real estate asset intensity. A six-factor Arbitrage Pricing Theory (APT) model, capturing changes in real estate prices, industrial production, expected inflation, unanticipated inflation, risk premium and term structure, shows that real estate exposure is priced. In addition, the real estate risk premium is found to vary across companies with different real estate asset intensity. a close linkage is also established between real estate exposure and various industries. Other than the real estate-intensive industries such as real estate, hotels and construction, conglomerates and financial companies also have a high exposure to real estate. Interestingly, our analysis shows that real estate exposure, which is computationally tedious to determine, can be proxied by real estate asset intensity, a simple accounting measure. The implications for portfolio management in a land-scare market are examined.

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Neighborhood Racial Composition and Mortgage Redlining: A Nationwide Analysis

Andrew Holmes

Concerns about fairness in the mortgage markets have motivated a large and growing literature and continues to be a regulatory issue impacting a wide range of financial institutions. However, disparate conclusions fron recent studies on redlining and discrimination leave the question of equitable lending unanswered. General inference from the existing evidence is hampered by the uncertainties surrounding regional variability and methodological discontinuity. For example, differences in data, variable definitions and statistical techniques inhibit comparisons across studies. Moreover, differing economic circumstances, employment conditions, industry representation, and perhaps, biases, will also induce dissimilar conclusions. This article analyzes the geographic flow of mortgage credit on a national basis with a single methodology. Thus, we avoid many of the pitfalls from earlier studies that impeded general inference concerning racially induces redlining. Our tests provide statistical evidence that neighborhood racial composition may affect the flow of mortgage credit in some regions. However, the economic significance of these results is, at most, small.

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Public versus Private Real Estate in Hong Kong

Raymond Y. C. Tse and James R. Webb

The main objective of this study is to examine the impact of real estate prices on real estate stock prices in Hong Kong. Real estate-related firms account for over 30% of Hong Kong's stock market capitalization. The real estate markets are therefore, potentially. Major determinants of changes in real estate stock prices. This study indicates that residential, office and industrial property prices (to a lessor degree) and the expected rate of inflation are important determinants of the change in real estate stock prices for Hong Kong. The results in this study make it easier to understand whether or not diversification can be achieved with different types of real estate.

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Time-Varying Expected Returns and Information in Home Prices

Yuming Li and Zhong-guo Zhou

In this article, we estimate a conditional two-beta asset pricing model in which the expected excess returns are not only related to the conditional beta with respect to the market portfolio of financial assets but also related to the conditional beta with respect to changes in home prices. We first apply a rolling regression procedure to form an ex ante factor mimicking portfolio that has a maximum correlation with changes in real home prices.When we conduct tests of the conditional two-beta asset pricing model in which the conditional betas vary in a nonlinear way with the real market returns and changes in real home prices. We find that home prices contain valuable information about the time-varying betas and expected stock and bond returns.

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Evaluating "Within Real Estate" Diversification Strategies

Timothy W. Veiser

This article refines previous comparisons of "within real estate" portfolio diversification by adding controls to the experimental design to determine why one strategy is superior to another. Two "new" economic diversification methods were among the thirteen strategies tested. The best strategy used sixteen dimensions (four property types in four geographic regions). The return/risk ratios was found to be more important than correlation matrix in explaining the ranking of diversification strategies. The article also discusses how the data's time period and market membership affect the weighting recommendations.

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