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Introduction
According to the data released by Savills World Research,in the year of 2017, total value of the global real estate has reached to $228 trillion, worth 2.8 times of the GDP. (Savills, 2017)Even though Warren Buffett used to express publicly for several times that he is not quite interested in the investment of real estate, he still keeps a watchful eye on the immovable properties. And each of the few only residential or commercial properties he purchased has returned him with dozens of times’ profits. The lynchpin is his catching of “right times” during which the inflation in US ran out of control and bulks of banks crumbled due to collapsed land price and debt defaults. In most of the South and Eastern Asian countries especially China, the development of urbanization and increasing population both boosted the straight climb of real estate prices for the past decades of years. In the traditional concept of Chinese, house and land are the foundation of life, along with the rapid growth of China economy and huge population, real estate has become the rigid demand in Chinese market. Over the past 20 years, average house price in the capital Beijing surged like a runaway horse from around $200 to $10,000.
Real estate carries great weight for the domestic and international economy growth, it booms a series of developments factors during the prosperity and it destroys the financial systemunder the economy bubbles. For individual investors, whether the decision made is wise or wrong can lead to the once a lifetime change. As a student in financial management, the study to clear the macro factors leading real estate fluctuation behind becomes significant either for economic analysis or the investment advice to seize the chance for good buys.
Most of the world’s real estate investment are backed by mortgage and debt. Except for the supply-demand relationship, real estate industry is highly related with the financial leverage policies regulated by the government, usually the central bank. After the financial crisis in 2008, the global rulers are controlling the pace and amount of leverage in the banking system.
Leveraging used to boost the commercial benefits for investors during the bull period of economy, the overlooked risks behind it ultimately led to an excessive use of liquidity and credit collapse. After the shock of financial tsunami and economic downturns occurred in recent years, risk management and deleveraging have become the new rhythm to keep the sustainable development of economy among the global atmosphere. The most effective deleveraging measures turned to be the macro-control policies taken by governments and the central banks. Deleveraging inevitable implies a decrease process in domestic economies including price falls in gold, diamond and grains. Meanwhile, it has a negative impact on stock and real estate markets. Mutual-promotion between the leverage and property mortgage are the initiators of economic bubbles in many markets, such as Japan in the 1990s. Deleveraging can’t be really implemented unless the real estate industry is managed under good manner. Thus, the “visible hand” of governments during this process must touch an optimal point in balancing the risks and returns. The financial indicators enacted and implemented by the central banks like interest rate, money supply amount often signal the control manner of government on the current situation and future trend of real estate.
Most experimental studies focused on the relationship between real estate performance and macro economic factors like
The study in this paper will target on the real estate markets for the top two economies as well as the local market (US, China and UAE).According to statistics provided by the National Association of Home Builders (NAHB), housing contributes around 15-18% weight in average for the US GDP. It’s quite necessary to study how the financial factors are impacting real estate sector in the world’s most developed country cum most mature market. Now the annual growth of primary and secondary industries in China have overpassed US, as the always soaring real estate belongs to the tertiary industry and weights almost 7% of China’s gross domestic product, the government of China keeps utilizing the real estate factor as an important tool for economic development and the regulators are very cautious in controlling its high risk and avoiding its recession. Behind the continuous rising house price, how China will guarantee its economic stability and at the same time put an end to the real estate bubble burst? The macro financial tools are valuable to be identified and analyzed. When it comes to the return on investment (ROI), UAE must be the country with significant advantage for property investment. Due to the special population composition, immigration policy and cushy government welfare for the native citizens, housing is not the rigid demand in UAE. However, the aliens which count for the majority of its population has formed for a considerable demand for the house rental.
During the study, the Arbitrage Pricing Theory (APT) Model has been implemented
Key Words: Real Estate, Deleveraging, Money Supply (M1), Capital to Asset Ratio, Real Estate Loans/ Credit, Individual Savings, Exchange Ratios, APT Model, Null Hypothesis, Stationery Test, Cointegration Test
Market Overview
The US economy suffered a hard landing during the 2008 financial crisis, however, through transferring the leverage from households and enterprises to governments, the deleveraging has got a success in the individual and social sectors. From the relevant economic indicators, we can see the success of US deleveraging policy. The unemployment ratio has been lowered, inflation keeps a stability and the economy shows a growth with momentum. Mainly reasoning to the increasing cost of credit, willingness of the purchasers fell and property prices has decreased.
It seems that China stood behind the safety line during the credit crisis due to its conservative strategy in foreign exchange reserves. But the Chinese government has been always showing the high concern in the deleveraging reform. Since 2015, the central government has assigned the deleveraging process as the critical task to proceed the supplying side structural reform. The neutral and steady policy hold by the Central Bank of China has also provided the suitable monetary financial circumstance for this reform. The political aim of the Communist Party of China is propagate as serving for the livelihood issues. As Chinese citizens have rigid demand on the residential properties with a large population background, and investment in real estate kept a rapid increasing trend for the past few years, residential property prices never stopped rising in almost all the urban areas in China. To control the speed of soaring prices, deleveraging is considered to be effective and necessary financial tool. Even though there has been some progress achieved in the deleveraging process, leverage ratio in state-owned enterprises in China still declines tardily, subgovernments are still facing high potential risks, debt ratios in the financial institutions are staying at a relative high level.
Despite of the global weak economy, the GDP of UAE has maintained a relative stable growth in the past 10 years. Alongwith the increasing trend recently in crude oil price, the Expo in 2020 may also help to enhance the confidence of investors and attract new residents. In addition, Dubai is facing an oversupply in real estate area. As per JLL MENA research, about 570,000 new-built units will be injected into the market by the year of Dubai Expo. Market price of the properties has kept declining since the past 2-3 years, how to use the deleveraging tools optimally to control the real estate drop and risk of new investments is the new challenge as well as chance for the UAE as a developing economy with a strong political stability for international investors.
Research Methodology and Data
The Arbitrage Pricing Theory (APT) was raised by Stephen Ross in the year of 1976. It is actually a model for capital asset pricing. This model shows that the return on capital assets is the result of a combination of macro factors, such as the property prices, growth of GDP, the level of inflation and other factors, not only affected by the internal risk factors of the portfolio. Differing from the CAPM Model, APT doesn’t only focus on one factor meanwhile it takes the advantage of mispriced securities. Independent variables in the APT Model are usually macroeconomic factors which can be considered as systematical risks affecting the target portfolio, diversification doesn’t help to reduce the risks.
In this case, the study will use the market index of real estate portfolios in each of the three countries as the dependant variables, and analyze how sensitively the independent variables of five macro financial leveraging indicators are affecting the real estate index changes in developed and developing markets. Each beta value represents the corresponding sensitivity of the deleveraging indicator on the real estate index performance. The quantitative relationship then can provide a clear and accurate advice for balancing the real estate price and deleveraging strength. Since multi economic factors such inflation rate, employment ratio, income growth, CPI and GDP growth always have the impact on market performance of the real estate from either demand or supply side, the erro term should also be added to the equation.
The study is conducted under the assumption that the five macroeconomic deleveraging factors are expected to have the linear relationship with the fluctuation of real estate index changes. Three individual equations will be run under the APT model for the selected indexes with its corresponding independent variables in each target market.
Before the equations are generated, the Augmented Dickey Fuller stationery tests are given on each series of the variables. The ADF tests are backed with the Null Hypothesis that the tested series of data has a unit root. P values at 5% level are used to decide the rejection or non-rejection of each result. When P value is less than 0.05, it’s able to reject the null hypothesis. Otherwise, the data has a unit root and can’t be used directly to generate the APT Model. After 1st differencing on the non-stationery data, unit roots are eliminated.
Then the Johansen Cointegration Test was conducted over the raw data to confirm the long-term relationship’s existing between the dependant and independant variables. P values are still used to judge the number of cointegrations at the 0.05 level under both trace and maximum eigenvalue tests. The first non-rejected null hypothesis finds the estimated number of cointegrations as “r”. Cointegration indicates the linear combination of the tested variables is stationery.
E-Views has been chosen as the soft ware to run any of the above-mentioned tests.
Among each five indicators used by the three markets, M1 is commonly applied. “M1 is the money supply that includes physical currency and coin, demand deposits, travelers checks, other checkable deposits and negotiable order of withdrawal (NOW) accounts.” CAR indicators for the three markets vary slightly due to the data availability controlled by each central bank. Capital & reserves to total asset ratio (monthly data available for UAE only), mortgage ratio (US), real estate related loans and resident deposits (US, China, UAE). Wherein capital & reserves to total asset ratio and policy rates show the level ofgovernment suppression on leverage risks of its commercial banks, resident deposits may reflect the individual and household credit situation, Mortgage Ratio is directly related to the real estate industry and influences the property prices with each other, Currency Exchange Ratio implies the national credit status, and Real Estate/ Mid & Long-term Loans reveals the country’s credit condition for property investment. The multi-factor asset pricing model Arbitrage Pricing Model (APT) will be applied in this study to analyze the relationship between deleveraging related ratios and real estate stock prices.
Analysis
Thus the APT Model equation is estimated as:
E(rRE) = β1RM1 + β2RCAR + β3RL + β4RS + β5REX + εt
References
American Real Estate Society Journals. (2019). Point of View: Deleveraging the Commercial Real Estate Market. [online] Available at: https://aresjournals.org/doi/abs ... 3.n822461182475542.
Basel Committee on Banking Supervision, 2011, Basel III: A global regulatory framework for more resilient banks and banking systems, Bank for International Settlements (2011) Technical Report 189
Chen, J., Feng, L. and Peng, J. (2019). Optimal deleveraging with nonlinear temporary price impact.
Deloitte United States. (2019). 2019 Commercial Real Estate Industry Outlook. [online] Available at: https://www2.deloitte.com/us/en/ ... ustry-outlook.html.
Sing, T., Tsai, I. and Chen, M. (2019). Time-Varying Betas of US REITs from 1972 to 2013. [online] Papers.ssrn.com. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2704403
“Feyen, Erik; Kibuuka, Katie; Ötker-Robe, İnci. 2012. Bank Deleveraging : Causes, Channels, and Consequences for Emerging Market and Developing Countries. World Bank, Washington, DC. © World Bank. https://openknowledge.worldbank.org/handle/10986/9317 License: CC BY 3.0 IGO.”<Roll, R., & Ross, S. A. (1984). The Arbitrage Pricing Theory Approach to Strategic Portfolio Planning. Financial Analysts Journal, 14-26.Li, W. and Gao, Z. (2012). Real Estate Investors and the Boom and Bust of the US Housing Market. SSRN Electronic Journal.Bertrand Renaud, Ph.D. (2010). Dubai Real Estate Boom | Dubai | United Arab Emirates. [online] Available at: https://www.scribd.com/document/151897889/Dubai-Real-Estate-Boom
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