CPF Multiplier Seminar
“IS PROPERTY A GOOD
HEDGE AGAINST INFLATION?
Sing Tien Foo
Centre for Real Estate Studies
National University of Singapore
3 August 2002
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 Programs
Mortgage Pools
Originators sell to FNMA.
FNMA creates large pools of mortgages
FNMA sells securities from pool.
Mortgage
Originator
Create
Pool
Issue
Securities
Investors
Why invest in Property?
For a wealth maximizing investor:
Pride of ownership
Desired rate of return
Capital 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
SES-All Share
SES-Property
URA-Property
78
Q2
79
Q3
80
Q4
82
Q1
83
Q2
84
Q3
85
Q4
87
Q1
88
Q2
89
Q3
90
Q4
92
Q1
93
Q2
94
Q3
95
Q4
97
Q1
98
Q2
60%
40%
20%
0%
-20%
-40%
-60%
-80%
-100%
-120%
-140%
-160%
Property Returns – by sector
60%
40%
20%
0%
-20%
-40%
Residential
Industrial
Shop
Office
78
Q2
79
Q3
80
Q4
82
Q1
83
Q2
84
Q3
85
Q4
87
Q1
88
Q2
89
Q3
90
Q4
92
Q1
93
Q2
94
Q3
95
Q4
97
Q1
98
Q2
-60%
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
19
78
19 3Q
79
19 4Q
81
19 1Q
82
19 2Q
83
19 3Q
84
19 4Q
86
19 1Q
87
19 2Q
88
19 3Q
89
19 4Q
91
19 1Q
92
19 2Q
93
19 3Q
94
19 4Q
96
19 1Q
97
19 2Q
98
3Q
Inflation Rate(%)
Inflation Rate (1978 – 1998)
5%
4%
3%
-1%
Second
oil price
shock
2%
1%
0%
Mid-80s
Recession
Asian
Crisis
-2%
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 subindices
 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
~
~
~
~
E ( R jt |  t 1 ,  t )  E ( jt |  t 1 )  E ( t |  t 1 )   j [ t  E ( t |  t 1 )]
 Regression model
~
~
R jt   j   j E (t | t 1 )   j [t  E (t | t 1 )]   jt
 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
Empirical Models
 Test against expected & unexpected inflations
~
~
R jt   j   j E (t | t 1 )   j [t  E (t | t 1 )]   jt
 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
Empirical Results (1)
Expected Inflation
Asset Type
Actual Inflation
Entire Sample
Period
Subperiod+
Low Vs. High
Inflation#


IV

Residential


IV

Office


I

Shop




Industrial


I
High
Stocks


IV

Real Estate
Stocks


IV

Real Estate
Empirical Results (2)
Unexpected Inflation
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

Asset Type
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
40%
30%
Industrial
Expected Inflation
Actual Infaltion
Unexpected Inflation
20%
10%
0%
-10%
-20%
78
Q2
79
Q3
80
Q4
82
Q1
83
Q2
84
Q3
85
Q4
87
Q1
88
Q2
89
Q3
90
Q4
92
Q1
93
Q2
94
Q3
95
Q4
97
Q1
98
Q2
-30%
Shop and Inflation
Shop
Actual Infaltion
Expected Inflation
Unexpected Inflation
78
Q2
79
Q3
80
Q4
82
Q1
83
Q2
84
Q3
85
Q4
87
Q1
88
Q2
89
Q3
90
Q4
92
Q1
93
Q2
94
Q3
95
Q4
97
Q1
98
Q2
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
-60%
Residential Return and Inflation
Residential
Expected Inflation
Actual Infaltion
Unexpected Inflation
78
Q2
79
Q3
80
Q4
82
Q1
83
Q2
84
Q3
85
Q4
87
Q1
88
Q2
89
Q3
90
Q4
92
Q1
93
Q2
94
Q3
95
Q4
97
Q1
98
Q2
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
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
Residential
Office
Shop
1.22%
1.42%
0.10%
Factory
Warehouse
All-Pro
1.44%
1.31%
1.17%
SES-Prop
CDL Share
2.39%
6.30%
SES-All
1.88%
Risk
1.24%
1.25%
0.81%
1.20%
1.58%
1.17%
4.71%
5.58%
3.58%
Optimal Portfolio Composition
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
0.1%
SES-All Share
Warehouse
Factory
Shop
Office
Residential
0.4%
0.7%
1.0%
1.3%
1.6%
OPtimal Asset Weight
Optimal Portfolio Composition
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
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
Portfolio Return
2.0%
1.5%
1.0%
0.5%
0.0%
0.0%
0.5%
1.0%
1.5%
Portfolio Risk
2.0%
2.5%
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