Gearing and the Australian real estate investment market

Purpose - The aim of the paper is threefold: to provide an overview of gearing in the Australian real estate investment market; formally examine the relationship between property returns, risk and gearing; and provide some guidance in evaluating “optimal” gearing levels for real estate investment. Design/methodology/approach - A mathematical modelling framework is presented for evaluating the relationship between investment returns, risk and gearing levels. Findings - The study highlights that risk rises with rising gearing levels and that risk‐adjusted returns fall with rising gearing. Furthermore, it is shown that the gearing‐risk relationship is influenced not only by the cost of debt structure but also the interdependency between ungeared returns and interest rates. Research limitations/implications - The study suggests that current gearing levels from Australian listed property trusts and unlisted wholesale property funds are relatively conservative. This implies that current gearing could be increased, in particular for wholesale funds, without taking on substantially more risk whilst enhancing returns. Practical implications - The paper is of value to industry and academia as it offers an extended framework for evaluating the relationship between risk and gearing. In particular, the framework provides insight for gauging gearing levels when constructing real estate investment strategies. Originality/value - Importantly, the paper shows that the interdependency between ungeared returns and interest rates significantly impacts the relationship between risk and gearing.