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Market risk of real estate: Using indirect data to understand direct risks

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Even if the market capitalization of direct real estate is comparable to that of equities and fixed income, the data on direct real estate is very poor. It is, therefore, difficult to estimate the market risk of this important asset class. Moreover, risk systems from most vendors cover equities and fixed income, but do not cover direct real estate. We propose a simple methodology that uses widely available data on indirect real estate to estimate the market risk of direct real estate. In particular, we use data on Real Estate Investment Trusts (REITs) returns, determine their factor exposures to other asset classes and deleverage these exposures according to REITs’ balance sheets. We show that direct real estate can be considered as a portfolio of equities, fixed income and credit combined with idiosyncratic risk. We find that the existing direct indices understate the risk of the real estate market. In addition, with our methodology, the correlations to other asset classes become materially different and higher.

Suggested Citation

  • Schlumpf, Felix & Tessera, Genene & Martínez, Catalina, 2013. "Market risk of real estate: Using indirect data to understand direct risks," Journal of Financial Perspectives, EY Global FS Institute, vol. 1(3), pages 111-120.
    • Handle: RePEc:ris:jofipe:0026
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    More about this item

    Keywords

    public and private real estate; real estate risk; mixed-asset diversification;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • R33 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Nonagricultural and Nonresidential Real Estate Markets

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