Asian markets A shortage of CPI-based rental indexation and the role played by market authorities in controlling real estate markets make real estate in Asia less potent as an inflation hedge than it is in the west, but only in the short term, as Patrick Lecomte reports

In 2008, as concerns were growing as a result of the expansionary monetary policies implemented in Asia and the West, APREA's Research Committee decided to add the issue of commercial real estate as inflation hedge on its research agenda.
An inflation hedge has long been sought by long-term investors. In the absence of mature inflation-linked securities (eg, inflation-linked bonds, inflation-indexed derivatives), analysts claim that Asian properties provide efficient hedging against inflation. While the topic has already been extensively covered in the academic literature, this claim is somewhat arbitrary as past research shows that findings are dependent on methodology and period. Nonetheless, the issue of real estate's inflation hedging benefits has taken on a new relevance in the aftermath of the sub-prime crisis. Big government stimulus packages have helped financial markets to recover and led investors to worry about inflation.

The situation facing investors nowadays is nonetheless very different from that of the past (1970s/1980s) when inflation was a major concern of investors in long-term assets. Most Asia-centric inflation studies were carried out at a time when the investment universe was much smaller than the wide scope of investment options now available to real estate investors. In recent years, Asian countries have developed sophisticated property vehicles (eg, REITs) while witnessing rapid growth in their direct markets owing to unprecedented economic development. This has greatly increased the potential hedging tools available to investors. Last but not least, in most Asian countries, the real estate sector plays a significant role in the economy. Reverse causality between Asian real estate markets and inflation is therefore a concern covered in APREA research.

Methodology and scope
Inflation hedging is actually a misnomer. Contrary to traditional hedging, which is akin to a process of negative replication, what investors are looking for is the ability of real estate assets to more than cover the increase in consumer prices. Methodologies applied in the research are selected to identify the short-term correlations and long-term co-integrations between real estate returns in Asian property markets and domestic inflation rates proxied by local consumer price indices. Researchers in charge of the project selected proven methodologies known for their robustness, in particular the Engle Granger co-integration tests, which provide more solid results than the usual Ordinary Least Square regressions.*

Due to their diversity and idiosyncrasies, Asian real estate markets present an array of challenges in terms of data collection. The APREA research project covers both securitised and unsecuritised property markets in six Asian countries encompassing eight major cities: China (Beijing, Shanghai, Guangzhou), Hong Kong, Japan (Tokyo), Korea (Seoul), Singapore, and Thailand (Bangkok). Securitised returns and unsecuritised returns are derived from FTSE EPRA indices and CBRE Capital Value and Rental indices respectively.

Findings
While Asian property delivers positive real returns on average, the short-run hedging effectiveness of real estate investments both in securitised and unsecuritised Asian real estate markets is neither strong nor consistent. This might be due to the fact that real estate assets are only remotely linked to inflation in the short run (eg, no CPI-based rental indexation in the countries under investigation, except South Korea) and the role played by market authorities in controlling real estate markets in Asia.

However, the findings show inflation rates and real estate returns are co-integrated in the long run, indicating that Asian real estate assets do hedge inflation over long periods of time (ie, over 10 years). Securitised markets in Hong Kong, Japan and Singapore have the largest co-integration with expected inflation rates while industrial and retail direct properties in Hong Kong are the least co-integrated. Rental indices (eg, Beijing and Shanghai retail markets) exhibit co-integration with inflation rates in the long run, albeit with a lag, as opposed to Capital Value indices, which tend to be immediately responsive.

Correlations between real estate returns and real GDP growth are relatively strong whereas correlations between real estate returns and real domestic stock market returns are consistently weak (with the exception of the Hong Kong office market and the Japanese securitised market), suggesting that Asian commercial real estate markets (both securitised and unsecuritised) are distinct asset classes from the public equity capital. Real estate returns in Asian direct real estate markets show no mean reversion effect contrary to securitised markets which exhibit consistent mean reversion across the board.

Research on the office market indicates that in the absence of official inflation targeting in most Asian countries (ex South Korea and Thailand), real estate markets are influenced by expansionary monetary policies epitomised by strong monetary growth and large Taylor ratios. This is particularly so in the Beijing and Shanghai office markets where real estate tends to act as a vector between money supply and inflation.

NOTE: * Co-integration tests pioneered by Nobel Laureates Engle and Granger are designed to test whether two or more time series (eg, real estate returns and inflation rates) share common long-term fluctuations although they might not move together in the short run


Patrick Lecomte is executive director and research fellow at Essec business school, Singapore