Economic Risk Factors and Commercial Real Estate Returns

The Journal of Real Estate Finance and Economics volume 14, pages283–307(1997)Cite this article

Abstract

A great deal of research has focused on the links between stock and bond market returns and macroeconomic events such as fluctuations in interest rates, inflation rates, and industrial production. Although the comovements of real estate and other asset prices suggests that these same systematic risk factors are likely to be priced in real estate markets, no study has formally addressed this issue. This study identifies the growth rate in real per capita consumption, the real T-bill rate, the term structure of interest rates, and unexpected inflation as fundamental drivers or “state variables” that systematically affect real estate returns. The finding of a consistently significant risk premium on consumption has important ramifications for the vast literature that has examined the (risk-adjusted) performance of real estate, for it suggests that prior findings of significant abnormal returns (either positive or negative) that have ignored consumption are potentially biased by an omitted variables problem. The results also have important implications for dynamic asset allocation strategies that involve the predictability of real estate returns using economic data.

This is a preview of subscription content, access via your institution.

Access options

Buy single article

Instant access to the full article PDF.

US$ 39.95

Tax calculation will be finalised during checkout.

References

  1. Banz, R. (1981). “The Relationship between Return and Market Value of Common Stocks,” Journal of Financial Economics 9, 3–18.

    Google Scholar 

  2. Breeden, D. (1979). “An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities,” Journal of Finance Economics 7, 265–296.

    Google Scholar 

  3. Campbell, J., and R. Shiller. (1988). “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors,” Review of Financial Studies 3, 195–228.

    Google Scholar 

  4. Chan, K., and N. Chen. (1988). “An Unconditional Asset-Pricing Test and the Role of Firm Size as an Instrumental Variable for Risk,” Journal of Finance 43, 309–325.

    Google Scholar 

  5. Chan, K., and N. Chen. (1991). “Structural and Return Characteristics of Small and Large Firms,” Journal of Finance 46, 1467–1484.

    Google Scholar 

  6. Chan, K., N. Chen, and D. Hsieh. (1985). “An Exploratory Investigation of the Firm Size Effect,” Journal of Financial Economics 14, 451–471.

    Google Scholar 

  7. Chan, K. C., P. Hendershott, and A. Sanders. (1990). “Risk and Return on Real Estate: Evidence from Equity REITs,” Real Estate Economics 18, 431–452.

    Google Scholar 

  8. Chen, N., R. Roll, and S. Ross. (1986). “Economic Forces and the Stock Market,” Journal of Business 59, 383–403.

    Google Scholar 

  9. Fama, E., and K. French. (1988a). “Business Cycles and the Behavior of Metal Prices,” Journal of Finance 43, 1075–1093.

    Google Scholar 

  10. Fama, E., and K. French. (1988b). “Dividend Yields and Expected Stock Returns,” Journal of Financial Economics 22, 3–25.

    Google Scholar 

  11. Fama, E., and K. French. (1989). “Business Conditions and the Expected Returns on Stocks and Bonds,” Journal of Financial Economics 25, 23–50.

    Google Scholar 

  12. Fama, E., and K. French. (1992). “The Cross-Section of Expected Stock Returns,” Journal of Finance 47, 427–465.

    Google Scholar 

  13. Fama, E., and M. Gibbons. (1984). “AComparison of Inflation Forecasts,” Journal of Monetary Economics 13, 327–348.

    Google Scholar 

  14. Fama, E., and J. MacBeth. (1973). “Risk, Return and Equilibrium: Empirical Tests,” Journal of Political Economy 81, 607–636.

    Google Scholar 

  15. Ferson, W. (1989). “Changes in Expected Security Returns, Risk, and the Level of Interest Rates,” Journal of Finance 44, 1191–1218.

    Google Scholar 

  16. Ferson, W. (1990). “Are Latent Variables in Time-Varying Expected Returns Compensation for Consumption Risk?” Journal of Finance 45, 397–430.

    Google Scholar 

  17. Ferson, W., and S. Foerster. (1994). “Finite Sample Properties of the Generalized Method of Moments in Tests of Conditional Asset Pricing Models,” Journal of Financial Economics 36, 29–55.

    Google Scholar 

  18. Ferson, W., and C. Harvey. (1991). “The Variation of Economic Risk Premiums,” Journal of Political Economy 99, 385–415.

    Google Scholar 

  19. Fisher, J., D. Geltner, and B. Webb. (1994). “Value Indices of Commercial Real Estate: AComparison of Index Construction Methods,” Journal of Real Estate Finance and Economics 9, 137–164.

    Google Scholar 

  20. Gallant, R. (1975). “Seemingly Unrelated Non-Linear Regressions,” Journal of Econometrics 3, 35–50.

    Google Scholar 

  21. Geltner, D. (1989). “Estimating Real Estate's Systematic Risk from Aggregate Level Appraisal-Based Returns,” Journal of the American Real Estate and Urban Economics Association 17, 463–481.

    Google Scholar 

  22. Geltner, D. (1991). “Smoothing in Appraisal-Based Returns,” Journal of Real Estate Finance and Economics 4, 327–345.

    Google Scholar 

  23. Glascock, J. (1991). “Market Conditions, Risk, and Real Estate Portfolio Returns: Some Empirical Evidence,” Journal of Real Estate Finance and Economics 4, 367–373.

    Google Scholar 

  24. Grissom, T., D. Hartzell, and C. Liu. (1987). “An Approach to Industrial Real Estate Market Segmentation and Valuation Using the Arbitrage Pricing Paradigm,” Real Estate Economics 15, 199–218.

    Google Scholar 

  25. Gyourko, J., and P. Linneman. (1988). “Owner-Occupied Homes, Income Producing Properties, and REITs as Inflation Hedges: Empirical Findings,” Journal of Real Estate Finance and Economics 1, 347–372.

    Google Scholar 

  26. Jorion, P. (1991). “The Pricing of Exchange Rate Risk in the Stock Market,” Journal of Financial and Quantitative Analysis 26, 363–376.

    Google Scholar 

  27. Keim, D. (1983). “Size-Related Anomalies and Stock Return Seasonality: Further Empirical Evidence,” Journal of Financial Economics 12, 13–32.

    Google Scholar 

  28. Ling, D. C., and A. Naranjo. (1997). “The Integration of Commercial Real Estate Markets and Stock Markets,” Manuscript, University of Florida.

  29. Lintner, J. (1965). “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets,” Review of Economics and Statistics 47, 13–37.

    Google Scholar 

  30. Liu, C., D. Hartzell, and T. Grissom. (1992). “The Role of Co-Skewness in the Pricing of Real Estate,” Journal of Real Estate Finance and Economics 5, 299–319.

    Google Scholar 

  31. Liu, C., D. Hartzell, W. Greig, and T. Grissom. (1990). “The Integration of the Real Estate Market and the Stock Market: Some Preliminary Evidence,” Journal of Real Estate Finance and Economics 3, 261–282.

    Google Scholar 

  32. Liu, C., and J. Mei. (1992). “The Predictability of Returns on Equity REITs and Their Co-Movement with Other Assets,” Journal of Real Estate Finance and Economics 5, 401–418.

    Google Scholar 

  33. McElroy, M., and E. Burmeister. (1988). “Joint Estimation of Factors Sensitivities and Risk Premia for the Arbitrage Pricing Theory,” Journal of Finance 43, 721–735.

    Google Scholar 

  34. Mei, J., and A. Lee. (1994). “Is There A Real Estate Factor Premium?” Journal of Real Estate Finance and Economics 9, 113–126.

    Google Scholar 

  35. Mei, J., and A. Saunders. (1995). “Bank Risk and Real Estate: An Asset Pricing Perspective,” Journal of Real Estate Finance and Economics 10, 199–224.

    Google Scholar 

  36. Merton, R. (1973). “An Intertemporal Capital Asset Pricing Model,” Econometrica 41, 867–887.

    Google Scholar 

  37. Mossin, J. (1966). “Equilibrium in a Capital Market,” Econometrica 34, 768–783.

    Google Scholar 

  38. Pagan, A. (1984). “Econometric Issues in the Analysis of Regressions with Generated Regressors,” International Economic Review 25, 221–247.

    Google Scholar 

  39. Park, J., D. Mullineaux, and I. Chew. (1990). “Are REITs Inflation Hedges?” Journal of Real Estate Finance and Economics 3, 91–103.

    Google Scholar 

  40. Ross, S. (1976). “The Arbitrage Theory of Capital Asset Pricing,” Journal of Economic Theory 13, 341–360.

    Google Scholar 

  41. Ross, S., and R. Zisler. (1991). “Risk and Return in Real Estate,” Journal of Real Estate Finance and Economics 4, 175–190.

    Google Scholar 

  42. Shanken, J., and M. Weinstein. (1990). “Macroeconomic Variables and Asset Pricing: Further Results,” Manuscript University of Southern California.

  43. Sharpe, W. (1964). “Capital Asset Prices: ATheory of Market Equilibrium under Conditions of Risk,” Journal of Finance 19, 425–442.

    Google Scholar 

  44. Sweeney, R., and A. Warga. (1986). “The Pricing of Interest Rate Risk: Evidence from the Stock Market,” Journal of Finance 41, 393–410.

    Google Scholar 

  45. White, H. (1980). “A Heteroscedasticity Consistent Covariance Matrix and a Direct Test for Heteroscedasticity,” Econometrica 48, 721–746.

    Google Scholar 

  46. Young, M., and R. Graff. (1995). “Real Estate Is Not Normal: A Fresh Look at Real Estate Return Distributions,” Journal of Real Estate Finance and Economics 10, 225–259.

    Google Scholar 

Download references

Author information

Affiliations

  1. Department of Finance, Insurance and Real Estate, Graduate School of Business Administration, University of Florida, Gainesville, FL, 32611-7160

    ANDY NARANJO & DAVID C LING

Authors
  1. ANDY NARANJO
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. DAVID C LING
    View author publications

    You can also search for this author in PubMed Google Scholar

Rights and permissions

Reprints and Permissions

About this article

Cite this article

NARANJO, A., LING, D.C. Economic Risk Factors and Commercial Real Estate Returns. The Journal of Real Estate Finance and Economics 14, 283–307 (1997). https://doi.org/10.1023/A:1007754312084

Download citation

  • real estate returns
  • asset pricing
  • economic risk factors
  • risk premiums
  • multibeta asset pricing model
  • systematic risk