“IS PROPERTY A GOOD HEDGE AGAINST INFLATION?

1. 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

2. 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

3. 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

4. Asset-Backed Securitization Deals

5. Other Secondary Property Market Instruments • Hedging instrument • Single Property Future • New mortgage instruments (Potential) • Mortgage REITs • Mortgage Backed Securities • Commercial Mortgage Backed Obligations

6. 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 Investors Create Pool Issue Securities

7. Why invest in Property? For a wealth maximizing investor: • Pride of ownership • Desired rate of return • Capital appreciation • Risk diversification • Hedge against inflation

8. Historical Performance of Property Market (Q278 – Q498)

9. Stock Vs. Property Returns

10. Property Returns – by sector

11. Historical Correlation Coefficients (3Q78 to 4Q98)

12. 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

13. Inflation Rate (1978 – 1998) Second oil price shock Inflation Rate(%) Asian Crisis Mid-80s Recession Year-Qtr

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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)

21. Data Source • Sample period 1978 Q3– 1998 Q4 • URA all property price index and related sub-indices • SES all-share index • Consumer Price Index (CPI) • Treasury bill rate • Nominal return • Rjt = Log (Pjt/ Pjt-1)

22. Theoretical/ Conceptual Framework • Nominal return of asset = real rate of return + expected inflation + unexpected inflation • Regression model • 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

23. Empirical Models • Test against expected & unexpected inflations • 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

24. Expected Inflation Asset Type Actual Inflation Entire Sample Period Sub-period+ Low Vs. High Inflation# Real Estate   IV  Residential   IV  Office   I  Shop     Industrial   I High Stocks   IV  Real Estate Stocks   IV  Empirical Results (1)

25. Unexpected Inflation Asset Type 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  Empirical Results (2)

26. 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)

27. 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.

28. Industrial Return and Inflation

29. Shop and Inflation

30. Residential Return and Inflation

31. 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

32. 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

33. 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

34. Historical Return (4Q93 – 4Q00)

35. Optimal Portfolio Composition

36. Optimal Portfolio Composition

37. Efficient Portfolio Frontier – Risk & Return tradeoff

38. 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

39. Thank you