Market Risk of Real Estate: Using Indirect Data to Understand Direct Risks
15 Pages Posted: 29 Nov 2017 Last revised: 30 Nov 2017
Date Written: November 21, 2013
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.
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