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

Felix Schlumpf (), Genene Tessera () and Catalina Martínez ()
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Felix Schlumpf: Zurich Insurance Company Ltd., Postal: Mythenquai 2, 8022 Zurich, Switzerland, http://www.zurich.com
Genene Tessera: Zurich Insurance Company Ltd., Postal: Mythenquai 2, 8022 Zurich, Switzerland, http://www.zurich.com
Catalina Martínez: Zurich Insurance Company Ltd., Postal: Mythenquai 2, 8022 Zurich, Switzerland, http://www.zurich.com

Journal of Financial Perspectives, 2013, vol. 1, issue 3, 111-120

Abstract: 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.

Keywords: public and private real estate; real estate risk; mixed-asset diversification (search for similar items in EconPapers)
JEL-codes: C32 G11 G23 R33 (search for similar items in EconPapers)
Date: 2013
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