Common Risk Factors and Risk Premia in Direct and Securitized Real Estate Markets

This study empirically examined the effects of systematic market and common risk factors in explaining the variations in excess returns of securitized and direct real estate using multi-factor asset pricing models (MAP). The homogeneity of risk premia associated with the economic risk factors was also tested to determine whether the two real estate markets were integrated. By constraining the risk premia to be constant within each of the real estate market using the seemingly unrelated regression (SUR) technique, we found that risk factors were priced differently in the two real estate markets. Credit risk, unexpected inflation and spread between government and commercial bonds were significantly priced in the securitized real estate market, whereas real T-bill yields and unexpected inflation were the two risk factors affecting the excess returns of direct real estate. The time-varying risk premia were also estimated using the standard FamaMacBeth two-pass regression technique. Credit risk factor remained significant in the pricing of excess securitized real estate returns, whereas term structure risk and unexpected inflation were the two factors significantly priced in direct real estate returns. We also tested the significance of the homogeneity of various risk premia across the two markets. The tests rejected the null hypothesis of integration of the two real estate markets in both fixed and time-varying MAP frameworks.