The Value of Debt on Property Investment Market Performance

Higgins, David M.

doi:10.1080/14445921.2014.11104386

Cited by 2 publications

(3 citation statements)

References 8 publications

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“…Commercial property investment requires significant levels of capital investment, which can be achieved by increased equity leading to high specific property risk or more often, debt financing forming a key property investment component. Whilst debt funding can improve property investment returns, it substantially increases the risk (Higgins, 2014).…”

Section: Resultsmentioning

confidence: 99%

“…• Benchmark tracking of the selected property market index is extremely difficult to achieve, and depending of tracking error would require numerous properties and beyond many investor's capabilities, see Callender et al (2007 Higgins (2014).…”

Section: Resultsmentioning

confidence: 99%

“…The autocorrelation for direct property lowers the reported volatility, and requires the data to be desmoothed to better reflect risk over any particular holding period. There is extensive literature detailing approaches to desmoothing property data, for coverage see Higgins (2014).…”

Section: Methodsmentioning

confidence: 99%

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Defining the three Rs of commercial property market performance

Higgins

2015

Journal of Property Investment &Amp; Finance

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Purpose – Modern property investment allocation techniques are typically based on recognised measures of return and risk. Whilst these models work well in theory under stable conditions, they can fail when stable assumptions cease to hold and extreme volatility occurs. This is evident in commercial property markets which can experience extended stable periods followed by large concentrated negative price fluctuations as a result of major unpredictable events. This extreme volatility may not be fully reflected in traditional risk calculations and can lead to ruin. The paper aims to discuss these issues. Design/methodology/approach – This research studies 28 years of quarterly Australian direct commercial property market performance data for normal distribution features and signs of extreme downside risk. For the extreme values, Power Law distribution models were examined as to provide a better probability measure of large negative price fluctuations. Findings – The results show that the normal bell curve distribution underestimated actual extreme values both by frequency and extent, being by at least 30 per cent for the outermost data point. For the statistical outliers beyond 2 SD, a Power Law distribution can overcome many of the shortcomings of the standard deviation approach and therefore better measure the probability of ruin, being extreme downside risk. Practical implications – In highlighting the challenges to measuring property market performance, analysis of extreme downside risk should be separated from traditional standard deviation risk calculations. In recognising these two different types of risk, extreme downside risk has a magnified domino effect with the tendency of bad news to come in crowds. Big price changes can lead to market crashes and financial ruin which is well beyond the standard deviation risk measure. This needs to be recognised and developed as there is evidence that extreme downside risk determinants are increasing by magnitude, frequency and impact. Originality/value – Analysis of extreme downside risk should form a key part of the property decision process and be included in the property investment manager’s toolkit. Modelling techniques for estimating measures of tail risk provide challenges and have shown to be beyond traditional risk management practices, being too narrow and constraining a definition. Measuring extreme risk and the likelihood of ruin is the first step in analysing and dealing with risk in both an asset class and portfolio context.

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Section: Resultsmentioning

confidence: 99%

Section: Resultsmentioning

confidence: 99%

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Defining the three Rs of commercial property market performance

Higgins

2015

Journal of Property Investment &Amp; Finance

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Residential property market performance and extreme risk measures

Higgins

2016

Pacific Rim Property Research Journal

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Residential property is a popular investment option and has historically attracted many small individual investors. For Australian small residential property investors, debt financing is attractive as can lower the initial equity component, comply with a favourable tax structure (negative gearing) and on past evidence provide long term headline returns. A major concern with this approach is uncertainty, where stable assumptions cease to hold and there is concentrated negative price movement. This extreme downside volatility may not be fully reflected in traditional risk calculations.This research studies 40 years of quarterly Melbourne established residential property market performance data for normal distribution features and signs of extreme downside risk. The resultsshow that the normal bell curve distribution underestimated actual extreme values both by frequency and extent for ungeared residential property data. This is magnified as the gearing is increased to an extent where the outermost data point on 80% debt leverage shows an unrealistic probability of a 1 in 192 year event. Alternatively adopting the Cubic Power Law of returns, the probabilities of the most extreme event occurring drops to a realistic 1 in 38 year event.In highlighting the challenges to measuring the impact of leverage on residential property market performance, the analysis of extreme downside risk should be separated from traditional standard deviation risk calculations. In recognising these two different types of risk, extreme downside risk has a magnified domino effect with increased gearing levels. Small negative price movement in housing values and interest rates can multiply the equity risk for the investor and can lead to financial ruin which is well beyond the standard deviation risk measure. This needs to be recognised and developed as there is evidence that extreme downside risk determinants are increasing by magnitude, frequency and impact.

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The Value of Debt on Property Investment Market Performance

Cited by 2 publications

References 8 publications

Defining the three Rs of commercial property market performance

Defining the three Rs of commercial property market performance

Residential property market performance and extreme risk measures

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