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February 22, 2017

This ANREV report investigates the relationship between the capital structure and performance of Asia Pacific non-listed real estate funds. It examines whether the inflation hedging quality of real estate can be further improved by the use of debt to finance the real estate assets. This proposition is based on the school of thought initiated by Fisher and Keynes, which suggests that in times of high inflation, debt will help hedge the real value of firm equity.

The theory predicts that if a real estate asset was to be financed with a fixed rate debt, high inflation would be beneficial to the real estate investor, as while the value of the real estate asset erodes (in real terms), the value of its debt erodes as well. This report empirically examines whether this hypothesis applies for Asia Pacific non-listed real estate funds, and whether funds holding greater debt tend to have better returns during periods of high inflation.

A regression analysis was performed on Asia Pacific non-listed real estate funds to determine the role of leverage in hedging against actual and unexpected inflation. The results show evidence that these funds provide hedging against inflation and that the use of leverage at moderate levels enhances their inflation hedging capabilities.

However, the findings for unexpected inflation provide an inconclusive indication that these funds can potentially hedge against unexpected inflation outside the ‘typical’ lease structure, given that Asia Pacific commercial leases tend to be varied and heterogeneous in nature. Nonetheless, investors can extract information about inflation hedging abilities of these funds from capital structure data, thus promoting efficient investment decisions.

The report also found that gearing style is important and indicates that the marginal impact of gearing on inflation is influenced by the type of fund. Core funds experience the strongest marginal impact of gearing followed by Value-Added and Opportunistic funds. Opportunistic funds tend to have the lowest gearing levels due to their greater focus on development activities characterised by varying capital flows throughout a project life, therefore, debt levels vary significantly.

The pan-Asia non-listed real estate funds industry has witnessed extraordinary growth over the past fifteen years. Non-listed real estate funds provide an investment approach that offers diversification benefits of real estate as part of a multi-asset portfolio and a more accessible and transparent route to gain exposure to the sector for a growing number of institutional and high net worth individuals.

ANREV data shows that the Asia Pacific non-listed real estate funds market has grown significantly since it started to track funds, increasing from 16 funds at the end of 2006 to 97 in 2014, with a total gross asset value of US$95.2 billion. In its ANREV 2016 Investment Intentions Survey, non-listed real estate funds remain the preferred route to increase real estate allocation for a majority of investors in the region.

This is a summary of an ANREV Technical Paper which is an abridged version of a dissertation authored by Thuqan Al-Hindawi, University of Cambridge, in 2016.

Nicholas Tan
CFA, Senior Research Analyst, Asia Pacific Capital Markets
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