Impact Stock Price and Interest Market in Japan

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Impact Stock Price and Interest Market in Japan
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  INTERNATIONAL JOURNAL OF BUSINESS, 18(4), 2013 ISSN: 1083-4346 The Impact of Stock Price and Interest Rate on the REIT Market in Japan   Takayasu Ito *    Faculty of Economics, Niigata University, Japan tito@econ.niigata-u.ac.jp ABSTRACT This paper analyzes the impact of stock prices and interest rates on the Real Estate Investment Trust (REIT) market in Japan. The entire sample is divided into two sub samples. Sample A runs from March 31, 2003 to May 31, 2007, and Sample B from June 1, 2007 to January 10, 2013. Sample B includes financial stress events such as the collapse of Lehman Brothers and the fiscal crisis in the euro zone. The positive impact of stock prices is larger in Sample B. On the other hand, negative impact of interest rates is larger in Sample B. This is because the financial stresses during the period of Sample B made it difficult for REIT companies to procure funding. The negative impact of swap rates is larger than that of Japanese Government Bond yields,  particularly for Sample B. This is consistent with the fact that benchmark interest rates for mid- and long term- loan are based on swap rates.  JEL Classifications: E43, G12  Keywords: financial crisis; interest rate swap; JGB; REIT; stock price * Useful comments by Professor Yutaka Kurihara and an anonymous referee are greatly appreciated. The research of this paper is supported financially by Trust Companies Association of Japan.  360 Ito I.   INTRODUCTION The first two REITs (Real Estate Investment Trust) were listed on the TSE (Tokyo Stock Exchange) in Japan on September 10, 2001 1 . Since its launch at the end of March 2003, the TSE REIT Index increased over several years before the sub-prime loan crisis in the US. The announcement by HSBC Holdings on February7, 2007 that its 2006 charges for bad debts from US housing loans would be more than $10.5 billion was a surprise, being 20 % higher than financial analysts had anticipated. The suspicion that subprime loan might be a big problem was disseminated in the financial markets the same day. Figure 1 shows the movement of the TSE REIT Index from March 31, 2003 to January 10, 2013. It can be seen that the Index peaked at 2612.98 on May 31, 2007. After the end of May, it began to decline, reducing further after subsidiaries of BNP Paribas announced on August 9, 2007 that they were suspending liquidations due to the difficulty of obtaining fair values for ABS (Asset Backed Securities) related assets under market pressure. Figure 1 Point TSE REIT Index  Notes: Sample period is from March 31, 2003 to January 10, 2013. After the collapse of Lehman Brothers on September 15, 2008, the REIT Index tumbled amid concerns as for the tightening of fund procurement. It declined to a record low of 704.46 on October 28, 2008. On October 9, 2008 the New City Residence Investment Corporation had filed a petition for protection with the Tokyo District Court under the Corporate Rehabilitation Law because it became difficult to procure funds. This was the first bankruptcy of a REIT listed on the TSE. Pacific Holding, owner of two REIT investment corporations (the Japan Commercial and Japan Residential Investment Corporations), also filed a petition for protection with the Tokyo District Court under the Corporate Rehabilitation Law on March 10, 2009 because of difficulty  procuring funds 2 . The Joint Corporation, owner of the Joint REIT Corporation, filed a similar  petition on May 29, 2009. After this case, the REIT market began to recover gradually  because concerns over the procurement of funds were progressively alleviated. The Great East Japan Earthquake on March11, 2011 cast a shadow over the REIT market,  INTERNATIONAL JOURNAL OF BUSINESS, 18(4), 2013 361  but the gradual recovery continued. After newly elected Prime Minister Sinzo Abe announced anti-deflationary measures in December 2012, the REIT market began to demonstrate an upward trend. The TSE REIT Index increased to 1,110.13 on December 21, 2012, thereby surpassing its closing price of 1,092.29 on March 10, 2011, the day  before the Great East Japan Earthquake. This was partially due to market speculation that the BOJ (Bank of Japan) was about to introduce an inflation targeting policy to  bring the Japanese economy out of deflation 3 . The BOJ therefore decided to introduce a  price stability target under the framework for the conduct of monetary policy on January 22, 2013. This target was set at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) 4 . According to the ARES (Association for Real Estate Securitization) (2012), in  November 2012, the portfolio asset size of the REIT market in Japan, which represents the total acquisition price of REIT-owned properties, reached ¥9 trillion. It had taken 1.4 years for the REIT industry to add ¥1 trillion properties to the portfolio since its size had reached the ¥8 trillion in June 2011. That compares to the 3.3 years it took to increase from ¥7 to ¥8 trillion, indicating an accelerating period of growth. The number of listed investment corporations by the end of 2012 was 37. According to ARES (2013), at the end of 2012, the equity market capitalization of J-REIT stood at ¥4.51 trillion, a rise of 53.4 percent from the previous year end figure of ¥2.94 trillion. This paper focuses on the impact of stock prices and interest rates on the REIT market in Japan. It examines two important issues. Firstly, it looks at the relationship  between the REIT market and stock prices. Investors are supposed to hold REIT and stock as risk assets. Kapopoulos and Siokis (2005) suggest that one of the mechanisms that can be used to interpret the relationship between real estate investment and stock is the wealth effect. Investors making gains in share prices will invest in real estate. Hence, the stock market will lead the real estate market. Ross and Zisler (1991), Ennis and Burik (1991), and Gyourko and Keim (1992) all conclude that returns on REIT are highly correlated with stock market returns. Secondly, the paper also looks at how the REIT market is related to interest rates. The REIT investment corporations procure funding via loans up to a certain Loan to Value (LTV) ratio. They usually set the upper limit of LTV at about 60 % to 70%. Thus a higher interest rates cause a difficulty for fund management by increasing costs. Previous studies have concluded that the returns of real estate and REIT are influenced  by interest rate movements. The results of studies by Chen and Tzang (1988), Chan et al. (1990), Mueller and Pauley (1995), Liang and Webb (1995), Ling and Naranjo (1997) and Brooks and Tsolacos (1999) generally support the idea that interest rates are signficant factor in the REIT pricing. This paper makes three srcinal contributions to the related literature. Firstly, Su et al. (2010) is the only previous study to focus on REITs in Japan, but their sample  period ends before the collapse of Lehman Brothers. This paper covers the period from March 31, 2003 to January 10, 2013, so events such as the collapse of Lehman Brothers and the fiscal crisis of the EU countries are included. Secondly, the entire sample period is divided into two around the point when the TSE REIT index hit a record high at 2612.98 on May 31, 2007. Accordingly, it is possible to investigate the asymmetrical impacts of stock prices and interest rates on the REIT market. Thirdly, this paper uses six types of interest rates in the analysis, namely Japanese Government Bond (JGB)  362 Ito yields and swap rates of 2, 5, and 10 years. As He et al. (2003), Chen and Tzang (1988), and Allen et al. (2000) indicate that the real estate sector uses long-term liabilities as financing sources, it is relevant to compare the impacts of different interest rates on the REIT market. II.   LITERATURE REVIEW So far, very limited analysis has been carried out on the relationship of the REIT market with stock prices and interest rates in Japan. Su et al. (2010) conduct a comparative analysis between Japan and the US. They investigate whether the behavior of REITs is more like that of common stocks or bonds by inspecting the conditional variance of the stock market. They find that the volatility of the stock market on REIT returns has an important impact. The remaining studies in this area focus on REIT markets other than Japan. Chen and Tzang (1988) analyze whether the US REIT market is sensitive to changes in short- and long-term interest rates. They find only the latter are significant over the period from 1973 to 1979, but from 1980 to 1985 the sensitivity to both types of rate change is evident. Chan et al. (1990) conclude that three factors, namely unexpected inflation, changes in the risk and term structures of interest rates and the percentage change in the discount on closed-end stock funds, consistently drive equity REIT returns in the US. Ross and Zisler (1991) indicate that real estate risk lies plausibly midway between that of stocks and bonds, in the 9 to 13 percent range. Ennis and Burik (1991) show that during the last half of the 1980s, the correlation coefficient of US stocks and REITs was 0.79. Gyourko and Keim (1992) indicate that the stock market appears to accurately reflect information about the risks and returns faced by different type of real estate firms. McCue and Kling (1994) indicate that movements in nominal interest rates account for more than 36 percent of the variations found in real estate returns. Muller and Pauley (1995) analyze the movement of REIT price changes during past interest-rate cycles in the US. Their results indicate that REIT price movements have a lower correlation with interest rates and changes in rates than with shifts in the stock market as a whole. Liang and Webb (1995) conclude that mortgage REITs are interest-rate sensitive  because of the nature of their asset portfolios, and point out that levels of sensitivity have changed over time. Ling and Naranjo (1997) identify the growth rate in real per capita consumption, the real Treasury-bill (T-bill) rate, the term structure of interest rates, and unexpected inflation as fundamental drivers or state variables that systematically affect real estate returns. Brooks and Tsolacos (1999) point out that unexpected inflation, and the interest rate term spread, both have explanatory power for the UK property market. Marcus et al. (2000) estimate the sensitivity of REIT returns to stock market and interest rate changes in US. They propose and implement a model for testing whether differences in asset structure, financial leverage, management strategy, and degree of specialization in REIT portfolios are related to their sensitivity to interest rate and market risk. Swanson et al. (2002) investigates several aspects of the relationship between
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