Comparative Analysis of the Relationship between Inflation and Indirect Real Estate Investments in Nigeria

Comparative Analysis of the Relationship between Inflation and Indirect Real Estate Investments in Nigeria

Chapter one/ Introduction

Background to the Study

The impact of inflation on investment returns of various asset classes have remained a primary challenge  to investors  in  both developed and developing economies. Previous studies have shown that during periods of inflation, some investment assets were observed to underperform, some  co-moved at  the  same rate  with inflation,  others outperformed specified benchmarks, while others provided negative return values (Arnason and Persson, 2012; Akpan and Ogunba, 2015; Dabara, Tinufa, Soladoye, Ebenezer and Omotehinshe, 2018).  Analysis  of specific  investment assets  in  respect of  their  response  to inflation becomes very important to help investors in making informed investment decisions.


This is because a wrong investment decision in an inflationary environment could lead to the erosion of the value of investors’ corporate earnings and devaluing of the purchasing power of  investors’  funds  (Bello,  2004;  Park  and  Bang,  2012).  Furthermore,  such  analysis becomes more imperative for specifically real estate investments because of their dynamic nature  and  localization  of  property  market  characteristics  across  divers  geographical locations.


The major theory underpinning the impact of inflation on investment returns is the Fama and Schwert (1977) theory on inflation hedging. The debate on inflation and investment returns pioneered by Fama and Schwert (1977) have produced an extensive literature (most of which is based on investment performance of asset classes in developed economies, creating a gap for studies from developing economies). Studies that made up such  literature includes  investigations  of the  inflation hedging  characteristics of  asset classes such as: investments in real estate, REITs (Real Estate Investment Trusts), gold, stocks, commodities, bonds, antiques, equities, and shares among others (Dabara,  Ogunba and Araloyin, 2015). The results of these studies have shown a varying pattern, indicating that there is no consensus on the hedging characteristics of various asset classes in different parts of the world.   An asset is said to be a hedge against inflation if it provides certain degree of immunization (protection) against a rise in the general level of prices of goods and services in an economy (inflation)  over  a period  of  time  (Arnasosn &  Persson,  2012).  The  inflation-hedging characteristics of real estate markets all over the world are of special interest to individual, institutional or portfolio investors because investors who do not give careful consideration to the inflation hedging characteristics of their investments risk  inflation eroding their investments’ real income streams.


Inflation hedging studies in  emerging countries are of increasing interest to investors and researchers because of the globalization of investment practices and  the fact that emerging markets  are characterized by a highly speculative nature, economic instability, and lack of liberalization/integration into global real estate markets as well as dearth of literature in this field. Nigeria is presented in this paper as a case study of an African emerging country where the property market is opaque with a high degree of property market immaturity and dearth of literature on hedging capabilities of indirect  investments  in  real  estate  (REITs  and  non  REITs  real  estate  equities)  for prospective investors’ consideration.


In the real estate sector, investors have the option of investing in either direct or indirect real estate investment assets (Blau, Nguyen and Whitby, 2015; Ankeli, Dabara, Oyediran, Guyimu  and  Oladimeji,  2015).  Investments  in  direct  real  estate  assets  implies  the acquisition and management of physical properties such as  residential and commercial buildings among others (Lee and Ting, 2009). Investments in indirect real estate on the other hand, denotes investing in a product whose performance is based on some measure of property performance; this includes buying shares or equities in a publicly quoted real estate company such as REITs or non REITs listed property companies (Kim, 2009, Li and Chow, 2015).  Dabara (2015) asserted that ‘one of the reasons for investors’ preference for real  estate  investment  is  its  seeming  ability  to  protect  the  purchasing  power  of  the  investor’s investment funds’. This has made investments in specifically indirect real estate assets such as Real Estate Investment Trusts (REITs) and other real estate equities gain global attention in recent times. Unlike investments in direct real estate assets which were observed to be hampered by its need for huge capital outlay and maintenance cost; the indirect form of investment in real estate was rather seen to be characterized by a more flexible  financial  requirement  which  accommodates  different  categories  of  investors irrespective of  their financial  capabilities. Furthermore,  it was observed  to have  been providing an  encouraging investment  performance that  makes them  very attractive  to investors (Devos, Ong and Speiler, 2016). The Nigerian listed property market is made up of both  REITs and non REITs listed  properties. In Nigeria  currently, there  exist three REITs companies  namely: Skye shelter  fund REITs, Union  Homes REITs and UPDC REITs. Similarly there is only one listed non REITs property company which is the UACN Property  Development  Company.  These  companies  are  listed  on  the  Nigerian  Stock Exchange (NSE) with a combined market capitalization of about ₦72,050,847,955 which is equivalent to $234,693,316 (Dabara, et al. 2018).


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