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).