Residential property market performance and extreme risk measures

Abstract

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.

Assessment of Residential Real Estate Investment Performance in Lafia Metropolis, Nigeria

“…Finally, the risk-adjust return performance of investment is measured using the modified Sharpe ratio. Higgins (2017) noted that residential real estate investment has become an attractive investment asset among Australian private investors owing to its uniqueness; RE is a good source of debt financing, provides tax advantage and commanding attractive return on investment. However, the author questioned the traditional technique for measuring risk which may not fully reflect extreme downside volatility of returns.…”