Systematic risk factors in European real estate equities

Purpose - The purpose of this paper is to investigate the pricing of European real estate equities. The study examines the main drivers of real estate equity returns and determines whether loadings on systematic risk factors - the excess market return, small minus big (SMB), HIGHminus low (HML) can explain cross-sectional return differences in unconditional aswell as in conditional asset pricing tests. Design/methodology/approach - The paper draws upon time-series regressions to investigate determinants of real estate equity returns. Rolling Fama-French regressions are applied to estimate time-varying loadings on systematic risk factors. Unconditional as well as conditional monthly Fama-MacBeth regressions are employed to explain cross-sectional return variations. Findings - Systematic risk factors are important drivers of European real estate equity returns. Returns are positively related to the excess market return and to a value factor. A size factor impacts predominantly negatively on real estate returns. The results indicate increasing market integration after the introduction of the Euro. Loadings on systematic risk factors have weak explanatory power in unconditional cross-section regressions but can explain returns in a conditional framework. Beta and to a lesser extent the loading on HML - is positively related to returns in up-markets and negatively in down markets. Equities which load positively on SMB outperform in down markets. Research limitations/implications - The implementation of a liquidity or a momentum factor could provide further evidence on the pricing of European real estate equities. Practical implications - The findings could help investors to manage the risk exposure more effectively. Investors should furthermore be able to estimate their cost of equity more precisely and might better be able to pick stocks for time varying investment strategies. Originality/value - This is the first paper to examine the pricing of real estate equity returns in a pan-European setting.