ASSESSMENT OF THE INFLATION HEDGING CHARACTERISTICS OF REAL ESTATE INVESTMENT (A CASE STUDY OF LAGOS AND ABUJA)

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

At a moment when the focus is on investment returns, analyzing the success of real estate investments is important for both commercial and residential properties. According to Mughees (2010), real estate is described as “land and improvements associated with it,” and Alabi, Okunola, Dabara, and Odewande (2012), real estate can be divided into the following core groups: residential, commercial, manufacturing, recreational, social, and agricultural. Real estate plays an important role in representing a society’s social, economic, and political circumstances, which provides a compelling opportunity for astute investors looking to build and maintain wealth through sound investments. Not only does the sector offer multiple long-term investing opportunities, such as healthy dividend yields, diversification, and inflation protection, but it also provides structural considerations including improving the overall investment portfolio’s risk/return characteristics (Thambiah & Foscari, 2011; Fiorilla & Halle, 2011; Dabara, 2015). Real estate investments can be made either directly or indirectly. The purchase and operation of physical assets was referred to as direct real estate acquisitions. This entails the acquisition of freehold or leasehold real estate rights (Holland, 2016). Indirect real estate ownership, on the other hand, involves purchasing shares or bonds of a publicly traded real estate business whose success is dependent on some measure of property efficiency (Glascock, 2011). One of the reasons for investors’ preference for real estate acquisitions, according to Dabara (2015), is the apparent desire to maintain the buying power of their investment funds. This is due to the fact that many investment asset classes lose purchasing power during periods of inflation, i.e., decrease in value as inflation rises (Jack, Micheal, & James, 1989; Odu, 2011; Dabara, 2014), necessitating the need for both individual and institutional investors to first determine an asset class’s inflation-hedging potential before committing their hard earned money. Inflation is defined as the rate of rise in prices over a specified time span (Oner, 2010).

Person and portfolio investors are particularly interested in the inflation-hedging characteristics of real estate investments around the world, since investors who do not carefully understand the inflation-hedging characteristics of their investments risk inflation eroding their investments’ real income streams. Because of the globalization of investment activities and the fact that emerging markets are marked by a highly speculative existence, economic uncertainty, and a paucity of literature, inflation hedging studies in emerging countries are becoming increasingly popular among investors and researchers.

In layman’s terms, inflation is described as “too much money chasing too few goods,” resulting in a rise in commodity prices. Investors are concerned about the inflation dilemma in relation to an investment asset’s hedging capabilities. This is how an asset class’s ability to hedge against inflation protects the assets of investors. In accordance with the preceding, an asset is said to be a buffer if it offers a degree of immunization (protection) against an increase in the general level of prices of goods and services in an economy (inflation) over time (Bodie 1976; Fama & Schwert 1977; Zhe, 2010). It is important that the inflation-hedging issue in different asset classes (whether real or financial assets) be thoroughly investigated and evaluated, with the findings made available to both domestic and international investors for investment decision-making. It should be noted, however, that the model(s) used in such research are critical in order to avoid misleading investors. Fama and Schwert’s (1977) regression model is, in general, the earliest and most commonly used model for evaluating the inflation hedging characteristics of an asset class around the world. Their strategy boils down to putting the Fisher theory to the test empirically. Fisher (1930) asserted that an asset’s expected nominal return is equal to its expected real return plus the expected rate of inflation in his popular and groundbreaking research work “Theory of Interest Rates.” Fama and Schwert (1977) adopted and updated this hypothesis in their study “Asset Returns and Inflation,” which later became the statistical basis for subsequent research on the relationship between asset returns and inflation. However, more recent research, such as Dabara (2014), have shown that the Fama & Schwert’ model was used without first doing a stationarity test, which the author believes could lead to the use of erroneous regression findings in analysis of variance of such data. To prevent using invalid regression effects, it was proposed that an initial stationarity test be performed on data series used in such experiments. Co-integration models were also found to be more suitable for evaluating the inflation-hedging abilities of asset returns for non-stationary data series (Mei-ling, 2013). In both developed and emerging economies, a large body of literature examines the inflation hedging ability of different asset groups. Direct real estate acquisitions, assets, currencies, equities, shares, real estate investment trusts (REITs), gold, and other transactions are all investigated (Oluwasegun & Dabara, 2013).

These studies were carried out in the bid to address the inflation-hedging issue of the different asset groups. i.e. to see whether the asset class in question works well as an inflation hedge or not. Intuitively, real estate has been thought to be a strong inflation shield all around the world (Peyton, 2011a). Various researches of both developed and emerging countries have been conducted to support or contradict this idea. In industrialized economies such as the United States (e.g., Fama & Schwert, 1977; Peyton, 2011) and emerging economies such as Nigeria (e.g., Bello, 2015; Ogunba Obiyomi & Dugeri, 2013), both residential and commercial real estate performed well as inflation-hedging assets. Similarly, real estate was seen as a good hedge in Austrialia (Leung, 2010) and Korea (Park & Bangs, 2012). However, in China, real estate was found not to provide inflation hedge (Zhou & Clements, 2010), this is congruent with the findings of Arnason & Parsson (2012) in Sweden. In the study conducted by Odu (2011), real estate was found to provide a perverse hedge in Lagos, Nigeria. The results obtained from these studies were observed to be inconsistent. Specifically, the findings on the inflation hedging question of real estate presented divergent findings, while some studies showed that real estate performed excellently as a hedge against inflation, others showed that it does not, in fact in some studies, it even showed that it serves as a perverse hedge against inflation (Dabara, 2014). The hedging potential of real estate across inflation components (actual, expected and unexpected) also differs considerably (Oluwasegun & Dabara, 2013). Odu (2011) asserted that this disparity can be attributed to various factors including ‘varying timeframes, fluctuating economic conditions, and differences in microeconomic and macroeconomic indicators among other things’. The non consensus with respect to real estate’ inflation hedging question poses great concern to real estate investors. It generates the question of whether real estate investments actually possess inflation hedging capabilities. Similarly, should an investor put real estate alongside other relative or alternative investment media, can real estate perform better? In an effort to address their concerns, investors and researchers all over the world are re-examining the capacity of various real estate types to offer inflation hedge, should inflation become problematic. This research efforts is justifiably linked to the fact that all over the world inflation is among the worst nightmares bedevilling investors (Amenc, Martellinil, & Ziemann, 2009; Thambiah & Foscari, 2011). This is because inflation has the capability to erode the value of corporate earnings and devalue the purchasing power of investors (Peyton, 2011b). It is in the light of the forgoing that this study aims at investigating real estate investments in relation to its inflation hedging question with a view to providing information that will guide investors in making their decisions.

1.2 STATEMENT OF THE PROBLEM

Inflation today, is a terrible phenomenon which most investors have been battling with and its risk on real estate investments cannot just be wished away. The inflation-hedging characteristics of real estate investments all over the world are of special interest to individual or portfolio investors in order to avoid the risk of inflation eroding investments’ real income streams.

In an emerging economy like Nigeria that is characterized by speculation and economic instability, the risk of inflation rate has become an issue to real estate investors, in that, the risk of inflation rate is capable of depreciating or eroding real estate income flows thereby lead to loss of investment (Odu, 2011; Dabara, 2014; Umeh & Oluwasore, 2015). Property asset contained inflationary protecting characteristics as it provides refuge against the risk of inflation from eroding the value of real estate returns (Case 2012; Umeh & Oluwasore, 2015). House price return measures turnover on housing investment, and it exposed to risk of inflation (Odu, 2011), and the study also clearly stated that risk of inflation is far higher than return on real estate investment. Furthermore, Peyton (2011) is of view that risk of inflation erodes the value of corporate investment earnings and batters consumers’ purchasing power in an emerging economy. Traditionally, property asset provide an hedge against dearth of inflation but the menace of economic recession which recently bedeviled Nigeria economy has therefore made the complete hedging capacity of real estate to be doubted due economic volatility and instability created by 2016 economic recession. It is on this basis the study emerges to examine the extent to which house price return has been partially, completely or perversely hedged against inflation in the Nigerian economy. The study focused on Abuja property market, in that, Abuja serves as the first heating-point of economic policy and due to its high quality of housing infrastructure, the city has been considered best in the quality of housing investment in Nigeria (Belo & Agbatekwe, 2012).

1.3 OBJECTIVES OF THE STUDY

The general objective of the study is to assess the inflation hedging characteristics of real estate investment. The specific objectives of this study include the following:

1. To assess Inflation Hedging performance of residential property and commercial property investment
2. To examine factors that drive property investment decisions in residential property and commercial property investment
3. To ascertain the returns from both residential and commercial properties in Lagos and Abuja
4. To investigate the inflation-hedging characteristics of properties relative to other inflation-hedging asset classes.
5.  To assess the investment implications of property investment in an inflationary environment.

1.4 RESEARCH QUESTION

1. What is Inflation Hedging performance of residential property and commercial property investment?
2. What are the factors that drive property investment decisions in residential property and commercial property investment?
3. What are the returns from both residential and commercial properties in Lagos?
4. What are the inflation-hedging characteristics of properties relative to other inflation-hedging asset classes?
5.  What are the investment implications of property investment in an inflationary environment?

1.5 RESEARCH HYPOTHESIS

Hypothesis 1

H1: There is no significant effect of inflation hedging performance on residential property and commercial property investment.

H0: There is a significant effect of inflation hedging performance on residential property and commercial property investment.

Hypothesis 2

HO: There is no significant relationship between inflation hedging characteristics and real estate investment of residential and commercial property

H1: There is a significant relationship between inflation hedging characteristics and real estate investment of residential and commercial property

1.6 SIGNIFICANCE OF THE STUDY

The findings of this study shall guide the investment decision of a prospective investor in any given location. Therefore, a study of this nature has great significant implications for both local and foreign investors (individual and institutional) desiring to invest in the Nigerian property market. The results of the study can be useful for investment forecasts as well as investment decisions on the asset types to include in portfolios as a measure for protecting the value of investors’ earnings from erosion by inflation. The result will also be a good and updated reference for academics and researchers in studying the Nigerian property market.

1.7 SCOPE OF THE STUDY

The title of this work clearly indicates the area of study. The issues that will be examined here is the assessment of the inflation hedging characteristics of real estate investment, a case study of commercial and residential properties in Lagos and Abuja.

1.8 LIMITATION OF THE STUDY

The limitation of time and other resources on the part of the researcher make it impossible to embark on a comparative study of similar organization at the same time. But it is true that the study will serve as a representative sample of similar researcher institution whose industries finding will generally accepted.

1.9 DEFINITION OF TERMS

Inflation: Inflation is the decline of purchasing power of a given currency over time. Inflation is a sustained increase in the general price level in an economy. Inflation means an increase in the cost of living as the price of goods and services rise.

Real Estate: Real estate refers broadly to the property, land, buildings, and air rights that are above land, and the underground rights below it.

Real Estate Investment: Investment real estate is real estate that generates income or is otherwise intended for investment purposes rather than as a primary residence. It is common for investors to own multiple pieces of real estate, one of which serves as a primary residence while the others are used to generate rental income and profits through price appreciation. 

Investment: An investment is an asset or item acquired with the goal of generating income or appreciation. An investment can refer to any mechanism used for generating future income, including bonds, stocks, real estate property, or a business, among other examples

Hedge: A hedge is an investment that protects your finances from a risky situation. Hedging is done to minimize or offset the chance that your assets will lose value. These are financial contracts that derive their value from an underlying real asset, such as a stock.