Investing in Property Stocks 101

Introduction
To date, Nerd Ball Ko has read various titles by prominent investors like Benjamin Graham (Security Analysis: Classic 1940 Edition, The Intelligent Investor), Philip Fischer (Common Stocks and Uncommon Profits), Seth Klarman (Margin of Safety), Peter Lynch (One Up Wall Street), George Soros (The Soros Lectures), Joel Greenblatt (The Little Book that Beats the Market). Nerd Ball Ko is a big fan of the logical thinking, the constant reminders for caution and conservativeness and the down-to-earth attitudes of these investing giants.

Nerd Ball Ko was lucky to be granted a sum of money to be used at his disposal for the purposes of growing it. If he attains any measure of success in his little venture at all, then all credit should go to his mother, for she gives him enough so that he will feel like he can do anything, but not so much that he will feel like doing nothing. He started out as a total beginner, lacking his own informed opinion and easily swayed by that of others. Along the way, he has learned many lessons, some of them learned the hard way. He would like to think after a few years in the game he has become less of a lamb to the slaughter, and more of the alpha male of a wolf pack. But sometimes, his line between reality and delusion becomes blurred.

To further his knowledge in the subject matter, he decided to do a dissertation (or FYP or thesis or whatever you like to call it) topic regarding the stock market. Specifically, he will study the property companies listed on the Singapore and Hong Kong stock exchanges. The reasons for choosing these two countries are elaborated further later.

Background
Traditionally, four major asset classes are identified in the core of the investment universe for portfolio planning: cash, stocks, bonds and real estate. Real estate plays a crucial role in offering investors diversification benefits, steady capital appreciation and protection against inflation. However, investing in direct real estate, i.e. physical land or buildings, is expensive and beyond the reach of the average investor. Furthermore, because of the private nature of real estate transactions, direct real estate is criticized for its illiquidity.

Property securitization, i.e. splitting the property holdings into publicly traded shares, offers a number of attractive investment benefits, chief of which includes improved tradeability, exposure to high quality assets and diversification risk in terms of geographical spread and property type. In the stock market, such investment vehicles include the shares of property companies or Real Estate Investment Trusts (REITs).

The Problem
From the valuation perspective, the worth of a property company is based on its Net Asset Value (NAV). It represents the underlying value of the company’s assets, after adjusting for liabilities and other claims on the company. Fundamentally, property company share prices should be equal to their underlying real estate values. This is because these shares are essentially claims on assets. In a perfect market, the share price should be equal to the NAV per share, but more often than not, they differ. This is because shares are valued in the stock market whereas properties are appraised in the property market.

If the company’s share price is trading at a discount to NAV, this represents a profitable arbitrage opportunity. The theory follows that investors will capitalize on the market mis-pricing and bring prices back to equilibrium. In reality however, share prices can deviate from NAV persistently, and also by a wide margin.

Indeed, one of the most vexing issues for analysts and managers of property companies has been the existence and persistence of NAV discounts of property companies. It is regarded as an important unsolved puzzle undermining theories of market efficiency and the Law of One Price.

The Research Sample
Nerd Ball Ko chose the Singapore and Hong Kong for his research because these two countries are geographically close and culturally similar. They are also land scarce, so their governments have adopted a judicious land planning approach. The importance of real estate to the proper functioning of their economies is reflected in the astronomical real estate values. Furthermore, Singapore and Hong Kong are touted as the gateway to the growing markets of South-east Asia and China respectively, so their markets will continue to grow in prominence. Already, some of the biggest property companies in the region are listed on their stock exchanges. An understanding of what the NAV discount behaviour is like will undoubtedly be useful to institutional investors with interests in property stocks in these two countries.

Nerd Ball Ko chose the study period from 2000 to 2010 because it covers the boom and bust phases in a property cycle, so potential biasness as a result of choosing a specific time period is diminished.

What’s Next?
In the next post Nerd Ball Ko will discuss the findings of his dissertation, as well as elucidate three key investment ideas. In the meantime, he'll leave you with this sweet heart-warming note. It was soothing cream for his scarred heart.. rejuvenating balm for his soul! She has began to heal hearts even before starting on her job proper!

 Thank you dear 'fan'!