Corporate Real Estate Holdings and Firm Returns of Shariah-Compliant Firms

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1 Corporate Real Estate Holdings and Firm Returns of Shariah-Compliant Firms Kola Akinsomi* Ong Seow Eng Muhammad Faishal bin Ibrahim School of Construction Economics and Management The University of the Witwatersrand, South Africa. Department of Real Estate National University of Singapore, Singapore.

2 CORPORATE REAL ESTATE HOLDINGS AND FIRM RETURNS OF SHARIAH-COMPLIANT FIRMS Research Questions: How do quantitative Shariah screenings affect the corporate real estate ownership of Shariah compliant firms? What role does corporate real estate holdings play in stock returns of Shariah compliant firms? Examine how restrictions in finance variables (quantitative screenings) may have an impact on the corporate real estate ownership of firms. Examine the impact of corporate real estate ownership ratios of Shariah compliant firms on risk and firm returns.

3 GROWTH OF ISLAMIC FINANCE As at 2011, Islamic assets reached US$1.3 Trillion (Anjuli Davies, 2012) As at 2012, UK had the highest Islamic asset under management at $US19 Billion outside the Middle East (UKIFS, 2013) The growth of Islamic finance led to the growth in interest for Shariah compliant stocks due to high demand by Islamic investors.

4 DOW JONES ISLAMIC INDEX Shariah Compliant assets must pass through two screenings: Qualitative Screening: - Certain activities are considered non-permissible such as alcohol, tobacco, entertainment, conventional finance services, defense/weapons. Quantitative Screening: - Total debt must not exceed 33% - Cash + interest bearing securities must not exceed 33% - Accounts receivables must not exceed 33%

5 HOW ARE SHARIAH INVESTORS AFFECTED BY QUANTITATIVE SCREENINGS FROM A CORPORATE REAL ESTATE PERSPECTIVE? Quantitative Screenings (Dow Jones Islamic Index) Corporate Real Estate Ownership CREO of Shariah Firms Firm Stock Returns US Shariah Compliant Firms Perspective?

6 LITERATURE REVIEW Role Corporate real estate plays in firm performance: Deng and Gyourko (2000) find there is a negative relationship between the idiosyncratic component of return (alpha) and CREO Sieler et al (2001) investigate CREO of US firms and find an insignificant negative relationship between CREO and systematic risks (beta) and risk adjusted return. Brounen and Eicholtz (2005) in CREO across nine countries and 5 continents and find a significant negative relationship between CREO and firm returns

7 LITERATURE GAP Shariah Quantitative screenings limit the financial restrictions (leverage, cash holdings, account receivables) of Shariah compliant firms. It is not known to what extent the quantitative Shariah screenings may have an effect on the corporate real estate ownership of firms. This study investigates the role Shariah quantitative screening play on corporate real estate ownership and subsequently how this affects firm returns.

8 RESEARCH HYPOTHESES There is a positive relationship (correlation) between leverage and corporate real estate ownership. There is a negative relationship (co-relation) between corporate real estate ratios and cash plus interest-bearing securities. There is a negative relationship between corporate real estate ownership and idiosyncratic component of return. There is a negative relationship between outperformance and high risk firms with high real estate concentration.

9 EMPIRICAL DATA (NEW DATA) Time Period : January 1996 to December Full Sample : Over 1,070 Shariah Compliant Firms from the NYSE, NASDAQ Stock Exchange. Data Source: Dow Jones Islamic Index, Compustat Database, Centre for Research Security Prices. Track Shariah Compliant Companies monthly and yearly.

10 METHODOLOGY Corporate Real Estate Ownership Ratio = Property Plant and Equipment Total Assets Deng and Gyourko (2000), Liow (2004), Brounen and Eicholtz (2005). Property Plant and Equipment is measured in intermittent breaks (3 years) as seen in Brounen and Eicholtz (2005).

11 METHODOLOGY Shariah restrictions and corporate real estate ownership CCCCCCOO ii = ƒ (SSSSSSEE ii, IIIIDD ii, LLLLLLLLLLLLLLEE ii, CCCCCCCCCCCCCCCCCCCCCCTT ii, AAAAAAAAAAAAAA RRRRRRRRRRRRRRRRRRRRSS ii ). Firm Risks and Firm Returns and corporate real estate ownership EEEEEETT iiii = αα ii + ββ ii EEEEEETT iiii + εε iiii ββ ii = ƒ (CCCCCCOO ii, SSSSSSEE ii, IIIIDD ii, PPPPPPPPPPPPPPPPPPPPEE ii ) αα ii = ƒ (CCCCCCOO ii, SSSSSSEE ii, IIIIDD ii, FFFFFFFFFFFFFFAA ii, PPPPPPPPPPPPPPPPPPPPEE ii )

12 SUMMARY STATISTICS (CREO) N CREO Leverage Cash + Interest bearing Account Receivables All Sectors Mining/Oil & Gas Extraction Business Services

13 SUMMARY STATISTICS (LEVERAGE) N CREO Leverage Cash + Interest bearing Account Receivables All Sectors Communications Retail Stores

14 CORRELATION COEFFICIENTS (CREO AND SHARIAH CONSTRAINTS) Return Risk SC Variables Standard Industrial Classification n Correl CREO, α Correl CREO, βe Correl CREO, DR Correl CREO, CR Correl CREO, AR All Sectors ** 0.48*** -0.06*** 0.02 Mining/Oil & Gas Extraction Chemical & Allied Products *** *** -0.16** *** *** All Sectors ** 0.48*** -0.06*** 0.02 Communications *** -0.56*** 0.18 Electric, Gas ***

15 BETA (RISK) AND CREO OF SHARIAH COMPLIANT FIRMS Variables Constant CREO Size Debt Cash Poor Performa nce A. Beta Overall 2.04*** *** *** 0.05 A. Beta Overall 1.85*** *** *** 0.23*** 0.07 CREO>50% 2.00*** *** -0.12* 1.31*** 0.05 CREO>50% 1.81*** *** *** 0.23*** 0.07 Apparel & Accessory Stores Business Services 3.01*** ** Statistical Insignificant relationship between risk and CREO Across industry classifications we observe a positive and insignificant relationship with beta Adj RR 2

16 ALPHA (OUTPERFORMANCE) AND CREO OF SHARIAH COMPLIANT FIRMS Constant CREO Size Debt Cash D.Beta Poor Performan ce B. Alpha Overall B. Alpha Overall CREO >50% ** CREO >50% Communications Electronic and Electrical equipment We observe a flat or zero correlation between CREO and idiosyncratic return of Shariah compliant firms. Results differ form earlier findings as seen in Brounen et al (2005) RR 22

17 IS THERE A RETURN PENALTY IN HIGH CREO & HIGH RISK SHARIAH FIRMS? Variable Model 5 Model 6 CREO Ratio * H Beta CREO Ratio * L Beta RC>50% * H Beta RC>50% * L Beta Log Size Poor Performance Leverage ** Cash Constant RR Deng and Gyourko (2000) find that high risk firms with high concentration of real estate suffer a return penalty Our findings show an insignificant relationship close to zero.

18 ROBUSTNESS TEST Asset betas are employed (Gyourko and Nelling, 1996). ββ AA = DD SS XX PP ββ DD + 11 DD SS XX PP ββ EE In the formula above ββ AA is the asset beta to be estimated, D is total debt (long term debt + short term liabilities), S is common shares outstanding, P is the Share Price,ββ DD is the debt beta of each firm (we assume debt beta of 0.20) and ββ EE is the equity beta of each firm which we estimate from equation 3.

19 ROBUSTNESS TEST (ASSET BETA) Variable Model 5 Model 6 CREO Ratio * H Beta CREO Ratio * L Beta RC>50% * H Beta RC>50% * L Beta Log Size Poor Performance Leverage * Cash Constant RR We find a negative insignificant relationship with high CREO, high risk firms and firm return (alpha). Deng and Gyourko (2000) find a significant relationship.

20 CONCLUSIONS Earlier findings on corporate real estate ownership on general firms show a negative relationship between CREO and firm performance (risk-adjusted returns). Restrictions in Leverage may reduce CREO in Shariah compliant firms and thus significantly reduces the role CREO has on returns of Shariah compliant firms. We find an insignificant negative relationship and a flat relationship between CREO and firm performance of Shariah compliant firms.

21 IMPLICATIONS AND FURTHER RESEARCH The General rule of thumb that corporate real estate ownership decreases return of the firm (Brounen and Eicholtz (2005) may not apply in some cases. Shariah compliant firms are one of such firms, results indicate that the sector in which a firm is active can skew the results of a significant relationship between CREO and firm returns. There is the need for this study to determine if a causal effect exists between the quantitative screenings of Shariah compliant firms and corporate real estate ownership.

22 THANKS! Comments and Recommendations are Welcome!