Real estate investment indices in Japan and their role in optimal international portfolio allocation

Abstract

It has been said that "home bias" exists among investors due to informational disadvantage involved in cross-border investment. But, real estate has become a major asset class and cross-border real estate investment has been surging. Behind this phenomenon is heightened awareness among investors of the modem portfolio theory and the benefits of diversification. Japan is not an exception. Since late 1990's, a large amount of capital has flowed into Japanese real estate markets. The markets have also experienced significant transformation. However, in the eyes of foreign investors they are far from transparent due to, among other things, lack of reliable investment indices of commercial real estate. Such indices cannot be generated overnight, and lack of such indices can be a critical issue for global real estate investors. This issue is contributing to under-investment in Japan's real estate from overseas. Facing this problem, researchers and industry practitioners launched a number of investment indices for private real estate in recent years, each of which has strong and weak points. Compared to other indices, the ARES J-REIT Property Index seems potentially the most reliable and promising index for Japanese commercial real estate.

(cont.) The purposes of this paper is to analyze and compare various investment indices for Japanese private real estate; to understand distortions i.e. the "lagging" and "smoothing" effects involved in appraisal-based investment indices to see the "true" pictures of private real estate returns; and then to apply such indices to an international portfolio analysis to see the relative position of Japan's private real estate as a global asset class. Simulations are used to understand the mechanism of appraisal-based investment indices. Introductory sections provide some background on globalization of real estate and issues with Japanese real estate markets.