A Study On Systemic Risk Of Real Estate Investment Trust

Since 1960s’market debut in United Sates, REITs (Real Estate Investment Trust) has been launched in 22 countries and regions. Also, another 4 countries are in the process of passing legislation of REITs. Therefore, it has quickly become one of the major financing and investment vehicles.The explosive development of REITs in foreign countries coincided with the sweeping wave of the global financial liberalization. But the seeming perfect and effective financial valuation and theoretical system based on neoliberalism was dealt a deadly blow by the global financial crisis which originated in United States since 2007. Among all lessons to learn, we painfully found out the rapid innovation of financial engineering not only failed to reduce the risk, instead, due to the lack of regulation, the risk was magnified with a unprecedentedly pace.It’s clearly this round of global financial crisis was closely correlated to the deterioration of real estate and financial market. So to a large extent, to evaluate the feasibility of REITs in China, we need to figure out how to measure and control the systemic risk REITs will bring to the whole financial market. It is crucial even for a country like China in which traditional financing still dominates.Because of the strict financial regulation and fragmentation of the economic structure, China was not affected badly by this round of global financial crisis (the same thing occurred in 1997, the Asian financial crisis). But, this low level static stability is at the cost of low efficiency and huge loss of benefits. On the other hand, the financial fragility in China, which is typical among developing countries, could trigger more systemic risk in financial system. Therefore, it’s more important for regulator and management in China to identify and prevent the risk.In this paper, we use historical review, theoretical and empirical analysis to try to explore and identify the nature and law of systemic risk of REITs. And based on that, we introduce the methods to predict and measure the risk, thus provide theoretical knowledge of risk management and preparation for the upcoming creation of REITs market in China. The basic conclusions are as follows:Financial liberalization and financial fragility are essentially tied in the dialectical relationship between each other. That is, on the one hand, financial liberalization is indeed beneficial to avoid financial risks, lower costs, increase money flow, increase profits for financial institutions, further develop the financial role in the market economy, and thus protect the security of financial intermediation and the entire financial system stability. But on the other hand, financial liberalization could exacerbate the negative effects of financial fragility, it has increased the tendency of the vulnerability of the financial system, and this tendency on a global scale, especially in emerging market countries has become increasingly prominent.Subject to the basic "emerging and transitional" national conditions, China’s financial liberalization and financial fragility are logically in the mix, of which the most prominent phenomenon is the financial repression caused by the man-made distortion. Although there is some improvement, but not much progress , so inevitably, in supporting the entity economic development, the Chinese real estate market itself is accumulating more and more significant risk factors.In addition to spread the risks of banks, the most important factor of the creation and development of REITs in Mainland China market is that the root of the accumulation of risk in Chinese real estate financial system is that the Chinese real estate market itself is not solid. It reflects in the rapid rise of the price, but the true defect is the real estate market shortage and structural imbalance caused by the financial repression.Currently, the conditions are ready for China to create REITs market. Based on the experience in foreign countries, the systemic risk of REITs market is lower than that of stock market. At the same time, because REITs use real estate property as collateral, real estate property has value in use and investment and the value change due to economical cycle varies on property type and location, so it has different asset income pattern than other securities. Therefore, REITs can be used by investors to diversify income and risk in their portfolios.But for investors of REITs, it’s easy to draw a wrong conclusion that because the risk in REITs market is mostly credit risk related to the income from real estate investment so the risk can be hedged in the portfolio. It is precisely this wrong impression may lead to excessive capital flows to REITs market and into underlying real estate market which may grow macroeconomic imbalances and quickly accumulate the systemic risk. Therefore, the main focus of this article is on the characteristics, root cause, measurement and monitoring of systemic risk of REITs market.Research methods used in this article focused on: comprehensive use of financial innovation in matured foreign markets, particularly the statistics, experience, lesson to learn of REITs market in these countries; rational use of modern tools and methods in statistical science to explore the rule behind phenomenon; flexible use of existing research results and the theoretical basis, summarize, analyze, improve to reveal the hidden systemic risk in China REITs market and based on it to create a mechanism to monitor and prevent the risk.We expect the time window for setting up experimental REITs market in mainland China is quickly approaching. As we all know, the most important factor in China’s financial industry development is the government regulation and intervention. Therefore, by revealing that the systemic risk of REITs market can be measured, monitored and controlled, and the development of REITs market can actually help reducing the overall systemic risk of China’s financial market, it will help to accelerate China’s development on financial tool to serve the rapid development of the real economy.